Thursday, October 1, 2015
Mark Carney, the current Chair of the Financial Stability Board, has recently been warning many about the financial risks that could be derived from climate change, like leaving a lot of fossil fuels stranded. He should first take better care of his own risk management responsibilities. In that area he has not earned the right to throw stones.
Regulators allow banks to hold much less capital against what, from a credit risk point of view, is perceived as safe than against what is from a credit point of view ex ante perceived as risky.
That means that banks can earn much higher risk adjusted returns on equity when lending to what is perceived safe, than when lending to those perceived risky, like the SMEs and entrepreneurs.
That is a huge economic risk, because the risky need to have fair access to bank credit in order to help the real economy to avoid to stall and fall.
That is a huge financial risk, because it guarantees excessive exposures against little capital, to precisely that of which great bank crisis are made of, that which ex post can come up as having been erroneously perceived as absolutely safe.
Tuesday, September 29, 2015
My bank regulator went to Basel, and all he brought me was this lousy credit risk weighted capital requirements
I sent my bank regulator to learn with the big boys in the Basel Committee for Banking Supervision about how to regulate banks. Among what he was supposed to pick up was an idea of how much capital he should require banks to hold, primarily against any unexpected losses.
He could have come back with capital requirements that considered all type of events that unexpectedly could blow a hole in a banks solvency like: cyber-attacks, a weather event with disastrous consequences, a major earthquake, the central banks or even the regulators themselves not knowing what to do, inflation suddenly popping up, crazy governments (I am from Venezuela), a set of important companies suddenly turning up engaged in some hanky panky, Systemic Important Financial Institutions (SIFIs) going belly up, internal or external fraud, a major loss from an authorized or unauthorized position in a speculative trading, unexpected consequences from new regulations and thousand of other things… and all he brought me was this silly risk weighted capital requirements based on expected credit risks, about the only risks banks are supposed to really take care of on their own.
If only it had been based on the risk that banks were not able to manage expected credit risk, then I could have accepted it… but that had of course nothing to do with the credit risk per se, in fact usually it is what is perceived as safe that could pose the biggest dangers for a bank.
And, to top it up, these credit risk based capital requirements were portfolio invariant, meaning independent of the size of the exposures, only because otherwise it would be too hard for him and his regulating colleagues to handle.
And, to top it up, these credit risk based capital requirements also smuggled in the absurd statist notion that sovereigns were infallible, de facto implying government bureaucrats knew better what to do with bank credit than "the risky" SMEs and entrepreneurs.
And to top it up, during his whole stay with the Basel Committee, and during his study visits to the Financial Stability Board and the IMF, not one single word was said about the societal purpose of banks.
And, so these credit risk based capital requirements guarantees to dangerously distort the allocation of bank credit to the real economy... which they did, look at how much credit Greece got... which they do, look at how little credit SMEs get.
And so these credit risk based capital requirements now guarantee that the next time a bank crisis resulted from excessive exposures to something that was erroneously perceived as very safe, which is precisely the stuff major bank crisis are made of, then banks will stand there with their pants down and no capital to cover themselves up with.
No! I will surely never ever send my bank regulator to Basel again.
Monday, September 28, 2015
I quote from a recent speech by Ms Sabine Lautenschläger, Member of the Executive Board of the European Central Bank and Vice-Chair of the Supervisory Board of the Single Supervisory Mechanism given September 28, 2015, titled Reintegrating the banking sector into society – earning and re-establishing trust
"Ladies and Gentlemen, esteemed audience,
How can bankers regain the trust that was lost during the crisis?
How can the banking sector be reintegrated into society?
There is no doubt that banks, bankers and the whole industry are experiencing one of the worst crises of confidence ever. The turmoil of 2008 and 2009 played a major role in this loss of public trust, but the problem did not end after the most acute phase of the crisis. Even seven years later, confidence in the banking sector is still very low.
Numerous scandals, like the manipulation of LIBOR rates…have reinforced the perception that wrongdoing is widespread in the banking sector.
But mistrust is not only confined to banks themselves. Investors and clients also have less confidence in the correct functioning of the banking sector and in the ability of supervisors and regulators to prevent excessive risk-taking.
We should worry about this loss of trust in the banking sector:
It impairs the proper functioning of banks to reallocate resources.
It hampers growth.
It leads to instability and costly crises.
But how can trust in the banking sector be restored? Who are the key players in this process? Is it enough to reform the regulatory and supervisory framework, as we have done in recent years?
But are the efforts of regulators and supervisors enough? Can trust be rebuilt simply by having better and more credible rules?
No! Rebuilding trust in the banking sector requires the active engagement of bankers and their stakeholders. Regulatory and supervisory reforms are necessary, but not sufficient to restore people’s trust in banks.
My view is that, while regulatory reform and supervisory action were certainly necessary to lay the foundations on which banks can restore trust, regulators and supervisors are not the key players in this process."
Bank regulators told banks: “We allow you to hold much less capital against assets perceived as safe than against assets perceived as risky, so that you can earn much higher risk adjusted returns on equity when lending to the safe than when lending to the risky.
That’s it! Just avoid the credit risks and you earn more, not a word about a purpose for banks, like helping to generate jobs for the young or making the planet more sustainable. Anyone regulating without defining the purpose of what he is regulating is as loony as they come.
And to top it up, the regulators assigned a risk weight of zero percent to the sovereigns (governments) and of 100 percent to the citizens and private sectors on which that sovereign depends. Which means they believe government bureaucrats can use bank credit more efficiently than SMEs and entrepreneurs.
And of course those regulations distort completely the allocation of bank credit to the real economy and, by diminishing the opportunities of the risky to gain access to bank credit, increases inequalities.
The manipulation of Libor rates is pure chicken shit when compared to the manipulation of the credit markets done by regulators with their credit risk weighing.
And here many years after it was clearly seen that the regulators efforts to prevent excessive risk taking only produced excessive risk taking in what was perceived as safe, here they are still talking about the need of “the ability of supervisors and regulators to prevent excessive risk-taking”. Without their regulations banks would have never ever been able to leverage as much as they did.
So forget it, I at least trust banks and bankers much more than their current regulators.
Friday, September 25, 2015
Should not the Financial Stability Board discuss the risk that the Basel Committee has no idea about what its doing?
The Financial Stability Board plenary met in London to discuss policy measures to end too-big-to-fail, concerns on market liquidity, shadow banking, derivatives, misconduct risks, audit and climate change.
For me, the number one issue they should discuss is whether their colleagues in the Basel Committee have the faintest idea of what they are doing and whether it is not hight time for capital requirements for banks to be set based on the risk their regulators are loony... or are smoking something not so good.
Saturday, September 19, 2015
The financial crisis explained to dummies in terms of capital requirements for banks: Lehman Brothers - AIG - Greece
The regulators, with Basel II, decided that against any private sector assets rated AAA banks, and against any sovereign rated as Greece was until November 2009, banks needed to hold only 1,6 percent in capital, meaning these could with those assets leverage their capital over 60 times to 1. (When holding “risky” assets like loans to entrepreneurs and SMEs they were only allowed to leverage 12 times to 1.
On April 28, 2004 the SEC decided that was good for the Basel Committee was good enough for them and allowed Lehman to leverage over 60 times to 1 with AAA rated securities guaranteed with mortgages to the subprime sector… Since Europe were allowing their banks to do the same… the demand for these AAA securities became so huge that it overpowered all the quality controls in their manufacturing and packaging process… and Bang!
If AIG that was AAA rated guaranteed an asset, banks could dramatically reduce the capital they needed to hold against that assets, and this overwhelmed AIG’s capacity to resist selling “very profitable” loan default guarantees… and Bang!
Greece was of coursed offered loans in such amounts and in such generous terms, so their otherwise "so" disciplined and fiscally conservative governments could not resist the temptations… and Bang!
And as should have been expected not one single asset class that was perceived as risky played any role in causing the financial crisis… although of course these assets also suffered a lot when the “safe” came tumbling down.
One would think regulators would by now have discovered that banks already clear for the perceived risks with their risk premiums and the size of their exposure; and so to also force them to also clear in the capital for exactly the same risks, would cause banks to overdose on perceived risks. But no, they haven’t. So this little financial history lesson for dummies is of course primarily directed to them.
What is our major problem now? John Kenneth Galbraith explained it well: “If one is pretending to knowledge one does not have, one cannot ask for explanations to support possible objections.”
Wednesday, September 16, 2015
We’ve heard a lot about predatory lending, and it should be avoided, but why allow predatory regulations?
An audit report from the office of inspector general of the FDIC broadly defines predatory lending as "imposing unfair and abusive loan terms on borrowers”
Regulators know very well that those perceived as risky have to pay higher risk premiums and have less access to bank credit than those perceived as safe.
Nonetheless regulators currently also require banks to hold much more capital against loans to those perceived as risky, when compared to what they need to hold against assets perceived as safe. And as a direct consequence those perceived as risky, when compared to those perceived as safe, will have to pay even higher interests and have even less access to bank credit.
Since that imposes unfair and abusive loan terms on borrowers… it should be regarded as predatory regulations… and of course, to top it up, by negating fair access to the opportunities for credit of those perceived as risky, these also represent a driver of inequality.
Let me quote here two passages from John Kenneth Galbraith’s “Money: Whence it came where it went” 1975.
First: “For the new parts of the country [USA’s West]… there was the right to create banks at will and therewith the notes and deposits that resulted from their loans…[if] the bank failed…someone was left holding the worthless notes… but some borrowers from this bank were now in business...[jobs created]
It was an arrangement which reputable bankers and merchants in the East viewed with extreme distaste… Men of economic wisdom, then as later expressing the views of the reputable business community, spoke of the anarchy of unstable banking… The men of wisdom missed the point. The anarchy served the frontier far better than a more orderly system that kept a tight hand on credit would have done…. what is called sound economics is very often what mirrors the needs of the respectfully affluent.”
Second: “The function of credit in a simple society is, in fact, remarkably egalitarian. It allows the man with energy and no money to participate in the economy more or less on a par with the man who has capital of his own. And the more casual the conditions under which credit is granted and hence the more impecunious those accommodated, the more egalitarian credit is… Bad banks, unlike good, loaned to the poor risk, which is another name for the poor man.”
And finally, let me just add that never ever are truly dangerous financial bank excesses built up with assets perceived as risky; these are always caused by excessive bank exposure to what is perceived ex ante as safe but that ex-post tum out to be risky… and so all this odious regulatory discrimination against the risky… is all for nothing.
PS. “If one is pretending to knowledge one does not have, one cannot ask for explanations to support possible objections” John Kenneth Galbraith dixit.
Saturday, September 12, 2015
Here are 7 questions on bank capital regulations that US Congressmen and Governors should ask the Fed, FDIC and OCC.
We have been made aware that currently banks are required to hold more capital, meaning equity, when lending to those perceived as safe from a credit risk point of view, like many sovereigns and private entities with good credit ratings, than what banks need to hold in capital when lending to those perceived as more risky, like SMEs and entrepreneurs.
Notwithstanding that sounds intuitively as quite reasonable, one can also argue the following:
Those perceived as safe from a credit point of view, without these regulations, already count with the benefit of larger loans and lower interest rates; while those perceived as risky have less access to bank credit and have to pay higher interest rates. Mark Twain’s saying that a banker is he who lends you the umbrella when the sun shines, but wants it back when it looks like it is going to rain, comes to mind.
So these capital requirements allow banks to leverage more their equity, and the support they in many ways receive from society, many times more when lending to The Safe than when lending to The Risky; and so banks can earn much higher risk adjusted returns on equity when lending to The Safe than when lending to The Risky.
As a result, these capital requirements enlarge the natural differences in access to bank credit between The Safe and The Risky. For instance we could say these regulations artificially favors American banks lending to European sovereigns and highly rated corporations, over lending to American small businesses and entrepreneurs.
And so we must ask you:
Q. Is such regulatory risk-aversion, which distorts the allocation of bank credit, a valid principle for regulating banks in the Land of the Free and the Home of the Brave?
Q. Do we not owe our descendants the same willingness to take risks as that which our fathers allowed our banks to take to get us here?
Q. Cannot it be said of such regulations, by creating incentives for these to refinance the safer past, impede banks from financing the riskier future?
Q. Is not fair access to bank credit an indispensable part of generating the opportunities that helps to reduce inequalities?
Q. Do we not have something called the Equal Credit Opportunity Act, Regulation B, which would seem to forbid this type of regulatory discrimination?
Q. Since the purpose of capital requirements for bank is to shield it against unexpected losses, how can it be you base these on the expected credit losses?
Q. Since what is perceived as risky never generate dangerous excessive financial exposures, that honor goes to what is perceived as safe but ends up being risky, do these regulations really help to build up a safer banking system?
Thank you... oh by the way, since I also heard that your capital requirements are portfolio invariant it just occurred to me to also ask: Should we not require banks to hold capital against the risk of their exposures instead of the credit risk of their assets?
Tuesday, September 8, 2015
The Circle of Reason will ask: "What did they do?"
My answer is that they decided banks needed to hold more capital against assets perceived as risky than against assets perceived as safe.
The Circle of Reason might then say: "But that sounds fairly reasonable, so why is it wrong?"
So here is a non-exhaustive list of reasons, in no particular order:
Banks already clear for perceived credit risk by means of risk premiums charged, size of exposure and other contractual terms so re-clearing for the same perceived risk only distorts.
Instead of looking at the risks of how banks managed the perceived risks of their assets, the regulators also focused on the same perceived risks.
Perceived credit risks are to be managed by the banks and if they cannot do that they should close down as fast as possible. Bank capital is to cover for unexpected losses and so to set the requirements of it based on the expected losses derived from perceived risks make absolutely no sense whatsoever.
The regulators decided that the capital requirements should be portfolio invariant, meaning these had nothing to do with the size of any bank exposure, meaning that all the benefits from diversification were ignored, meaning that they did not know one iota about what they were doing.
To top it up bank regulators decided that the risk weight of sovereigns was to be zero percent while the risk weight for the citizens that make up that sovereign was to be 100 percent, which, unless you are a runaway statist or communist, makes absolutely no sense.
The regulators never understood that allowing banks to have less capital against The Safe, would allow banks to leverage the equity and the support of society much more on loans to The Safe, which allowed banks to earn much higher risk adjusted returns on equity when lending to The Safe than when lending to The Risky.
The regulators regulated the banks without defining what the purpose of banks is, which meant that they for instance ignored the whole topic of allocating credit efficiently to the real economy. Only that should suffice to earn them a place in the Hall of Shame.
The regulators never studied what had caused major bank crises and so confused the ex ante perceived risks with the ex-post real risks. Had they done so they would have noticed that major bank crises result from excessive exposures to something ex ante perceived as safe… and so their capital requirements should perhaps be 180°different, higher for what is perceived safe than for what is perceived risky.
The regulators just focused on the bust event of an economic cycle, not caring about what the whole boom-bust cycle produced… and so they totally ignored that risk-taking is in fact the oxygen of any development.
In these days in which inequality is much discussed the regulators never understood that denying a fair access to bank credit to those perceived as risky, is a potent inequality driver.
If they absolutely wanted to distort, in order to show they were working, why did they not distort with a purpose, like basing the capital requirements on job-creation and sustainability ratings?
The regulators awarded so much power to some human fallible credit rating agencies so that credit ratings became a huge source of systemic risk that would travel at globalized speeds.
The regulators have, now soon ten years after a crisis that was initiated by excessive exposure to AAA rated securities, sovereigns like Greece, real estate in Spain and much other assets that all shared the commonality of generating very low capita requirements for banks, not yet been able to understand the causality.
I could probably go on for quite some time, but this should be enough to at least establish The Basel Committee (and the Financial Stability Board) as serious candidates to be inducted to The Circle of Reasons' Hall Of Shame.
A former Executive of the World Bank (2002-2004)
Sunday, September 6, 2015
G20, keeping our economies from stalling and falling might depend on unregulated shadow banks… a ‘Banca sommerza’.
On September 17, New Rules for Global Finance and the International Trade Union Confederation are hosting a seminar titled “Reducing Unemployment & Inequality: Policy Options for the G20”
And I would like the participants, in preparation for it, to read the following which is quoted from John Kenneth Galbraith’s “Money: Whence it came where it went” 1975.
“For the new parts of the country [USA’s West]… there was the right to create banks at will and therewith the notes and deposits that resulted from their loans…[if] the bank failed…someone was left holding the worthless notes… but some borrowers from this bank were now in business...[jobs created]
It was an arrangement which reputable bankers and merchants in the East viewed with extreme distaste… Men of economic wisdom, then as later expressing the views of the reputable business community, spoke of the anarchy of unstable banking… The men of wisdom missed the point. The anarchy served the frontier far better than a more orderly system that kept a tight hand on credit would have done…. what is called sound economics is very often what mirrors the needs of the respectfully affluent.
The function of credit in a simple society is, in fact, remarkably egalitarian. It allows the man with energy and no money to participate in the economy more or less on a par with the man who has capital of his own. And the more casual the conditions under which credit is granted and hence the more impecunious those accommodated, the more egalitarian credit is… Bad banks, unlike good, loaned to the poor risk, which is another name for the poor man.”
And then I would like the participants to reflect on the fact that the pillar of current bank regulations, is the perceived-credit-risk capital requirements for banks, less-risk-less-capital more-risk-more capital, which allow banks to earn much higher risk-adjusted returns on equity on what is perceived as safe than on what is perceived as risky. And this, as should easily be understood, kills the opportunities for SMEs and entrepreneurs to in a fair way access that bank credit with which they could help generate the next harvest of decent jobs; and also serves as a potent inequality driver.
Friends, or we free our formal banks from this loony regulatory risk aversion to credit risk already cleared for by risk premiums and size of exposures, or the interests of job creation and equality might be best served by unregulated banks operating in the shadows… a Banca Sommersa.
You decide, personally I am surprised to see a big majority of progressives keeping silence on bank regulations that clearly serve best the interests of “the respectfully affluent”… or those of aging baby-boomers’ après nous le deluge.
Let us responsibly live up to our part in that intergenerational continuum of the past, the living and the unborn, that Edmund Burke spoke about.
And this issue is also relevant to many of those you would define as being as far away as possible from the progressives… but which is of course no reason to shy away from it... much the contrary.
As an example, Mark R. Levin initiates his “Plunder and Deceit” by asking: “Can we simultaneously love our children but betray their generations and generations yet born?
G20, please, for the future of our descendants, let us pray together “God make us daring!”
Why on earth do regulators refuse to discuss the issue of how their bank capital requirements distort the allocation of credit to the real economy? I once again refer to Galbraith’s Money: “If one is pretending to knowledge one does not have, one cannot ask for explanations to support possible objections.”
What shall we do with regulators that have clearly failed? I once again refer to Galbraith’s Money: “We should be kind to those whose performance has been poor. But we must never be so gracious as to keep them in office.”
Wednesday, September 2, 2015
Many hold that Mark Twain said: “A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain”... and so
The so anxious Basel Committee for Banking Supervision thought banks lend out their umbrella much too little when the sun was out, and much too much when it looked like it was going to rain.
And so even though banks already cleared for credit risk perceptions, by means of risk premiums and size of exposures, the bank nannies decided that the capital banks should be required to have, should also consider those same credit risk perceptions; more risk more capital – less risk less capital.
And that means banks can now leverage much more their equity, and the societal support they receive, for instance by means of deposit guarantees, when lending out the umbrella on sunny days than when lending it out on rainy days.
And so banks are lending out less than ever the umbrella when it looks like to rain… and as a consequence the real economy is getting wet and getting a cold.
And all for nothing since never ever have major bank crises resulted from too much lending of the umbrella on days perceived as rainy, but always from too much lending when a sunny day was announced, but the weatherman got it all wrong.
I ask, where would we be if our forefathers’ banks had been subject to credit-risk weighted capital requirements?
Sunday, August 30, 2015
Stop the risk aversion and pro-government bias of bank regulations. Deceitfully it plunders our young's future.
A friend told me I had to read Mark R. Levin´s “Plunder and Deceit”, and when I saw it was subtitled “Big governments exploitation of young people and the future” I immediately ordered a copy.
And in its first chapter I read about the intergenerational continuum of the past, the living and the unborn… and I knew the author and I, at least in this respect, shared very similar concerns.
And just looking through the index, I knew I had to add a chapter to this book titled: “God make us daring!”
Why? Because the most important driving force on the intergenerational continuum is the willingness of those of us here now, to take the risks needed today in order for the tomorrows of our descendants to be brighter and brighter.
But, unfortunately, tragically, our most important societal financiers of risk-taking, the banks, have been instructed not to attend to the credit needs of The Risky, but to keep financing solely The Safe. How come?
Regulators imposed capital requirements on banks that are much higher for what is perceived a risky, from a credit risk point of view, than for what is perceived as safe. That allows banks to leverage their equity and the support these receive from the society much more when lending to The Safe than when lending to The Risky. And that of course allows banks to earn much higher risk adjusted returns on equity when lending to The Safe, than when lending to The Risky.
And so regulators have impeded the fair access to bank credit of those perceived as risky, like SMEs and entrepreneurs, and therefore banks are no longer helping out financing the future of our young people, they are only refinancing the past.
And, to top it up, with that so amazingly unnoticed historical event of the Basel Accord of 1988, regulators decided the risk-weight for sovereigns was zero percent, while the risk-weight of citizen 100 percent. And with that these statist/communists de facto made our banks to operate under the assumption that government bureaucrats use bank credit more efficiently than the private sector.
And the credit-risk-aversion and pro-government bias introduced in our bank regulations, has our western civilization going down and down
In April 2013 the Washington Post published the following letter I wrote:
“It suffices to remember the saying about “a banker being that chap who lends you the umbrella when the sun shines but wants it back as soon as it looks like it is going to rain” to know that those assets perceived as safe are already much favored over those perceived as risky. The risk weights applied by the Basel regulations and based on exactly those same perceived risks only increase the gap between “The Infallible” and “The Risky.”
And that is why I very much salute the bill by Sens. Sherrod Brown (D-Ohio) and David Vitter (R-La.) that looks to “require more capital and better capital but also limit the ‘risk-weighting’ of assets.” More capital is a perfectly legitimate requirement, but the imposition of risk weights is fundamentally incompatible with “a land of the brave.” The United States did not become what it is by avoiding risks.”
Unfortunately, in the Home of the Brave, the interests of bankers making their dreams of very high returns with very little risks come true, seems to trump the needs of its younger.
America: Why do you saddle your young and brightest with huge education loans, if you’re not willing to allow banks financing those who might generate the jobs your young need in order to service that debt?
US Congressmen and Governors: How come you allow your banks to hold less capital when financing sovereigns and members of the AAArisktocracy, than when financing your own small unrated local businesses?
US bank regulators: Have you never heard of the Equal Credit Opportunity Act (Regulation B)?
A verse of a Swedish Psalm 288 reads:
“God, from your house, our refuge, you call us
out to a world where many risks await us.
As one with your world, you want us to live.
PS. And all this risk adverse and pro-sovereign regulations for nothing! Major bank crisis do not result from excessive exposures to what was perceived as risky, these always result, no exceptions, from excessive exposures to what was erroneously perceived as very safe. Just look at the AAA rated securities backed with mortgages to the subprime sector... and Greece.
Saturday, August 29, 2015
Why does IMF never mention that credit-risk-weighted capital requirements for banks, is a potent inequality driver?
I refer to an IMF Staff-Discussion-Note titled “Causes and Consequences of Income Inequality: A Global Perspective”. It includes among other “Factors Driving Higher Income Inequality” the following:
“Financial globalization. Financial globalization can facilitate efficient international allocation of capital and promote international risk sharing. At the same time, increased financial flows, particularly foreign direct investment (FDI) and portfolio flows have been shown to increase income inequality in both advanced and emerging market economies… Financial deregulation and globalization have also been cited as factors underlying the increase in financial wealth, relative skill intensity, and wages in the finance industry, one of the fastest growing sectors in advanced.
Financial deepening. Financial deepening can provide households and firms with greater access to resources to meet their financial needs, such as saving for retirement, investing in education, capitalizing on business opportunities, and confronting shocks. Financial deepening accompanied by more inclusive financial systems can thus lower income inequality, while improving the allocation of resources… Theory, however, suggests that … inequality can increase as those with higher incomes and assets have a disproportionately larger share of access to finance, serving to further increase the skill premium, and potentially the return to capital.”
And again I must ask: Why does IMF insist on keeping mum on that huge financial inequality driver that is the risk-weighted capital requirements for banks?
Society lends bank much support, not only directly, by entrusting it with its deposits, but also indirectly, by offering deposit guarantees that if called upon will be paid by taxpayers.
And the Basel Committee thought it could make banks safer by making the capital requirements for banks to be dependent on perceptions of credit risk… while entirely ignoring that those perceptions of risk were already cleared for, by means of risk premiums and size of exposure.
And so, for instance with Basel II, regulators decided that banks were allowed to leverage the societal support over 60 times to 1 when lending to the AAArisktocracy, namely those rated AAA to AA, but only about 12 times to 1, when lending to unrated SMEs and entrepreneurs. That, which allows banks to earn much higher risk-adjusted returns on equity when lending to “The Safe”, blocks the opportunities of “the risky” to obtain fair access to bank credit. It therefore constitutes a huge driver of inequality.
And since the document refers to “Financial deregulation” I must also ask, for the umpteenth time…what financial deregulation? That where a small number of regulators redirect the allocation of bank credit all over the world… de facto imposing global capital controls? You’ve got to be kidding!
No! The Basel Committee is just a nest of irresponsible populist technocrats, who frankly have no idea of what they are doing. For instance they derive those capital requirements, that they themselves declare should be there to cover for unexpected losses, from the perceptions of expected losses. How loony is not that? Clearly the safer something is perceived, the bigger its potential to deliver truly disastrous unexpected losses.
I have often complained about these regulations on the IMF blog… you can Google it on “blog-imfdirect.imf.org Kurowski”. But I have never received an answer from IMF, seemingly the automatic solidarity among technocrats is very strong.
Tuesday, August 25, 2015
One of Basel Committee’s many monstrous regulatory mistakes made easy. The expected and the unexpected mix up.
As regulators have explicitly stated, banks should be required to have capital (equity) as a cushion against unexpected losses.
In Basel II, the risk weight applied to assets of private corporations rated AAA to AA, was 20%. This weight, applied to a base capital of 8%, signified banks had to hold 1.6% in capital against these “safe” assets. And the correspondent risk-weight for assets rated BB- and below, was 150%, which meant banks had to hold 12% in capital against these “risky” assets.
Let me ask anyone of you… what carries a larger potential of dangerously high-unexpected losses, what is rated AAA to AA, or what is rated below BB- and for which therefore the expected losses are huge?
Do you get the drift?
Also, the moment a risk is generated for a bank is not when an asset is down-rated, but when that asset is put on the bank’s balance sheet. But currently it is when a credit gets down-rated that regulators, much too late, jack up the capital requirements; something which makes it even more difficult for banks to manage the problem assets.
PS. This is one of the many observations regulators have steadfastly refuse to comment on. If anyone of you is able to extract something of an answer from these not accountable to anyone regulators, I would be grateful to know about it.
Friday, August 21, 2015
World Bank, before Public Credit Guarantee Schemes (CGSs) help removing the obstacles to bank lending to SMEs
“The World Bank Group and FIRST Initiative are inviting stakeholders -- governments, credit guarantee schemes (CGSs) and lenders -- to provide input on how to improve access to finance for SMEs through an effective design, implementation and evaluation of Public Credit Guarantee Schemes CGSs.”
As a justification the document states something we can all surely agree on: “Financial inclusion, particularly for small and medium enterprises (SMEs), is widely recognized as one of the key drivers of economic growth and job creation in all economies. SME credit markets are notoriously characterized by market failures and imperfections including information asymmetries, inadequacy or lack of recognized collateral, high transaction costs of small-scale lending and perception of high risk.”
We also read: “In order to address these market failures and imperfections, many governments intervene in SME credit markets in various forms. A common form of intervention is represented by credit guarantee schemes (CGSs). A CGS provides third-party credit risk mitigation to lenders with the objective of increasing access to credit for SMEs. This is through the absorption of a portion of the lender’s losses on the loans made to SMEs in case of default, in return for a fee. The popularity of CGSs is partly due to the fact that they typically combine a subsidy element with market-based arrangements for credit allocation, therefore involving less room for distortions in credit markets than more direct forms of intervention such as state-owned banks.”
And I would want to draw your attention specifically to: “they typically combine a subsidy element with market-based arrangements for credit allocation, therefore involving less room for distortions in credit markets.”
That because the World Bank Group and the FIRST Initiative, are aware of the existence of risk-weighted capital requirements for banks which allow banks to leverage much less their equity when lending to “The Risky”, like SMEs than when lending to “The Safe” like sovereigns and the AAArisktocracy.
And they must also be aware that these regulations impede “market-based credit allocation, and cause huge distortions in credit markets”. We know that because already in the World Banks' The Global Development Finance 2003 (GDF-2003), “Striving for Stability in Development Finance” it had this to say on Basel II, pages 50-52
“The new method of assessing the minimum-capital requirement [proposed by the Basel Committee for Banking Supervision (BCBS)]… will be explicitly linked to indicators of credit quality… The regulatory capital requirements would be significantly higher in the case of non-investment-grade emerging-market borrowers than under Basel I. At the same time, borrowers with a higher credit rating would benefit from a lower cost of capital under Basel II….”
And so, though welcoming very much this initiative of the World Bank and the FIRST Initiative, I pray that it is not in substitution of getting rid of the portfolio invariant credit-risk weighted capital requirements for banks, which blocks SMEs from having fair access to bank credit. If it is, then let me assure you the “Public Credit Guarantee Schemes (CGSs) for SMEs” discussed amounts to a petty consolation prize for the SMEs, and could even increase the existing regulatory distortions.
We read the consultation invites “stakeholders -- governments, credit guarantee schemes (CGSs) and lenders” should not SMEs, or those who speak up for the borrowers’ rights of not being discriminated against by regulators, be specifically invited?
The Basel Committee is a pitiful bunch of bank regulators incapable of expressing even the smallest “We’re sorry Greece”
There is no doubt whatsoever that had regulators not allowed to leverage their equity over 60 times to 1 when lending to Greece, Greece not matter what accounting shenanigans it could come up with, would not have been able to borrow as much as it did.
And now, as a consequence, we read about Greece having to hand over 16 of its airports to those who in order for the creditors to be paid, have paid for the right of charging a toll on much of the future tourism to Greece.
And yet not even the slightest hint of the Basel Committee telling Greece, and its creditors, they're sorry. What a sad bunch of technocrats.
Wednesday, August 19, 2015
Q. What is the most dangerous for banks?
A. That they build up excessive dangerous exposures to something that turns out much riskier than they expected
Q. When do banks usually build up such exposures?
A. Obviously when they perceive something as very safe and they expect to make very good returns on it.
Q. And what else can make those excessive bank exposures especially dangerous, for instance for the taxpayers?
A. That the banks, if something goes wrong, stand there almost naked with very little equity to cover the losses.
Q. So hypothetically, mind you, what would you think of credit-risk weighted capital requirements for banks that are especially low for what is perceived as safe?
A. Well, since that would allow banks to earn the highest risk adjusted returns on what is perceived as safe, it would therefore, sooner or later, cause banks to build up dangerously excessive exposures to what is perceived as safe against very little capital, and so it sure sounds like the perfect way to blow up the banking system..... Sir, excuse me, why do you ask all this?
PS. 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 it collapse”
Note: My January 2009 AAA-Bomb blog
PS. 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 it collapse”
Note: My January 2009 AAA-Bomb blog
Saturday, August 8, 2015
Pension funds, widows and orphans have been told to keep out of what’s perceived safe, that’s now the banks’ domain
Bank regulators, with their credit-risk-weighted capital requirements, allow banks to leverage their equity and the support received by deposit guarantees and similar, immensely, as long as they stick to lending to “The Safe”... in their mind the infallible sovereigns, the AAArisktocracy and housing.
Consequentially the more regulators favor and therefore subsidize bank lending to “The Safe”, the lower will be the interest rates paid by “The Safe”... sometimes even down to zero interests, and, of course, in relative terms the higher the rates “The Risky” need to pay.
Ergo… non-banks who have to evaluate the increased spreads between The Safe and The Risky, without counting with the regulatory bank-subsidies, are more tempted by, or are in more need of the higher rates paid by The Risky.
Pension funds, widows and orphans who were the one investing in “The Safe”, have now been told to get out of there… “That’s for the banks!”
"The Risky", like the SMEs and the entrepreneurs they used to have access to the banks… now they are left out in the cold… desperately looking for some crowd-funding.
Wednesday, August 5, 2015
Why has not a proper independent autopsy of the financial crisis 2007-08 been done? The answer: What would be found!
When we see with how much care and dedication investigators perform the autopsy of the causes of an accident whenever a plane crashes, one can truly be surprised about how little autopsy has been performed on the 2007-08 financial crash.
But of course those performing the autopsy of a plane crash are not the designers of the plane, nor those responsible for its maintenance, nor air-traffic controllers nor, of course, those who were flying it… and so there are no conflicts of interests present in the investigation (I presume).
In the case of the Financial Crisis 2007-08 crisis any outside completely independent investigator would have determined its principal cause to be:
The very low capital requirements for banks when holding assets perceived as “safe”, and which created unmanageable perverse incentives for banks to lend or invest excessively in what was ex ante perceived as safe.
Evidences?: Just look at the debris: AAA rated securities, credit default swaps issued by AAA rated AIG, loans to sovereigns like Greece, loans to real estate like in Spain. Nowhere is something ex ante perceived as "risky" found to have caused any problem. What more can you need for a prosecutor to rest his case?
But since those investigating the Financial Crash 2007-08 were, by commission or omission, directly responsible for those risk weighted capital requirements, they all found it in their best interest to shut up.
Until now their strategy has worked splendidly for them... even deregulation is denounced a thousand times more as the source of the problem than their misregulation... and some of them have even been promoted, like to BIS and ECB... and other have found job working on Basel III.