Friday, November 26, 2010
Saturday, November 20, 2010
The basic mistake that caused Basel II to be so shamefully inappropriate was that the Basel Committee explicitly ignored the fact that perceived risk of default is already cleared for in the market by means of the risk premiums charged and so making a difference for it in the capital requirements accounts twice for the same risk. And that leads to making access for those perceived as less risky even easier and cheaper, creating the perfect storm conditions as bank crisis only occur because of excessive investments or lending to what is ex-ante perceived as not risky; and causes that those who already have difficulties accessing bank credit at a reasonable rate, like the small business and entrepreneurs, will find it even harder and more onerous to do so.
But the Basel Committee, instead of tackling the fundamental weakness of Basel II, the risk-weights, is in Basel III working on important but yet marginal issues. Clearly the lower but much stricter and cleared defined basic capital requirement of 7 percent announced is an improvement, but, its final effectiveness depends 100% on correcting the issue of the risk-weights... and which basically means throwing them out completely.
And that is why we get so nervous when according to re-“Calibrating regulatory minimum capital requirements and capital buffers: a top-down approach” October 2010 we read of how the Basel Committee tries to capture empirical knowledge by analyzing the “Return on Risk-Weighted Assets” completely ignoring that risk-weighted assets when weighted with their risk weights have no real meaning at all.
Clearly the Basel Committee has fallen under that spell identified by J.K. Rowling as “Confundus” (causes the victim to become confused, befuddled) and the first order of day must be to break it. How can it be achieved? First, we need to get rid of those regulators in the Basel Committee who are way beyond any salvage; and then we must awake the rest by asking the magical question “Propositum Bancos”… what is the purpose of the banks?
Of course too many banks should not fail by not being able to maintain sufficient capital to survive throughout a significant sector-wide downturn, but that is more of a minimum requirement, a restriction, and not at all a purpose. If we, after their huge failure, are to allow the Basel Committee on Banking Supervision to keep on regulating globally the banks, the least they should tell us is what they think the purpose of the banks is, and we should be able to agree on that.
Wednesday, November 17, 2010
Tuesday, November 16, 2010
Monday, November 15, 2010
The financial crisis: What went wrong and what to do… in the eyes of an interested and concerned citizen observer.
Sunday, November 14, 2010
Thursday, November 11, 2010
Capital requirements for banks based on job creation, makes more sense than those based on risk of default.
Friday, October 29, 2010
Of course, if the regulators wanted to calibrate adequately for the default risk of any bank exposure to any credit rating, they could only do so by taking into account how the banks would react to those credit ratings…as well as considering the banks’ relative exposure to the different credit ratings. If a bank lends only to triple-A rated clients then its systemic danger, is only represented by its triple-A rated clients.
Since perceived risk is cleared in the market through the interest rates charged, this has signified that the relative profitability for the banks of lending to what is perceived as not risky, like what has a triple-A rating, increased dramatically, while the relative profitability for the banks of lending to what is perceived as more risky, like unrated small business and entrepreneurs, decreased.
Knowing as we should know that no bank crisis has ever resulted from excessive lending to what is perceived risky and that they have all resulted from excessive investments to what is perceived ex-ante as not risky, applying the Basel Committee’s current regulatory paradigm of capital requirements based on risk results clearly in counterfactual and stupid regulations. Also, since the most important role of commercial banks is to help satisfy the financial needs of those who are perceived as more risky and have not yet access to the capital markets, the odious discrimination against these clients (who are already paying much higher interest rates into the capital of banks) is doubly stupid.
If by any chance the issue of regulating on climate change would fall in the lap of an entity like the Basel Committee… we would all be toast.
For over a decade, even as an Executive Director of the World Bank 2002-2004 and always under my own name and indicating my email, I have presented many arguments against the current central regulatory paradigm use by the Basel Committee, that of capital requirements based on perceived risk of default, and called it stupid, stupid, stupid!
And by the way, if the regulators absolutely have an existential need to calibrate for risks, what is so particularly risky with defaults? Is not the risk of not creating jobs or the risk of increased un-sustainability worse? Does not just to think of a world without defaults make you shiver?
Having said that, not once, in all these years, has anyone identified as having anything to do with the Basel Committee ever denied my accusations, presented any counter-argument, or shown the least willingness to discuss the issue. Is it not strange? Could it really be that little me is right and these so expert experts are so utterly wrong? I dare them to prove me wrong!
In October 2010, during the annual meetings of the International Monetary Fund I publicly asked “Right now, when a bank lends money to a small business or an entrepreneur it needs to put up 5 TIMES more capital than when lending to a triple-A rated clients. When is the IMF to speak out against such odious discrimination that affects development and job creation, for no good particular reason since bank and financial crisis have never occurred because of excessive investments or lending to clients perceived as risky?” Dominique Strauss-Kahn, IMF’s Managing Director, answered in no uncertain terms that “capital requirement discrimination has no reason to be”, and so it seems that there are also other who agree with that the Basel Committee stands there completely naked without a functional regulatory paradigm.
In this moment when an extremely serious financial crisis affects the world and when the Basel Committee is digging us even deeper in the hole they placed us in, would we all not feel more comfortable if the Basel Committee at least agreed to a public debate on what I criticize?
Therefore…members and professionals of the Basel Committee consider yourselves slapped on the face with a glove and dared to accept the challenge. Wear with dignity your cones of shame!
Want a more detailed explanation? Listen to this video
Ps. I appreciate any help I could get in provoking the Basel Committee to respond to this challenge
Ps. Is the Basel Committee another Nut Island type disaster?
Ps. US Congress, what are you up to? Over 2.000 pages of financial reform and you do not even mention once the Basel Committee which has so messed up the capital requirements of your banks.
Ps. A small numeric example: If banks were allowed to leverage only 12.5 to 1 when lending to triple-A rated clients, which is what they were allowed to leverage when lending to small businesses under Basel II, then if they made a .5% margin, they would obtain return on capital of 6.25% lending to AAAs, decent but nothing to write home about, less pay bonuses on. But since they were allowed to leverage 62.5 to 1 they could, with the same .5% margin then make a return of capital of 31.25%. No wonder banks stampeded after the AAAs!
Ps. A visitor from outer space, observing that banks are required to have 8% of equity when lending to a small businesses, but zero% when lending to a triple-A rated sovereign as the US, would he be at fault thinking he had landed on a communistic planet? With such an arbitrary discrimination in favor of the public sector, do you really know the real market interest rates on public debt?
Ps. Since I am no regulator, or a PhD with published research on the subject, hereafter follows some very few pieces of my curriculum against the Basel Committee, and that evidences I am just not another Monday morning quarterback:
November 1999 in an Op-Ed in the Daily Journal of Caracas 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 the collapse, of the only remaining bank in the world”
March 2003 in a published letter to the Financial Times I wrote “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds”
October 2004 in a formal written statement delivered as an Executive Director of the World Bank I warned “We believe that much of the world’s financial markets are currently being dangerously overstretched through an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions”
Monday, October 25, 2010
A Swedish psalm 288 Text: F Kaan 1968 B G Hallqvist 1970
Gud, från ditt hus, vår tillflykt, du oss kallar
ut i en värld där stora risker väntar.
Ett med din värld, så vill du vi skall leva.
Gud, gör oss djärva!
“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.
God make us daring!”
“God make us daring!” That is indeed a prayer that the regulators in the Basel Committee for Banking Supervision do not even begin to understand the need for.
Wednesday, October 20, 2010
Tuesday, October 19, 2010
Friday, October 15, 2010
Since all past financial and bank crisis have resulted from excessive investments in what ex-ante was perceived as low risk, I also saw these requirements of more-risk-more-capital, less-risk-less-capital, to be absolutely counterfactual.
As I frequently spoke out about the previously in very clear and harsh words, and never received a response, I simply assumed the Basel Committee regulators to be lost for words and incapable of assuming their responsibility; or just plain thick-as-a-brick.
Unfortunately, now I must also accuse them of gross negligence, as I have only recently been able to internalize to its full extent that when the regulators calculated their risk-weights, they never considered the fact that the riskier pay much higher premiums, and which, when repaid, as it most often is, goes directly to the capital of the banks.
In “An Explanatory Note on the Basel II IRB Risk-Weight Functions", July 2005 prepared by the Basel Committee on Banking Supervision we read: “Interest rates, including risk premia, charged on credit exposures may absorb some components of unexpected losses, but the market will not support prices sufficient to cover all unexpected losses.” That would prove the regulators decided to completely ignore the markets… with premeditation.
This is exactly like if the insurance regulators required the insurance companies to post higher capital when insuring the health of persons who represent higher health-risks, without accounting for the fact that these persons will be obliged, precisely therefore, to pay much higher insurance premiums.
How negligent can one be? This negligence resulted in an odious regulatory discrimination of those perceived as “risky”, like the many small unrated businesses or entrepreneurs who, as a result did not get access to bank credit or had to pay much more than the market premiums for it. It also directly provoked the current crisis by creating the incentives that made the banks stampede after AAA-ratings, until they took the world over the subprime cliff.
I do not know whether or where you can present an accusation against the Basel Committee for gross negligence, but I do know that all its members should be forced to parade down the major streets of many capitals in the world, wearing their cone of shame.
Thursday, October 14, 2010
Could it really be that regulators completely ignored what “the riskier”, when paying higher interest rates than for instance those rated triple-A, contributed to bank equity?
Sunday, October 10, 2010
The Basel Committee on Banking Supervision has only a completely wrong and harmful tool in its toolbox.
Saturday, October 9, 2010
Thursday, October 7, 2010
Wednesday, October 6, 2010
Thursday, September 30, 2010
Wednesday, September 29, 2010
Basel III now tells us that the basic capital requirement for banks is not any longer going to be the 8 percent of wishy-washy made up capital of Basel II, but a more real and solid 7 percent. Good news!
But unfortunately Basel III completely ignores mentioning the risk-weights, though these were the real source of the problems with Basel II.
And so now with Basel III, since the risk-weight for operations with triple-A rated securities is still 20%, the “more real and solid” equity required is 1.4 percent; the new authorized leverage for banks when investing in exactly the same type of securities that set of the current crisis, is 71.4 to 1.
Are you really ok with this?
Tuesday, September 28, 2010
Friday, September 24, 2010
Sunday, September 19, 2010
One of the primary purposes of banks is tending to the financial needs of those small businesses and entrepreneurs who might be the source for the future generation of decent jobs, but are yet too small for the capital markets. If so why are you making it less attractive for banks to do just that by, in relative terms, placing much higher capital requirements on whom naturally must be perceived as riskier? Is not being perceived as riskier a heavy weight by itself? Do these clients not have to pay higher interest rates anyhow?
A banker’s most important mission is to learn to analyze a client and find ways of how to safely satisfy his credit needs. If so why are you implicitly ordering all bankers just to follow the opinions of some few credit rating agencies?
An absolute perfect credit rating, guarantees an exact pricing, and therefore provides no special profits to any side of the operation. Special profits, for one side or another, do only arise from incorrect perceptions of risk. If so, why are you creating risk information oligopolies which, when captured, can only leverage incorrect risk perceptions into a systemic risk?
Current financial regulations requires a bank to hold 100% of the standard Basel II or Basel III capital requirement when lending to a small business or entrepreneur, but allows it to hold zero percent of that same standard Basel II or Basel III capital requirement when lending to a triple-A rated sovereign like that of the USA. If so could not a visitor from outer space, looking solely at the financial regulations, simply conclude that planet earth is communistic?
In order to regulate banks, one would naturally assume the need of establishing a purpose for the banks. The Basel Committee does no such thing!
Titling the comment as I do, am I to harsh with the Basel Committee? I don’t think so!
In 1999 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 the collapse”; and as an Executive Director at the World Bank I did all I could to warn about what I was certain was doomed to happen. But I was blithely ignored by this small group of regulators who were just too cozy in their little mutual admiration club.
Well the AAA-bomb finally exploded and the Basel Committee does still not take any questions from outside their own circle, which now includes the Financial Stability Board. And now they are only giving us their “Razzle Dazzle 'em, Bazzle III 'em” treatment. That is inacceptable for a world that is and will be going through much suffering, precisely because of the Basel Committee.
Thursday, September 16, 2010
It was built with lousy materials, like arbitrary risk-weights and humanly fallible credit rating opinions.
And it was built on the absolutely wrong frontier, for two reasons:
First, it was build where the risk are perceived high, and where therefore no bank or financial crisis has ever occurred, because all those who make a living there, precisely because they are risky, can never grow into a systemic risk. Is being perceived as risky not more than a sufficient risk-weight?
Second it was built where it fends of precisely those clients whose financial needs we most expect our banks to attend, namely those of small businesses and entrepreneurs, those who could provide us our next generation of decent jobs and who have no alternative access to capital markets.
Now with their Basel III the Basel Committee insists on rebuilding with the same faulty materials on the same wrong place and it would seem that we are allowing them to do so.
I am trying to stop them… are you going to help me or do you prefer to swim in the tranquil waters of automatic solidarity with those who are supposed to know better?
The implicit stupidity of the current Basel regulations could, seeing the damage these are provoking, represent an economic crime against humanity!
Monday, September 13, 2010
Give 'em the old Razzle Dazzle, Razzle Bazzle 'em,
Friday, September 10, 2010
When I talk about an authorized leverage of "64.5 to 1" the real figure is "62.5 to 1". Since there could be some debate on whether I was trying to see if you were following me, catch you sleeping, or because I did not use a calculator I made a mistake... be my guest and pick any explanation you choose, it won´t matter anyhow for the conclusions… and I will not repeat the class just because of that.
Wednesday, September 1, 2010
3.- What is the rationale of a regulatory system where if the bank lends to an unrated small business or entrepreneur it needs to have 8 percent in capital but, if it instead lends to the government of an AAA rated sovereign, like the USA, so that government bureaucrats lend or give stimulus to the unrated small businesses and entrepreneurs, the banks need to hold zero capital? Is this not plain pro too-obese-to-succeed government regulation? What do the interest rates on public debt really signal with this type of regulations interfering?
The questions at the IMF blog
Sunday, August 29, 2010
Saturday, August 21, 2010
Friday, August 20, 2010
Conclusion: If you think bank profits and bankers´ bonuses are excessive, then you need to focus much more on where the stuff is generated and much less on how it gets distributed.