Thursday, August 28, 2014

Do bank regulators really believe ordinary bankers to be so stupid, or are they really so stupid themselves?

As in Basel II, do bank regulators believe ordinary bankers to be so blind and dumb, so they need to require them to hold 5 times as much capital when they lend to someone they know has a BBB+ to a BB- rating, or no rating at all, than when they lend to someone they know has an AAA to AA rating? Do they not know this will distort the allocation of bank credit to the real economy? Do they not know this means those with BBB+ to BB- ratings, or no ratings at all, will get much too little bank credit?

Or, as in Basel II, are bank regulators so dumb so as to believe ordinary bankers when they argue they should need only to hold a fifth of capital when lending to someone who has an AAA to AA rating, than what they are required to hold when lending to someone with a BBB+ to BB- rating, or no rating at all? Do they not know this will distort the allocation of bank credit to the real economy? Do they not know this will mean those with AAA to AA ratings will get much too much bank credit?

Sunday, August 24, 2014

An urgent message to those holed up in Jackson Hole. Stop profiling risk! Our economies need regulatory neutrality.

Forget risk-weights and apply exclusively your leverage ratio capital requirement for all exposures that represent for instance less than a 1000nd of a bank’s balance sheet. 

There is no reason on earth why a bank should find it harder to lend a small amount to a medium or a small business, an entrepreneur or a start-up, than a huge amount to an infallible sovereign or to a member of the AAAristocracy.

Please, on our knees, we beg you… Stop profiling risk! That is an odious discrimination that impedes banks allocating credit efficiently. We need regulatory neutrality. 

PS. And all you reporters there... dare to ask The Question!


Friday, August 22, 2014

Bank regulators hate me when I ask this simple question. They refuse to answer it. They can’t! That’s the real problem!

The Question: Sir, current risk weighted capital requirements for banks are based on the perceptions of risk by credit rating agencies and bankers. But if bankers and credit rating agencies perceive the risks correctly there should be no major problems. So why are not the capital requirements for banks based instead on the credit risks not being correctly perceived by bankers and credit agencies?

As is, the perceived risks are now, besides being cleared for in the interest rate charged by the banks and in the amount of exposure accepted,also cleared, for a second time, in the required bank capital (equity). And that has created the distortions that make the banks lend dangerously much to what is perceived as “absolutely safe”, and dangerously little to what is perceived as “risky”, like to medium and small businesses, entrepreneurs and start ups.

As is, the risk with risk weighted capital requirements for banks is much greater than the risks which are being weighted! Got it?

I suspect the whole mess results from the fact that when regulators were given an explanation similar to that which appears in “The Basel Committee on Banking Supervision´sExplanatory Note on the Basel II IRB Risk Weight Functions of July 2005”… they did not understand one iota of it, but did not want to admit that in front of their equally befuddled colleagues. In other words, could it be the weak egos of expert bank regulators which provoked this financial crisis.

A subsequent problem is of course that too few are capable of daring to think that globally renowned experts can be so utterly wrong… and so they do not dare to help me to ask The Question.

Friends, we have to put a stop to the lack of accountability of those working in Committees which decisions have global implications. Can you imagine what could happen to the earth if similar weak egos are placed in charge of a Global Warming Supervision Committee in Basel?

Thursday, August 21, 2014

US Congress, you are the legislators, so who of you ordered the banks in the home of the brave to become risk adverse?

Fact: Banks give larger loans, charging lower interest rates and allowing for leaner terms to those perceived as absolutely safe, than when lending to those perceived as risky. And that so much, that your Mark Twain described bankers as those who lend you the umbrella when the sun shines but want it bad as soon as it seems it might rain.

Fact: Your regulators now allow banks to hold much less capital for what from a credit risk perspective is perceived as “absolutely safe” than against what is perceived as “risky”.

Fact: And that means banks can leverage their equity much more when lending to those perceived as “absolutely safe” than when lending to those perceived as “risky”.

Fact: And that means banks will earn much higher expected risk adjusted returns on their equity when lending to those perceived as “absolutely safe” than when lending to those perceived as “risky”.

Fact: And that means banks will lend almost exclusively to those perceived as “absolutely safe”, and basically nothing at all to those perceived as “risky”.

Fact: And that seems as far away as can be for the home of the brave which became a great land of the free primarily because of risk-takers… as few risk adverse crossed the ocean to reach its coasts.

And so the question: Who of you US legislators ordered the banks in the home of the brave to become even more risk adverse than what Mark Twain held these to be?

And legislators, if you are somewhat confused by these comments, may I suggest you invite your bank regulators to an open hearing to explain their main scripture, “The Basel Committee on Banking Supervision´s Explanatory Note on the Basel II IRB Risk Weight Functions of July 2005” to you. 

But then you might really going to be scared.

Thursday, August 14, 2014

No more champagne, only milk, and which sooner or later could turn sour or even dangerously spoiled

Perceived credit risks are similar to those risks described by Hans Karl Emil von Mangoldt in his 1855 example about the risks that a bottle of champagne bursts, and referred to by Frank H. Knight in his 1921 “Risk, uncertainty and profit”. 

In essence it all boils down to that those risks do not alter the results, the profits, because they can be accounted and provisioned for.

And yet, our too creative and I would say too loony bank regulators decided that if a bank was going to produce champagne using “risky” bottles, it needed to hold much more capital (equity), than if it was going to produce milk using safer milk bottles.

No wonder we now find less and less of the exciting champagne in our economies.

But “we have at least milk” you say? Not so, there are risks with binging on milk too.

Our bank crises have never ever resulted from banks drinking too much risky champagne, these have always resulted from drinking too much of what ex ante was considered as very safe milk, but that ex post turned out to be quite soured milk... or even dangerously spoiled milk.

Tuesday, August 12, 2014

The Basel Committee’s and the Financial Stability Board’s Credo

We believe that banks should give larger loans, on lower interest rates and on softer terms than usual, to those who are ex ante perceived as “absolutely safe”, like the infallible sovereigns and the AAA-ristocracy; and that they should give smaller loans, at higher interest rates and on harsher terms than usual, to those who are ex ante perceived as risky, like medium and small businesses, entrepreneurs and start-ups… so that we can go home and sleep calmly.

Since that could expose us to accusations of being discriminatory, we believe that the risk-weighted capital requirements for banks, by which we allow banks to earn higher risk-adjusted returns on equity when lending to the “absolutely safe” than when lending to “the risky”, is the least transparent and therefore the most effective regulatory pillar by which we can reach our objectives.

And, to those who might criticize us we say… we believe it is not our role to guarantee an efficient allocation of bank credit so that the economy grows sturdy and stays healthy… that is definitely somebody else’s business.

Monday, August 11, 2014

Europe beware, you´ve got yourself a very sad bunch of systemic risk experts reviewing the systemic risks of your banking system.

In the so posh sounding European Systemic Risk Board’s Advisory Scientific Committee´s report titled “Is Europe overbanked?” dated June 2014, we read:

“Large banks were able to increase their leverage - and therefore their return on equity (unadjusted for risk) – while complying with risk-based regulatory ratios”

And that is not correct... the lower risk weights in the risk-weighted capital requirements for banks, translates into allowing banks to hold much less capital against assets perceived as “absolutely safe”, which signifies that banks can leverage their equity much more with assets perceived as “absolutely safe”, and therefore earn much higher expected RISK-ADJUSTED returns on equity when lending to “The Infallible” than when lending to “The Risky.”

And this has made a true mockery of the report´s: “Financial development can also foster growth by allocating capital more efficiently, channeling resources to better projects and thus boosting total productivity”

Current risk weighted capital requirements signify that resources will be transferred in function of ex-ante perceived credit risks, which has of course not one iota to do with guaranteeing the transfer of these resources to better projects that can boost total productivity.

And in this respect, as I have been arguing for more than a decade, the risk weighted capital requirements represents the largest possible systemic risk to our banks and to our economies... as it basically prohibits much of the risk-taking necessary for our economies to move forward and for our descendants to have a future. 

As an example January 2003 in a letter published by FT I wrote “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds. Friend, please consider that the world is tough enough as it is.”

And yet, now soon 7 years after the crisis broke out, that systemic risk has not even been identified by those who allow themselves to be called experts in systemic risk. How come?

The report refers to “some reason, such as badly designed prudential regulation” in order to get to “banks’ rapid expansion into loans secured against residential real estate”

And yet the report does not mention the truly bad design of the prudential regulations that resulted from assigning very low risk weights against loans secured against residential real estate… which meant that banks could leverage much more their equity when giving loans secured against residential rate… which of course meant that banks would earn much higher than normal relative risk adjusted returns on equity on loans secured against residential real estate… which of course led to an explosion of bank loans secured against residential real estate.

And the report asks “Why has overbanking occurred?” and advances the explanation of “deposit insurance schemes may themselves generate moral hazard. Capital requirements can often be circumvented by banks, especially the largest ones, which have greater capacity to engage in risk-weight manipulation”

Circumvented? Hell no! The regulators allowed banks to hold only 1.6 percent in capital against securities rated AAA which meant authorizing a mindboggling leverage of 62.5 to 1… does as a bank really need to circumvent that? No! What they might need though, is to find some AAA ratings issued by the friendly and human fallible credit rating agencies. 

And let us not even go to the area of bank lending to the “Infallible Sovereigns” where no equity is required and the sky is the limit for bank leverage. In November 2004 FT published a letter in which I asked “How many Basel propositions will it take before they start realizing the damage they are doing by favoring so much bank lending to the public sector (sovereigns)?”

And so I must conclude in a: “Europe, beware, you´ve got yourself a very sad bunch of systemic risk experts reviewing the systemic risks of your banking system”

Am I to harsh in my criticism? Absolutely! If this was the first time I criticized. But, considering I have been asking the regulators my questions for more than a decade, all over the web and in hundreds of conferences, and they have never ever dared to give me a straight answer (with one incredible exception) and much less have dared debate me on these issues… I do not feel I am too harsh or too impolite in any way shape or form. 

On the contrary, I feel it is my responsibility to shame them in all the ways I can, so that no regulator dares to act ever again with so much hubris, believing he can be the risk manager for the world.

To finalize… may I kindly suggest these systemic risk experts that their so impressive list of 130 documents referenced does not include the most basic and important document required to understand the mumbo jumbo of financial regulators namely the Basel Committee on Banking Supervision´s Explanatory Note on the Basel II IRB Risk WeightFunctions of July 2005. That this document, has clearly not been reviewed by those preparing the report, is by itself something impossible to understand, unless of course they want to avoid shaming some members in a mutual admiration club.

Friday, August 8, 2014

Does really a bank´s "living will" make much sense?

Living wills: “Detailed plans that would enable banks to stipulate in advance how they would raise funds in a crisis and how their operations could be dismantled after a collapse”.

The whole concept of living wills for banks’ designed by the bankers themselves, for how to handle a collapse, seems to me a bit of a show by regulators to show they are doing something and to have something to put the blame on tomorrow…. “They gave us a bad living will” 

I mean if I was a regulator, and wanted to go down that route, I would at least have a third party to look into what could be done in the case a bank passed away, and now and again confront the managers of the bank with those plans, in order to hear their opinions.

For instance there is a world of difference between a living will where the dead are going to be the own executors of the will, and one in which the dead will be dead and others will take care of the embalming.

And talking about this should not the Fed or the FDIC first state what contingent plan they really want… one where the bank is placed on artificial survival mode, and for how long, or one where it is sold in one piece, by pieces or even cremated?

To me it would seem that the Fed and FDIC need to give much clearer instructions about what they want those bankers who are currently working under the premise the bank will live on forever to do… as I can very much understand bankers being currently utterly confused.

PS. And, to top it up, regulators should worry more about how banks live than about how they die. Thanks in much to the distortions created by the regulators with their risk-based capital requirements, the banks are not allocating credit efficiently and their legacy is therefore condemned to be poor. And… excuse me, that´s a far more serious problem.

Thursday, July 24, 2014

Great expert bank regulators of Europe, why do you believe in this regulatory nonsense?

Banks are now required to hold much much more capital when lending to SMEs than when financing houses; and so banks, because of a much much higher leverage, earn much higher risk-adjusted returns on equity when financing houses than when financing those who could create the next generation of jobs our young needs. 

What do you mean, are we all going to sit in or houses playing with our I-pads without jobs? 

Banks are now required to hold much much more capital when lending to citizens than when lending to the supposedly “infallible sovereigns”; and so banks, because of much much higher leverage, earn much much higher risk adjusted returns on equity when lending to governments than when lending to citizens.

What do you mean, what kind of back-door communism is this?

Do you really think you are making the world a safer and better place with this nonsense? Don’t you all see you are bloody killing the economy of Europe with this dumb risk aversion? Don't you see you are with no right whatsoever closing the horizons of our young?

John Augustus Shedd, 1850-1926 said: “A ship in harbor is safe, but that is not what ships are for.”... And that goes for banks too!

Q. Why do you agree with this regulatory nonsense, Mario Draghi, President of the European Central Bank and former Chairman of the G20s Financial Stability Board?

Q. Why do you agree with this regulatory nonsense Stefan Ingves, Governor of Sveriges Riksbank and current Chairman of the Basel Committee on Banking Supervision?

Q. Why do you agree with this regulatory nonsense Jaime Caruana, Chairman of the International Bank of Settlements and former Chair of the Basel Committee on Banking Supervision?

Q. Why do you agree with this regulatory nonsense Mark Carney, Governor of the Bank of England and current Chairman of the G20s Financial Stability Board?

PS. I am sorry... but somebody has to ask... and keep on asking. God make us daring!

Wednesday, July 23, 2014

Mark Carney violates the ethics of Adam Smith that he himself emphasizes.

Mark Carney, Governor of the Bank of England, in the Commonwealth Games Business Conference, Glasgow 23 July 2014, in a speech titled “Winning the economic marathon” stated:

“Adam Smith emphasized the importance of conduct, or what he referred to as ‘the established rules of behavior,’ by which ‘many men behave very decently, and through the whole of their lives avoid any considerable degree of blame. Those established rules of behavior – social capital – underpin the functioning of the free market. In short, to be effective, markets must also be fair”

And in this respect Mark Carney, as a bank regulator, as the Chairman of the Financial Stability Board, should take note that he himself, by approving of risk-weighted capital requirements for banks, those which discriminate against those who are already discriminated against by being perceived as “risky”, is not behaving fairly, distorts the functioning of the free markets, and is in utterly noncompliance with what “Adam Smith emphasized”.

Comment on BoE´s Sir Jon Cunliffe´s speech, July 17, 2014, on the leverage ratio in bank regulations.

Sir Jon Cunliffe of the Bank of England, Deputy Governor Financial Stability, Member of the Monetary Policy Committee, Member of the Financial Policy Committee, Member of the Prudential Regulatory Authority Board gave a speech on July 17 on the role of the leverage ratio. In it he states: 

“The underlying principle of the Basel 3 risk-weighted capital standards – that a bank’s capital should take account of the riskiness of its assets – remains valid. But it is not enough. Concerns about the vulnerability of risk-weights to ‘model risk’ call for an alternative, simpler lens for measuring bank capital adequacy – one that is not reliant on large numbers of models. 

This is the rationale behind the so-called ‘leverage ratio’ – a simple unweighted ratio of bank’s equity to a measure of their total un-risk-weighted exposures. 

By itself, of course, such a measure would mean banks’ capital was insensitive to risk. For any given level of capital, it would encourage banks to load up on risky assets. 

But alongside the risk-based approach, as an alternative way of measuring capital adequacy, it guards against model risk. This in turn makes the overall capital adequacy framework more robust. 

… bank capital adequacy is subject to different types of risks. It needs to be seen through a variety of lenses. Measuring bank capital in relation to the riskiness of assets guards against banks not taking sufficient account of asset risk. Using a leverage ratio guards against the inescapable weaknesses in banks’ ability to model risk. 

Whether the leverage ratio or the risk weighted capital ratio bites on any individual bank will depend on what are the greatest risks facing that bank” 

And those assertions contain some important impreciseness and problems on which I must comment. 

First “that a bank’s capital should take account of the riskiness of its assets – remains valid… Measuring bank capital in relation to the riskiness of assets guards against banks not taking sufficient account of asset risk” 

Absolutely not so! A banks capital should take account of the risk of the bank, which though related to the risk of its assets, is something quite different from the risk of its assets. For instance a bank that has an overconcentration in some few very absolutely safe assets might be infinitely more risky than a bank that has a great diversified exposure to risky assets. The most unfortunate part of current capital requirements is that they are portfolio invariant. 

Second “a leverage ratio guards against the inescapable weaknesses in banks’ ability to model risk”.

Not just so! Models are based on expected risks, while leverage ratios should cover primarily for unexpected risks, and “model risks”, the risk of models sometimes not being correct, has even a lot of being an expected risk. And so in this respect the leverage ratio is to cover for much more unknowns than model risk.

Third “Whether the leverage ratio or the risk weighted capital ratio bites on any individual bank will depend on what are the greatest risks facing that bank”

Not so! What will bite an individual bank has nothing to do with risks, and all to do with its current capital position. If a bank is under the leverage ratio then that is its binding constraint, and if over it, the risk-weighted capital is.

And here is where I need to express my most serious concern with the leverage ratio, and that is that as it increases the floor of minimum capital, it will intensify the distortions produced by risk-weighing. Do you remember the movie the “Drowning pool” where Paul Newman and Joanne Woodward are pressured against the ceiling by an increasing level of water? Precisely that way!

Conclusion: I want a leverage ratio 6-8% but not in the company of the so odiously distorting risk-weights.

Tuesday, July 22, 2014

This is how are banks are regulated, and how they could have been, if only they listened to what we want our banks do for us.

The pillar of current bank regulations is capital (equity) requirements based on perceived risk. It allows for much lower capital for assets perceived as safe than for assets perceived as risky… which means banks will be able to leverage much more their equity when lending to the safe than when lending to the risky… which means banks will earn much higher risk-adjusted returns on equity when lending to the safe than when lending to the risky… and which means banks will not lend to the risky, like medium and small businesses, entrepreneurs and start ups.

Unfortunately, that will not stop major bank crises, because these result only from excessive exposures to what was wrongly perceived as absolutely safe, and never from excessive exposures to what was ex ante correctly perceived as risky… just like the latest crisis happened.

Had regulators asked us, we would have suggested the following:

First, forget about perceived credit risks. Bankers already consider these when they set interest rates size of exposures and other terms. And if as bankers they are not able to handle credit risk, then it is better their banks go broke, fast, before these grow into too-big-to-fail banks.

Now if you want banks to have capital as a reserve, as you should, set these based on unexpected risks. And since you never really know where these unexpected risks can occur, better set one fix percentage, for instance 8%, against any bank assets.

But also, if you really want banks to help out, then perhaps you could reduce slightly that 8% floor, not based on credit ratings, but based on potential-for-job-creation ratings, or sustainability-of-Mother-Earth ratings. That way banks will be able to earn a little bit more on their equity, when trying to do something good for us.

Because, at the end of the day, what are banks for, if not to help us, our economy and our planet? And by the way doing that is the only way for banks to achieve long term stability. There is no such thing as banks standing intact among economic rubble.

I guarantee you that had bank regulators followed this road, we might have some other type of crisis, but not one as serious as the current one… and definitely banks would be helping out much more in terms of creating jobs for our young, and in terms of helping the environment in many ways.

I ask for your help in putting our banks back on track... current regulators juts refuse to admit their monstrous mistakes... they do not even answer my questions.

In November 1999 in an Op-Ed I wrote: “The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause its collapse”… and unfortunately that they keep on doing! Basel III is in many ways only digging our banks deeper into the hole.



Monday, July 21, 2014

“The Parade of the Bankers’ New Clothes Continues: 28 Flawed Claims Debunked” by Anat Admati and Martin Hellwig


As I have argued before the authors present a better description than most of the problems of current bank regulations.

Unfortunately, though they correctly identify that relying capital requirements that are risk-weighted is a flawed concept, they do not yet identify the most serious problem with doing so, namely that it dramatically distorts the allocation of bank credit to the real economy.

Since the perceived risks, like for instance those reflected in credit ratings, are already cleared for by means of interest rates, size of exposure and other contract terms, to also clear for the same perceptions of risks in the capital, signifies a double consideration of risk perceptions… and any risk perception, even if absolutely correct, will lead to the wrong conclusions if excessively considered.

In this particular case that signifies that banks will be able to earn much higher risk adjusted returns on equity on assets considered “absolutely safe” than on assets considered “risky”… and that in its turn means that banks will not serve in a fair way the credit needs of those who might most be need in access to it, like medium and small businesses, entrepreneurs and start-ups.

And the main reason for why we ended up with these bad regulations was that nowhere did bank regulators define the purpose of those entities they were regulating.

Another objection to risk-weighing not clearly identified by the authors, is that what regulators really need to consider when setting the capital requirements is not the expected risks or losses, but the unexpected risk and losses. And the Basel Committee, in a document where they explained the methodology of the risk-weighing explicitly stated that, since unexpected risks are hard to measure, they would use the expected risks in substitution of the not-expected… something which of course does not make any sense at all.

The same explicatory document from the Basel Committee on Basel II’s risk weights also states that the capital requirements are portfolio invariant, meaning that they do not consider the risk of over concentrating in what is perceived as safe, nor the benefits of diversifying in what is perceived as risky. And the argument to do so, amazingly, is that otherwise it would be too difficult for regulators to manage the system.

In summary one can say that regulators concentrated on the risks of the assets of the banks, and not on the risk of the banks… which is of course not the same.

Also any empirical study would have shown that bank crises always result from excessive exposures to something perceived as safe... and never from excessive exposures to something perceived as risky. 

Finally, and though there are some other issues I slightly disagree on, let me here conclude with reference to their remarks on:

"Flawed Claim 13: There is not enough equity around for banks to be funding with 30% equity."

"Flawed Claim 14: Because banks cannot raise equity, they will have to shrink if equity requirements are increased, and this will be bad for the economy."

"Flawed Claim 15: Increasing equity requirements would harm economic growth."

I agree with the authors those are mostly flawed claims, but primarily so from the point of view of a static analysis.

But unfortunately, the road from where our banks now find themselves, to where they propose and many would love the banks to be in terms of equity, makes for a very difficult journey.

In my opinion in order to speed up the travelling, before our young  run the risk of becoming a lost generation, will for instance perhaps require awarding special tax exemptions, in order to make those equity increases feasible over a not too long time span…. because we might in fact be talking about at least a trillion dollars of new equity.

And of course, meanwhile, make all fines payable in voting shares.

Please... again...more important than more bank capital is less distorting bank capital requirements.

Saturday, July 19, 2014

Mr. George Banks, asked by his board about risk weights, Tier 1 capital and CoCos, decides to better go and fly a kite

At the Board of Directors of Dawes Tomes Mousley Grubbs Fidelity Fiduciary Bank


Mr. Dawes Sr asks: Mr. Banks as it is for us to decide what do you suggest we do?

Should we stop lending to our old and loyal small businesses and entrepreneurs which, because of their high risk weights might lead us to not be in compliance with Tier 1 capital requirements?

Because if we do not do so we will force those old and loyal investors of ours who bought our Contingent Convertible bonds, the CoCos, because they paid slightly higher interest, to convert these into bank shares.



Mr. Banks answers. Sorry Mr. Dawes Sr. perhaps I better go and fly a kite... 

Yes, indeed I think I will!!!


Splendid idea George, with loony regulators like the Basel Committee we better fly a kite too!


Wednesday, July 16, 2014

Is there a point at which a Nobel Prize must be recalled so as to avoid reputational and other damages?

How much can Nobel Prize winners be allowed to ignore facts relevant to what they are discussing?

Facts: 

1. The pillar of current bank regulations is the risk-weighted capital requirements for banks

2. These because regulators cannot differentiate between ex ante and ex post risks, allow banks to leverage their shareholder´s capital much higher when lending to “the infallible” than when lending to “the risky”. 

3. And that results in that banks can earn much higher risk-adjusted returns on their equity when lending to “the infallible” than when lending to the risky.

4. And that distorts and makes it impossible for medium and small businesses, entrepreneurs and start-ups to have access to bank credit in fair market conditions.

5. And that makes it impossible for the liquidity or stimulus provided by quantitative easing (QEs), fiscal deficits or low interest rates, to reach what needs most to be reached.

6. And all that for no good reason at all since bank crises are never ever the result of excessive exposures to what is ex ante perceived as risky.

And so when time and time again I read that a Nobel Prize winner asks for more economic stimulus and less austerity, without the slightest reference to the need of removing that huge regulatory boulder that stands in the way of job creation and sturdy economic growth, I can´t help but to ask… is there a point at which a Nobel Prize must be recalled so as to avoid reputational damage?

Of course I do understand the difficulties for the Committee for the Prize in Economic Sciences in Memory of Alfred Nobel. That prize was endowed by the Swedish central bank… and the current president of Sveriges Riksbank, Stefan Ingves, is also the current chairman of the Basel Committee, the committee responsible for creating the regulatory boulder that stands in our way... and that is a huge reputational risk in itself.

How dangerous it can be when reputational risks intertwine so much... in mutual admiration clubs.
  

Monday, July 14, 2014

Caveat emptor! Contingent Convertible Capital Instruments CoCos

Contingent Convertible Capital Instruments CoCos, which counts as Additional Tier 1 debt, and which could be forced to convert only because a regulatory change in risk-weights, or in the risk appreciation of some assets by credit rating agencies, or because of bank manipulations is pure lunacy for all… especially for investors.

Could investors sue regulators for forcing them to convert? What responsibilities have regulators on informing investors about the possibilities of conversion?

If getting close to a conversion do banks have an obligation toward investors to sell assets with high risk weights in order to avoid conversion, or can the banks instead take on assets with high risk weights in order to force conversion on investors?

The only cocos that make sense, are those based on a leverage ratio (not risk-weighted)…for instance not less than 6 percent.

Saturday, July 12, 2014

What would the reactions be if capital requirements for banks discriminated against gays, the sick, women or black people?

Those perceived as risky credit risks do already pay higher interest rates, do get smaller loans and do have to accept harsher terms… and so why on earth would regulators require banks to have much more capital when lending to the risky than when lending to the “safe”, and so that the risky need to accept even higher interest rates, even smaller loans and even harsher terms… and all this when there has been no major bank crises in history that has resulted from excessive exposure to those ex ante perceived as not risky? Are current bank regulators sadists?

What would the reactions be if capital requirements for banks discriminated against gays?
What would the reactions be if capital requirements for banks discriminated against the sick?
What would the reactions be if capital requirements for banks discriminated against black people?
What would the reactions be if capital requirements for banks discriminated against women?

All hell would break lose!

But, no these only discriminate in favor of the “infallible” and against “the risky”, and so nobody cares.


Wednesday, July 2, 2014

Fed Chair Janet Yellen has not been briefed on the real implications of current risk-weighted capital requirements for banks.

I refer to Fed Chair Janet L. Yellen speech At the 2014 Michel Camdessus Central Banking Lecture, International Monetary Fund, Washington, D.C. July 2, 2014 on Monetary Policy and Financial Stability.

From it I deduct that she has not yet been fully briefed about the real implications of the pillar of current bank regulations namely the risk-weighted capital requirements for banks.

I will illustrate this with two examples:

First Yellen states: “A smoothly operating financial system promotes the efficient allocation of saving and investment, facilitating economic growth and employment. A strong labor market contributes to healthy household and business balance sheets, thereby contributing to financial stability. And price stability contributes not only to the efficient allocation of resources in the real economy, but also to reduced uncertainty and efficient pricing in financial markets, which in turn supports financial stability.”

Absolutely, the problem though is that by means of risk-weighing the capital banks are required to hold, you allow banks to earn different risk-adjusted returns on equity something which stops in the tracks any possibility of efficiently allocating bank credit in ways that permit sturdy economic growth. In essence current requirements, by allowing banks to earn more on the “absolutely safe” it has stopped banks to lend sufficiently to the risky, like medium and small businesses, entrepreneurs and start-ups. And, an economy with insufficient risk-taking, is doomed to recede.

But also, from the perspective of financial stability the current risk weights are completely wrong, since never ever do big bank crises erupt from too much bank exposure to what is ex ante considered risky, they always result from too much bank exposures to what ex ante is considered absolutely safe, but that ex post turns out very risky.

Second Yellen states: “Tools that build resilience aim to make the financial system better able to withstand unexpected adverse developments. For example, requirements to hold sufficient loss-absorbing capital make financial institutions more resilient in the face of unexpected losses.”

Absolutely, the problem though is that the current risk weights have nothing to do with unexpected losses, and all to do with the expected losses derived from the perceived credit risks which are already cleared for in interest rates, size of exposures and other contractual terms.

And the consequence of that is that expected losses get cleared for twice, while the unexpected losses are not considered, and huge distortions ensue.

In the remote possibility that Janet Yellen would read this, let me end here by assuring her that if banks had had to hold the same capital against any asset, for instance the basic Basel II's 8 percent, something else might have happened… but not the current crisis.

PS. Here is a link to a fuller list of the Basel II mistakes.

Tuesday, July 1, 2014

My list of the biggest X mistakes of risk-weighted capital requirements for banks, which regulators (and FT) ignores

For the time being, and in no particular order… 

1. The risk-weights are portfolio invariant, which means these do not reflect the dangers of excessive concentration or the benefits of diversification. The main explanation for the why of this is, amazingly, that otherwise it would have been too difficult for regulators to manage.

2. The risk-weights are based on the expected risk which is already being cleared for by bankers, by means of interest rates, size of exposure and other contractual terms; and not based on the unexpected risks, that which should really be the concern of regulators.

3. The risk-weights with their consequential different capital requirements for different assets allow banks to earn higher risk-adjusted returns on its equity on assets classified as "safe" than on assets deemed "risky", something which hugely distorts the allocation of bank credit in the real economy.

4. One thing is the risk for the banks of the expected risks of their assets… and another completely different the risk for regulators of the banks not perceiving the expected risk correctly.

5. The less the number of those officially appointed to perceive credit risks, like the human fallible credit rating agencies, the larger the consequences of a magnificent risk-perception imperfection.

6. The only reason for which regulators can set higher capital requirements for banks when lending to “the infallible” than when lending to “the risky” is that they did not do any empirical research on what always causes bank crises, namely excessive exposures to something ex-ante considered "absolutely safe" but that ex-post turned out not to be.

7. To believe that the risks of huge loans to an infallible sovereign are greater than many small loans to that sovereigns subjects, is about as crazy as it gets… unless of course you are a communist.

8. Emphasizing the avoidance of short term perceived credit risks, without considering the benefit that loans to "the risky" might bring to the sturdiness of the real economy, causes banks to concentrate on financing the safer past and to avoid financing the riskier future… which is something our children will pay dearly for.

9. Ridiculously small capital requirements, 4%, 2.8%, 1.6% and even 0% constitute of course the best growth-hormones for the “too-big-to-fail” banks.

10. Diminishing the importance of capital allows for outrageous bankers’ bonuses.

11. Of course underlying all of the problems of Basel II is that there is not a word to be found in all the Basel Committee’s regulations about what is the real purpose of the banks. No wonder!

12. To ignore the consequences of all the distortions in the allocation of credit to the real economy this has and will cause, is sheer lunacy!

PS. This post will be continuously revised.

Sunday, June 29, 2014

Jaime Caruana, go home. You and your Basel II colleagues have done enough damage, and should not now block the fixes.

Jaime Caruana was the Chairman of the Basel Committee for Banking Supervision at the time Basel II regulations were approved in June 2004; and since I consider these the most outrageous, dumb and irresponsible bank regulations ever, I of course think that he should have retired a long time ago.

But no, ten years later, now as the General Manager of the Bank of International Settlements he still refuses to accept any responsibility. 

Let me for instance refer to his speech “Stepping out of the shadow of the crisis: three transitions for the world economy” given on the occasion of the BIS’s Annual General Meeting in Basel on 29 June 2014 

There he states: “A reliable financial system requires more than resilience. Resilience is the starting point, but let me mention some other key elements. The first is confidence in banks’ risk management. This goes all the way from the overall risk culture to the risk models themselves. The large reported dispersion in risk-weighted asset calculations suggests that there is still plenty of scope for inconsistency, and perhaps even for gaming the rulebook.” 

Not even a hint of the possibility that in fact it was the regulators’ who with their risk-weighted capital requirements for banks, the pillar of Basel II, gamed the rulebook and upset risk-models.

He also says: “ Stringent regulation can alleviate this problem. Constraints on modelling assumptions can improve comparability and curb arbitrage.”

Yes but who will constrain the regulators from arbitraging against their short term credit risk monsters, ignoring the risk-taking the economy needs? 

He also holds: “If calibrated rigorously, the leverage ratio can create a credible backstop for the risk-weighted ratios.” 

Yes but why was this not there in Basel II, and why is it there now only as a backstop, something which allows the risk-weights to distort more than ever on the margins?

He also says: And, implemented consistently, global minimum regulatory standards can reduce the risk of fragmentation along national borders and increase credibility. 

Indeed, but unfortunately, with wrong regulations, like Basel II, that can also increase the global systemic risk in banking.

And he suggests: “to encourage a prudent risk culture, one that allows for diversity and risk sensitivity, but penalises and prevents attempts to game regulations.”

Obviously Caruana has no idea that a prudent risk culture for regulators starts by defining which the objectives of that which is being regulated are, so as to know what they cannot risk distorting with their regulations. If Caruana and his colleagues had known that, then they would have understood that the last thing they could do was to distort the allocation of bank credit to the real economy… as they so blithely did and do!

As is those foremost responsible for gaming bank regulations to suit their own beliefs and not having been penalised for it, are the Basel Committee and the Financial Stability Board members.  

Jaime Caruana… by not being willing to admit the mistakes of Basel II, and occupying a crucial post, you are standing in the way of what needs to be corrected… so go home!