Saturday, May 21, 2016

“Futures Unbound” A Cato summit on bank regulations “Finance is about the future” Will the real questions be asked?

Current bank regulations require banks to hold more capital when financing what is perceived as risky than what is perceived as safe.

That means banks will be able to leverage more their equity, and the support they receive from the society, when financing what is perceived as risky than when financing what is perceived as safe.

That means banks will be able to earn higher risk adjusted returns on equity, when financing what is perceived as risky than when financing what is perceived as safe.

That means banks will no longer finance sufficiently the riskier future, they will mostly refinance the safer past.

And that silly credit risk aversion has been introduced in the Home of the Brave

To top it up, regulators have assigned a risk weight of zero percent to the sovereign and one of 100 percent to the citizens who give the sovereign its strength.

And all for nothing, since never ever has a major bank crises erupted because of excessive exposures to something ex ante perceived as risky, these have always resulted from excessive exposures to something ex ante perceived as safe.

I wonder if Cato is going to bring up the issue of how unelected technocrats, who have clearly never walked on Main Street, have thought it their right to distort the allocation of bank credit to the real economy.

Thursday, May 12, 2016

Dare answer this question, and then dare reflect on current bank regulations, and then dare doing something about it.

An AAA rating signifies a “prime” asset and assets rated below BB- signify, at their best as “highly speculative”

So here is the question: 

What might be more dangerous to the banking system, too much exposure to AAA rated assets, or too much exposure to below BB- rated assets?

Which is your answer? If you reply as I do, that of course banks will never-ever build up excessive and dangerous to something rated below BB-, and that this is much more likely to happen with AAA rated assets, then I dare you to reflect on the following:

Your regulators, for the purpose of deciding the capital requirements for banks, assigned a risk-weight of 150% for assets rated below BB-, and a risk-weight of only 20% to AAA rated assets.

Does that sound like the regulators know what they are doing?

If you answer “Yes!” go back to sleep, but if by any chance you answer “No!, then you must know you have a very important assignment in front of you, that is, if you care about the future economic perspectives of your children and grandchildren.


PS. What legal consequences should a bank regulator face if, informed of a serious mistake, he does nothing to correct it?

Sunday, May 8, 2016

Crony bank regulations got us into serious problems

For the purpose of setting the capital requirements for banks…

To our bosses, the infallible sovereigns, the governments, let’s give them a zero percent risk weight,

To that house financing politicians want to favor, let’s give them a 35 percent risk weight.

To that AAArisktocracy that we meet in Davos, let’s give them a 20 percent risk weight.

But to the SMEs, entrepreneurs and citizens, so that we seem prudent and conservative, let’s give them a 100 percent risk weight.

And for better measure, to the below BB- rated, let us assign them a 150 percent risk weight

And so banks earned higher risk adjusted returns on what was perceived, decreed or concocted safe, than on what was perceived as risky.

And so banks held too much AAA rated securities, loans to Greece and residential housing finance… and we got us the 2007-08 crash.

And so banks hold too little loans to “risky” SMEs and entrepreneurs… and so we can’t get ourselves out of the doldrums.

Anyhow let us pray Per Kurowski does not insist in explaining to others that, with respect to the real risk assets can pose to the banking system, these risk weights could be just 180 degrees the opposite.

Don’t put the blame on politics, when clearly technocratic stupidity is at fault

Below the abstract from a recent paper by Jihad C. Dagher from the International Monetary Fund titled "Regulatory Cycles: Revisiting the Political Economy of Financial Crises"

“Financial crises are usually perceived and analyzed as purely economic phenomena. The political economy of financial booms and busts, while far from ignored, remains under-emphasized and has often been analyzed in isolated episodes. 

The recent wave of financial crises has brought unprecedented attention to financial regulatory policy; yet the policy discussions and economic literature, which are usually cast in technical terms, tend to overlook political forces that shape regulations and impact their effectiveness over time. 

This paper examines the political economy of financial policy during some of the most infamous financial booms and busts and finds consistent evidence of pro-cyclical policies. 

Financial booms, and risk-taking during these episodes, were often amplified, if not ignited, by a political regulatory stimulus and interventions. The bust has always resulted in an overhaul of the regulatory and supervisory framework and a political turnover. The interplay between politics and financial policy over these cycles, and their institutional underpinnings, deserve further attention. 

Politics can be the undoing of macro-prudential policy”

Basel II, of June 2004, for the purpose of determining the capital requirements for banks, set the risk weights for corporates rated AAA at 20% and that of those rated below BB- at 150%.

Sorry, frankly, those who believe that those below BB- rated pose a greater risk for the banking system, have no idea about what they are talking about, and have probably never ever left their desks to walk down on Main Street.

That has nothing to do with politics, that is sheer technocratic stupidity

Saturday, May 7, 2016

Why was the most important obstacle for small businesses accessing bank credit not even mentioned in 2012 JOBS Act?

Bank regulators consider small unrated businesses to be much more dangerous to the banking system and to financial stability, than well-rated corporations.

That is an extremely flimsy and wrong proposition, based on absolutely nothing! 

And that is why, with Basel II, for the purpose of defining the risk weighted capital requirements for banks, regulators assigned a risk weight of 100 percent for the small unrated businesses and one of only 20 for AAA to AA rated corporations.

And that translated into banks being allowed to hold much less capital against “the safe” assets than against “the risky assets; which meant banks could leverage more their equity lending to the safe than lending to the risky; which meant banks earn higher expected risk adjusted returns on equity when lending to the safe than when lending to the risky.

And that represents the most significant cause for small-unrated businesses not having fair access to bank credit.

And not a single word about that obstacle, and the need to remove it, was mentioned in the Jumpstart Our Business Startups (JOBS) Act of 2012

And amazingly, the issue of the distortions in the allocation of bank credit to the real economy that credit risk aversion causes in the Home of the Brave, is still not even being discussed.

Tuesday, April 26, 2016

America "The Home of the Brave" is going down, because of bank regulators' silly/sissy credit risk aversion.

Banks use to decide whom to lend to, based on who offered them the highest risk adjusted interest rates. 

Not any more. Now banks have to calculate what those risk adjusted interest rates signify in terms of risk-adjusted rates of return on their equity. That is because with their risk weighted capital requirements, regulators now allow banks to hold less capital, and therefore be able to leverage more their equity, when engaging with The Safe than with The Risky.

And those perceived, decreed or concocted as belonging to The Safe, include sovereigns (governments), members of the AAArisktocracy and the financing of houses.

And those belonging to The Risky are SMEs, entrepreneurs, the unrated or the not-so good rated, and citizens in general.

And that of course has introduced a regulatory risk aversion that distorts the allocation of credit to the real economy. By guaranteeing “The Risky” will now have too little access to credit, that dooms the economy and the banks to slowly fade away.

But the banks and the economy could also disappear with a Big Bang. That because by giving banks incentives to go too much for The Safe, sooner or later, some safe havens will be dangerously overpopulated, and we will all suddenly find ourselves there gasping for oxygen.

In essence, because of this regulation, banks no longer finance the riskier future; they just refinance the (for the time being) safer past.

How did this happen? There are many explanations but the most important one is that regulators never defined the purpose of the banks before regulating these.

“A ship in harbor is safe, but that is not what ships are for.” John A Shedd, 1850-1926

PS. That also goes for the rest of the world. For instance the Eurozone was done in with it.

Saturday, April 23, 2016

There are risks and risks. Bank regulators promote the worst and avoid the best.

We now read “US federal regulators this week proposed new pay rules intended to limit excessive risk-taking”

And so its time again to understand there are different “excessive risk-taking”.

One “excessive risk-taking”, is that of creating dangerously large exposures to what is perceived, decreed or concocted as safe. Those exposures currently require very little bank capital. That was the “excessive risk taking” that caused the 2007-08 crisis; AAA rated securities, residential housing finance and sovereigns like Greece.

Another different “excessive risk-taking” is taking risks on the risky, like on SMEs and entrepreneurs. These risks, because they currently generate much higher capital requirements, are risks not sufficiently taken by the banks, and the economy suffers from that.

Do regulators really know what “excessive risk-taking” they want to limit? I seriously doubt it. The “more-risk less-pay” and the “less-risk more-pay” is just the typical kind of intervention that brings on unexpected consequences.

More-risk more-capital less-pay. Less-risk less-capital more-pay. Friends with these regulations we will soon all end up suffocating because of lack of oxygen in some over-populated safe haven!

And our children, they will be without jobs. Because with this regulatory silliness banks do not finance the riskier future any longer, they just refinance the for the short time being safer past.

In short, any senseless risk aversion, whether in bank regulations or elsewhere, condemn our economies and nations to fizzle out.

Friday, April 22, 2016

The Vasa and the Basel I, II and III disasters

Stefan Ingves, the chair of the Basel Committee, in a speech titled "From the Vasa to the Basel framework: The dangers of instability" last November, said the following:

“In 1625, King Gustav II Adolf of Sweden ordered the construction of…the mighty Vasa. 

It took three years and 300 men to build the Vasa. And 40 acres of timber were consumed. 

The final result was impressive. The Vasa had two gun decks, 64 bronze cannons, and its tallest mast soared to 57 metres. The ship was the result of a quest for perfection. 

This perfection was, alas, short-lived. Tragically, the Vasa sank on its maiden voyage, after sailing only 1,300 metres, on 10 August 1628. 

After so much planning, so many resources and so much time and effort, why did the Vasa sink? According to the King, it was the result of ‘foolishness and incompetence’ 

But historians generally agree that a key factor in the Vasa's fate was the lack of stability and the hull's excessive rigidity… the Vasa was well constructed but incorrectly proportioned” 

As I read it if the historians are right, then clearly so is the King.

And bank regulations designed by the Basel Committee, especially the risk weighing of the capital requirements, was absolutely “incorrectly proportioned”, and so to me the regulators have been foolish and utterly incompetent.

And with respect to Basel III Stefan Ingves said: “The framework has remained unchanged from Basel II across two broad dimensions: first, the way in which risk is measured - and in particular, the reliance on banks' own estimates of risk - has remained the same following the crisis; and second, the risk-weighted approaches are essentially the same as they were before the crisis"

But, in order to “address the fault lines that emerge from these two dimensions” Ingves now tells us that the regulators are working to fix that with "(i) enhancing the risk sensitivity and robustness of standardized approaches; (ii) reviewing the role of internal models in the capital framework; and (iii) finalizing the design and calibration of the leverage ratio and capital floors."

As I see it, in Vasa terms, the hull of Basel III still lacks stability, but the Basel Committee just keeps on loading more “bronze cannons” on its deck.

“Enhancing the risk sensitivity”? For God’s sake, they are still looking at the risk of the assets and not at the risk those assets pose to the banks… and so they still do not understand that the safer an asset might be perceived, the riskier it could be for the banking system.

And they still have not defined the purpose of the banks, and so they still do not care one iota about if their risk weighing distorts the allocation of credit to the real economy.

I ask, would, King Gustav II Adolf of Sweden have given the constructors of Vasa the resources to build another boat, like we allow the same regulators who designed Basel I and Basel II to now work on Basel III? I don’t think so!

And in wikipedia we read “An inquiry was organized by the Swedish Privy Council to find those responsible for the Vasa disaster, but in the end no one was punished for the fiasco.”

Lucky Stefan Ingves... in the case of the monumental failings of Basel II there has not even been an inquiry!

“A ship in harbor is safe, but that is not what ships are for.” said John Augustus Shedd, 1850-1926. Well, if built by something like the Basel Committee, it is not even safe in the harbor J


Thursday, April 21, 2016

Let us tell the story of the Basel Committee’s risk weighted capital requirements for banks this way:

This happened during a meeting in the Basel Committee for Banking Supervision

Q. Colleagues, how on earth can we stop banks from failing? 

A. Well they must avoid taking risks?

Q. Absolutely! But how do we stop them from taking risks?

A. Perhaps by giving them great incentives to make their profits where it is safe?

Q. Sounds great! Any idea how?

A. Well we could allow them to leverage much more when lending to what is safe than when lending to what is risky.

Q. How would that help?

A. Well then the banks could obtain higher risk adjusted rates of return on lending to what is safe than on lending to what is risky.

Q. But, could that not distort the allocation of credit to the real economy?

A. Oh that is not our problem. We are just here to make banks safe. 

Q. But, what if something perceived as safe turns out to be risky?

A. Don’t be so negative. We will deal with that later if it ever happens.

Q. But could not someone argue we are introducing a regulatory discrimination against The Risky?

A. Who cares? The sovereign will be more than happy if we give it a zero percent risk weighting. The banks, making their best profits on what is safe, will only have their wettest wet dreams realized. And the risky, the SMEs and entrepreneurs, they have no voice… hey they are not even invited to the World Economic Forum at Davos… there we only meet the AAArisktocracy.

Q. Dear colleague, you have convinced all of us… let us go for it. By the way, what is your name?

A. Chauncey Gardiner Sir

Tuesday, April 19, 2016

Current bank regulators are a serious threat to economic growth and financial stability; and they promote inequality.

Risk weighted capital requirements for banks, more perceived risk more capital; less risk less capital, results in the following: 

It allows banks to leverage more their equity with what is perceived as safe than with what is perceived as risky; and banks will therefore be able to earn higher expected risk adjusted return on equity on what is perceived as safe than on what is perceived as risky. 

And so banks will therefore lend too much and in too easy conditions to The Safe, like to sovereigns, residential housing and the AAArisktocracy; and too little in too harsh terms to The Risky, like SMEs and entrepreneurs.

That has negative consequences for:

Economic growth: It is affected negatively by hindering the access to bank credit of those most likely to open new paths of growth. Now banks are not financing the riskier future, thet are just refinancing the, for the short time being, safer past

Risk of financial instability: It grows since bank crisis never ever result from excessive exposures to something perceived as risky, they always result from excessive exposures to something erroneously perceived as safe. And in this case all is made worse by the fact that when an explosion occurs, the banks will stand there with specially little capital to cover themselves up with.

Inequality: Is promoted by denying “The Risky” a fair access to the opportunities that bank credit can provide. 

The regulators have gone mad! You want proof? Here are four of many:

1. The bank regulators are regulating the banks without having defined the purpose of these. Anyone trying to regulate anything without asking what he regulates is for, is as crazy as can be. “A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926

2. In Basel II, June 2004, regulators assigned a 35 percent risk weight to residential mortgages; AAA-rated securities backed with mortgages to the subprime sector carried a 20 percent risk weight; the risk weight for sovereigns rated like Greece, hovered between 0 and 20 percent… but assets rated below BB- carried a 150 percent risk weight.

Who in his sane mind can believe that assets rated below BB- pose a bigger risk to our banking system than those assets believed to be safe?

3. Bank capital is primarily to cover for unexpected losses. Who in his sane mind would estimate unexpected losses based on expected credit losses? If anything what is perceived as safe has greater potential to deliver unexpected losses than what is perceived as risky.

4. Regulators ignored that any risk, even if perfectly perceived, leads to the wrong actions if excessively considered. Credit risk are already cleared for by banks by means of interest rates and size of exposure, so that to also order the same risks to be cleared for again in the capital, completely distorted the allocation of bank credit to the real economy. Who in his sane mind could think that, as a regulator, he was authorized to do a thing like that?

Thursday, April 14, 2016

IMF & World Bank Spring Meetings: Time again for finance ministers not daring to ask bank regulators THE QUESTION

Dear regulator

Because of your risk weighted capital requirements, banks are allowed to hold less capital against assets that are perceived as safe than against assets perceived as risky.

That means of course that banks can leverage equity more with assets perceived as safe than with assets perceived as risky.

That means of course that banks can obtain higher expected risk adjusted returns on equity with assets perceived as safe than with assets perceived as risky.

So here is THE QUESTION:

Does that not distort the allocation of bank credit to the real economy, causing banks to lend way too much to those perceived, decreed or even concocted as safe, and way too little to those perceived as risky, like SMEs and entrepreneurs?


PS. Where did all our current bank regulators, those who are writing up Basel I, Basel II, Basel 2.5, Basel III or what have you, study their Bank Regulations 101? Who checks the CVs of these appointees, or do they appoint themselves? Might they just have dropped in like any Chauncey Gardiner?

Monday, April 11, 2016

The way governments are cooking it perhaps we should all run to Panama, for our children and grandchildren’s sake.

Look at what government’s are doing.

The regulators set risk weights for public debt at zero percent, which means that the banks need to hold the least capital when lending to those who sort of appoint them, talk about a conflict of interest… talk about lobbying.

The central banks, with their QEs, buy mostly sovereign debt.

And the central banks with their negative interest rates benefit mostly governments, since who in his sane mind would lend to his neighbor at a negative rate?

So really, what do they need our taxes for?

But those who will surely have to pay for all this madness, will be our children and grandchildren, and so perhaps we, responsible fathers and grandfathers, should all be running to Panama and similar places to see what we can safeguard for them.

William C Dudley, Fed New York, does still not understand how risk-weighted capital requirements for banks distort

On March 31, 2016 William C Dudley of the Federal Reserve Bank of New York, gave a speech titled “The role of the Federal Reserve – lessons from financial crises” 

There are many issues I do not agree with in that discourse but let me here concentrate on “lessons from financial crisis”. 

Mr Dudley stated: “The crisis showed that the regulatory community did not fully grasp the vulnerability of the financial system. In particular, critical financial institutions were not resilient enough to cope with large scale disruptions without assistance, and problems in one institution quickly spread to others.”

Not a word about how the risk-weighted capital requirements for banks; which permit banks to leverage more on what is perceived, or has been decreed, or has been concocted as safe, than with what is perceived as risky; which means banks earn higher risk adjusted returns on equity on what is "safe" than on what is “risky”; which means banks will lend too much to what is “safe”, like sovereigns and the AAArisktocracy, and too little to what is “risky”, like SMEs and entrepreneurs.

And anyone who has still not understood the dangers that distortion of the allocation of bank credit poses to the banks, and to the real economy, doest not have what it takes to work on bank regulations.

The main lesson here is: It was the regulators who, by allowing banks to hold less capital against precisely the stuff that all major bank crisis are made of, namely what is ex ante perceived as safe, made the banking sector more vulnerable.

Thursday, April 7, 2016

The regulatory powers of our bank regulators need to be urgently regulated, at least those of the Basel Committee.

What do you think the world would have said if the Basel Committee had informed it that it would regulate the banks, without considering the purpose of the banks? 

What do you think the world had said if the Basel Committee had informed that in order to make the banks safer, they were going to distort the allocation of credit to the real economy?

What do you think the world would have said if the Basel Committee had informed it that even though all major bank crises have always resulted from excessive exposures to something ex ante erroneously perceived as safe, they would allow for especially low capital requirements against bank exposures to what ex ante was perceived as safe.

What do you think the world would have said if the Basel Committee had informed it that even though the society considered that banks giving credit to SMEs and entrepreneurs was very important, they would saddle the banks with especially large capital requirements on account of those “risky” being risky.

What do you think the world would have said if the Basel Committee had informed it that it was going to assign a zero risk weight to sovereigns and a 100 percent risk weight to the citizens, and which indicated their belief that government employees could make better use of other people’s money than private citizens could use theirs. 

What do you think the world would have said if the Basel Committee had informed it that even though banks already cleared for credit risks with interest rates and size of exposure they would also require banks to clear for that same risk in the capital; and that even though any risk that is excessively considered leads to the wrong actions even if perfectly perceived.

What do you think the world would have said if the Basel Committee had informed it that because they could not estimate the unexpected losses that bank capital is primarily to cover for, they would use expected credit risks as a proxy for the unexpected.

What do we think about that even when the 2007-08 clearly evidenced the failure of the regulators, they go on as if nothing, using the same regulatory principles? I just know that neither Hollywood nor Bollywood would ever have permitted those creating the box-office flop of Basel II, to go on working on Basel III.

Sincerely, are we really sure all these regulators in the Basel Committee, and in the Financial Stability Board, are just not some Chauncey Gardiner characters?

Tuesday, April 5, 2016

Again the Basel Committee for Banking Supervision evidences it is a clueless producer of systemic risks.

I refer to a speech by William Coen the Secretary General of the Basel Committee, given in Sydney on 5 April 2016 and titled “The global policy reform agenda: completing the job” Coen said: 

“A bridge is an apt metaphor for the Basel framework. Bridges must be safe and sound. A safe and sound banking system is exactly what the Basel framework aims to support. Bridges facilitate movement, commerce and trade. The financial system plays a crucial role in directing investment and funds between individuals and businesses…

For the past 25 years, the foundation of the international approach to the prudential regulation of banks has been a risk-based capital ratio.

The level of capital is a difficult question. There are many views on what the "right amount" should be”

So it is clear that the Basel Committee still does not understand the distortion they cause. Its risk-based capital ratios, which allows banks to leverage equity differently with different assets depending on their ex ante perceived risk, amounts to building some very wide bridges where banks and “the safe” can interact a lot with ease, and then some very narrow bridges that make the relations between banks and “the risky” much harder than they already were.

Coen confesses: “We have spent several years developing a framework to make sure that banks' capital and liquidity buffers are strong enough to keep the system safe and sound.” And that is precisely the problem; they only cared about the condition of the banks and not one iota about the fundamental social purpose of banks, which is allocating credit efficiently to the real economy.

And Coen also quoted the Dutch central bank with: "today's undesirable behavior in financial institutions is at the root of tomorrow's solvency and liquidity problems".

That is correct but I would also add: Today’s undesirable regulatory failure is and will be at the root of tomorrows problems with the real economy… and in the long run no bank system cam be safe and sound, if the underlying real economy is not safe and sound.

And by the way, the root of 2007-08’s solvency and liquidity problems, laid in those authorized leverages of over 60 to 1 for AAA rated securities and sovereigns like Greece.

What are we to do with this bunch of not accountable to any technocrats that have never walked on Main Street, and are incapable of understanding that risk-taking is the oxygen of all development? 

A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926 

Please, give our banks one sole equal capital requirement for all assets, to protect banks not against expected credit risks already cleared for, but against unforeseen risks, such as the Basel Committee falling into the hands of clueless regulators.

Let us never forget that the most dangerous systemic risks can easily be introduced by the regulators.

Wednesday, March 30, 2016

Houston we’ve got a huge problem. Bank regulators and other experts don’t get it!

With Basel II, banks were authorized to leverage their defined equity:

Unlimited times when lending to AAA to AA rated sovereigns
62.5 times to 1 when lending to the AAA to AA corporates, the AAArisktocracy
35.7 times to 1 when financing residential housing
And only 12.5 times to 1 when lending to unrated citizens SMEs and entrepreneurs

And that of course allowed banks to earn quite different expected risk adjusted returns on equity not based on what the market offered, but based on what the regulators dictated.

And regulators, finance professors, FT editors and journalists, and many other experts simply do not understand that this distorts the allocation of bank credit to the real economy.

What are we to do?

Tuesday, March 29, 2016

Mr Hiroshi Nakaso, you are wrong! You and your colleagues, so irresponsibly, changed the nature of our banks.


In it he said: “Joseph Alois Schumpeter, in his seminal “The Theory of Economic Development” stresses the important role played by the “banker”, as well as that of the “entrepreneur”. The banker profits from her ability to identify those entrepreneurs who develop truly innovative undertakings that are high-quality startups, and from generating information that leads to improved corporate performance. Schumpeter expects that such profit motives of the banker backed up by her exceptional ability to pick winners would bring about a more efficient reallocation of risks in the macro economy and lead to an endogenous rise in the economic growth rate.

This role of the banker- promoting the creative destruction through financial intermediation – has not changed since the time of Schumpeter.”

You are so wrong Mr Nakaso! You and your colleagues have changed the role of the banker.

With your risk weighted capital requirements for banks, which allow banks to leverage more their equity with what is perceived safe than with what is perceived risky; and thereby be able to obtain higher expected risk-adjusted returns on equity when financing what’s “safe” than when financing what’s “risky”, have certainly changed the role of the banker.

Nowadays his role, as you and you colleagues have seen it fit, is simply to avoid taking credit risks.

If you do not believe me look at the following authorized bank equity leverages in Basel II. (The risk weights in Basel III remains the same)

When lending to prime sovereigns, the sky is the limit. 
When lending to the AAArisktocracy 62.5 times to 1.
When financing residential housing 35.7 times to 1
And when lending to risky unrated SMEs and entreprenuers, only 12.5 times to 1

And that Mr Nakaso, is why banks do not any longer finance the riskier future, they just refinance the, for the very short time being, safer past.

The next generations will hold you and your colleagues accountable for this regulatory atrocity.