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 un-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 what they write about:

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.

On that the authors are mostly correct in their comments from the point of view of a static analysis. But unfortunately, the road from where our banks now find themselves, to where they propose banks should be in terms of equity, makes for a very difficult journey. In my opinion it would perhaps require for instance 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.

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?


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?

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.

Not even the Congress of the home of the brave
Not even those in charge of supervising the Equal Credit Opportunity Act

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!

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!

Monday, June 23, 2014

Who supervises that FDIC, Fed, OCC, with their risk-weights, do not distort allocation of bank credit to the real economy?

The FDIC writes: “The Federal Deposit Insurance Corporation (FDIC), the Federal Reserve Board (Board), and the Office of the Comptroller of the Currency (OCC) (collectively, the agencies), under the auspices of the Federal Financial Institutions Examination Council (FFIEC), are requesting comment on proposed revisions to the risk-weighted assets [used to determine the regulatory capital banks should hold].”

And in a reference material titled “New Capital Rule: Community Bank Guide” we read:

“This guide summarizes significant changes from the current general risk-based capital rule for exposures commonly held by community banking organizations, and it provides relevant information regarding the treatment of more complex exposures such as securitization exposures, equity exposures, and exposures to a foreign government or bank. Community banking organizations become subject to the new rule on January 1, 2015. 

The new rule takes important steps toward improving the quality and increasing the quantity of capital for all banking organizations as well as setting higher standards for large, internationally active banking organizations. The agencies believe that the new rule will result in capital requirements that better reflect banking organizations’ risk profiles, thereby improving the overall resilience of the banking system. The agencies have carefully considered the potential impacts on all banking organizations, including community banking organizations, and sought to minimize the potential burden of these changes where consistent with applicable law and the agencies’ goals of establishing a robust and comprehensive capital framework.”

All of which leads us to ask again, for the umpteenth time… who is in charge to supervise that the risk- weighing of bank assets does not distort the allocation of bank credit to the real economy?

How can anyone think of "a robust and comprehensive capital framework" that does not even consider the consequences of distortions which could be much more dangerous for the overall safety of the economy than the presence of unsafe banks?

Do these risk weights really consider any unexpected events and losses banks could suffer or are they based on the same risk perceptions used by the banks to clear for expected risks? 

Thursday, June 19, 2014

The capital control the IMF supports

Overwhelmed by what is happening in my country Venezuela, I briefly pause to refer to the war that incompetent and pusillanimous regulators in the Basel Committee and the Financial Stability Board, have declared against what they consider is the risk of banks.

The pillar of their current banking regulations are shareholder capital requirements against the various bank assets, according to the perceived credit risk.

For example the Basel II rules allow banks to lend huge sums to "infallible" sovereign against zero capital; huge amounts to private borrowers rated AAA against only 1.6% equity; while, against small loans to businesses or entrepreneurs, they are required to hold 8% in capital.

Since the perceived credit risk is already considered by the banks in the interest rates they charge, the above translates into banks being able to earn much higher risk adjusted returns on equity when lending to the "safe" than when lending to the “risky".

And, as a result, the portfolio of banks each day focuses more on what is perceived as “safe”, while bank credit to “the risky”, the credit needed to finance our future, becomes more each day scarce.

If one insures against all risks, one runs the risk that after paying all insurance premiums, you do not have anything left to eat with. In that sense you must always before analyzing risks define what the most important objective, so as to better understand what risks you cannot help but to assume.

And the citizens have a vital interest in that bank credits are awarded to the real economy efficiently, because on that will depend their future jobs. And therefore, avoiding the risk of banks to fail, you should never include something that makes it difficult to properly allocate banking credits.

If bank capital requirements were somewhat lower for projects that had very good potential of generating new-and-different-jobs-ratings, then I might understand ... but only to avoid the risk of bankruptcy of some banks… never!

And even when those regulations function as de facto capital controls, channeling bank credit to the "safe" and away from "risky", the International Monetary Fund, who has so much history opposing capital controls, plays along as if it does not understand.

Of course the IMF, among its explicit responsibilities, has to seek to ensure financial stability, and so that there can be some confusion with respect of avoiding bankruptcy of some banks. But even if so, a simple empirical study on the causes of banking crises, would have indicated the IMF that these never ever result from excessive lending or investment to what is perceived risky, but exclusively because of excessive exposures to what is ex ante believed to be absolutely safe, but is not so, ex post.

And the World Bank is complicit in the silence. As the first development bank in the world it must know that without risking open doors behind which, hopefully, we can find what can help propel us forward, we will only be stuck in the past,

Also, today, when the issue of inequality has been made so fashionable by Piketty, do not ignore that discriminating against the weak, the “riskier”, can only increase inequality.

Monday, June 16, 2014

Janet Yellen why are bank capital requirements based on credit ratings and not on job creation ratings?

Bank lending to small businesses has never had anything to do with causing the latest or any other financial crises for that matter; and risk-weighted capital requirements for banks makes it impossible for “the risky” small businesses to access bank credit in a fair way… 

Now knowing that, as Federal Reserve Chair Janet L. Yellen must know, how can you give a speech such as that delivered at the National Small Business Week Event at the U.S. Chamber of Commerce in May 2014?

She speaks much of the importance of job creation. Indeed, if I had been invited and allowed to make a question, that one would be… why do you base capital requirements for banks on perceived credit risk ratings and not on job creation ratings?

Thursday, June 12, 2014

Risk-weighted capital requirements creates a competitive disadvantage for community banks; as well as for their clients usually perceived as "riskier" .

Inasmuch the clients of the community banks belong more to the category of “risky”, like medium and small businesses, entrepreneurs and start-ups, whose fair access to bank credit is discriminated against, by banks being required to hold more capital against them that against the “safe”… and inasmuch larger banks have more access to borrowers perceived as "safe", or can easier structure operations as “safe”, and therefore benefit from lower capital requirements... which means being able to leverage their equity much more…. we can indeed argue that current regulations place community banks in a competitive disadvantage.

And so if community banks want to survive, they need to protest and fight against the whole concept of risk weighted capital requirements… and that should not be so difficult since the de-facto discrimination against the fair access to bank credit of “the risky”, should not be permitted under Equal Credit Opportunity Act (Regulation B).

And besides, community banks, ask your regulators to show you evidence of when excessive bank exposures to those ex ante perceived as "risky" have ever set off a major crisis. They will not be able to do so!

And agreeing from a different perspective with Thomas Hoenig of the FDIC, I guarantee you that letting the Too-Big-To-Fail-Banks roam in regulations distinct from that of the community banks, would only, medium term, condemn the community banks and bankers to disappear.

Frankly... in the "Home of the brave"... who came up with the idea of discriminating against the "risky" risk-takers who have made this country, so that they do not have any longer a fair access to bank credit? 

Wednesday, June 11, 2014

Don’t you understand how utterly immoral and dumb current bank regulatory discrimination is?

Suppose a busybody ministry of economy came up with the idea that in order to strengthen the competitiveness of the nation’s private sector, and make really sure the firms employed the best and brightest, they were going to give special tax incentives for hiring students with grades over a specified level. 

What would happen?

All those who had not achieved that great level of grades would scream bloody murder and accuse the ministry for discriminating against them, for something which they were already being discriminated in the job market. And if by any chance the ministry would still be able to impose its nutty and odiously discriminatory plan… you would automatically begin to see some inexplicable inflation in the level of grades.

And that is basically what the risk-weighted capital requirements for banks concocted by the Basel Committee for Banking Supervision do:

First: These capital requirements odiously discriminate, for a second time, against those who because of being perceived as risky already get smaller loans and pay higher interest rates.

Second: Borrowers have always wanted to be perceived as safer than what they are… but now the lenders dangerously have a vested in sharing that interest in too... so the credit rating agencies will be pressured for better ratings from both sides.  

Third but foremost: By allowing banks to earn higher risk-adjusted returns on equity when lending to “the safe” these capital requirements distort the allocation of bank credit to the real economy

And fourth: It all serves absolutely no purpose, since never ever do bank crises result from excessive exposures to what is perceived as risky, but always from excessive exposures to something erroneously ex ante perceived as absolutely safe.

Saturday, June 7, 2014

@ECB Mario Draghi: Europe urgently needs to stop the discrimination in favor of “the safe” and against “the risky”.

Europe, much more than quantitative easing, “targeted long-term refinancing operations” or lower rates would need Mario Draghi to declare 

“From now on we the ECB will not admit bank regulators treating lending to medium and small businesses, entrepreneurs and start-ups, as intrinsically more risky for Europe, than lending to the “infallible sovereigns”, the housing sector and the AAAristocracy”

That refers to the need of stopping the distortion that risk-weighted capital requirement produce in the allocation of credit in the real economy ,something which is the number one reason for having caused the crisis (AAA rated securities Greece), and the number one reason for which the young unemployed Europeans might be doomed to become a lost generation.

Would that endanger the banks? Of course not! Who has ever heard about a bank crisis caused by excessive exposures to what was ex ante considered risky, these have always resulted from excessive exposures to what was ex ante considered “absolutely safe” but that ex post turned out not to be.

Friday, June 6, 2014

How can Christine Lagarde, of the IMF, say such things on the Amartya Sen Lecture?

Invited to speak on the Amartya Sen Lecture, ChristineLagarde said “In more unequal societies, too many people lack the basic tools to get ahead—decent nutrition, healthcare, education, skills, and finance. This can create a vicious cycle”

Yes! Indeed. And IMF should be ashamed of not criticizing the risk-weighted capital requirements for banks that so discriminates “the risky”, the medium and small businesses, the entrepreneurs and the start-ups from a fair access to bank credit.

Twice I have told her about it, here and here, and yet, acknowledging the problem, she seemingly does not care.

Wednesday, June 4, 2014

Here for discussion is an alternative, less distorting, risk-weighted bank capital requirement regulation.

I have for more than a decade strongly opposed the Basel Committee’s risk-weighted capital requirements for banks. 

This primarily because these seriously distort the allocation of bank credit in the real economy, but also because they make little empirical sense, since what historically have caused all major bank crises, are not big bank exposures to what ex ante is considered risky, but always too large exposures to what was erroneously perceived ex ante as absolutely safe.

But since it seems that regulators do not feel they are doing their job if they don’t do risks weighting, my criticism has not been sufficiently considered.

In that respect let me here briefly express a simple alternative of risk-weighing the capital of a bank.

Though it would not increase the ultimate long term safety of the banks, because of the fundamental regulatory mistake of confusing ex-post risks with ex-ante perceptions, it could at least produce much less distortion in the allocation of bank credit.

1. Calculate the risk-weighted size of the bank’s balance sheet. 

2. Divide that number by the gross balance sheet of the bank. 

3. Multiply the resulting ratio times a basic capital requirement, for instance Basel II’s 8 percent.

4. Make the resulting percentage the general capital requirement for that bank in particular and to be applied to all its assets.

5. Make a medium term plan on how to increase that percentage for that particular banks, to for instance Basel II's 8 percent.