Friday, April 12, 2013

No Mme Lagarde… you are wrong! Bank regulators are more to blame than bankers.

Christine Lagarde, the Managing Director of the International Monetary Fund, at the Economic Club of New York on April 10, 2013, with respect to the financial sector reform said: 

“The bottom line is that we need a global financial system that supports stability and growth” 

Yes! Absolutely! No doubt! And that is why during a Civil Society Town Hall meeting in 2011 I asked Mme Lagarde: 

“If bank regulators had defined a purpose for banks before regulating this, we might have had a very different bank crisis, but not as large, systemic, and dangerous as this one. IMF, World Bank, when are you, as our global development agents, going to require from the regulators in the Basel Committee to openly and explicitly define the purpose of our banks… to see if we all agree? 

And Mme Lagarde answered: 

“On the purpose of banks, it is a very good debate to have, and it is one that I think the Vickers Commission Report is actually helping to build--what are banks for, and what are the state guarantees or general deposit guarantees intended for? Is it to actually guarantee the savers and the depositors, or is it something that is intended to fuel and benefit other activities that are really within a completely different realm of activities? 

My sense is that the most critical mission for the banks--and that is what we are trying to say when say that banks have to rebuild their capital buffers--is to actually finance the economy, first and foremost, and that should be really the critical mission” 

But Mme Lagarde, unfortunately, as you know, that debate and the definition of the purpose of banks have not happened yet, and the Basel III producers keep on working as if that is not necessary. 

And so when Mme Lagarde now says: “we have seen what happens when a banking sector chooses the quick buck over the lasting benefit, backing a business model that ultimately destabilizes the economy” I must object, because much more that a wrong business model it was a wrong regulatory model that destabilized the economy and the banks. 

It was bank regulators that while for instance requiring German and Cyprus banks to hold 8 percent when lending to German and Cypriot small business and entrepreneurs, which implies a 12.5 to 1 authorized bank equity leverage, allowed German and Cypriot banks to lend to a sovereign like Greece, or buy triple-A rated securities in the US, holding only 1.6 percent in capital, and which implies a mindboggling 62.5 to 1 authorized bank equity leverage. 

Though banks clear for perceived risk in the numerator, by means of interest rates, amounts of loans and other terms, bank regulators required the banks to also clear for the same risks, in the denominator, with capital requirements based on the same perceived risk. 

And the consequence of that is that banks earn much higher expected risk-adjusted returns on equity when lending to “The Infallible” than when lending to “The Risky” and that has of course fully distorted out common sense from our banking system 

And this has been one of the greatest regulatory stupidities ever, and neither the IMF nor Christine Lagarde should help to cover it up. 

PS. Here is how Mr. Zoellick as the President of the World Bank answered my question during that same Town Hall Meeting: 

“Your point about the Bank regulators is a particularly intriguing one, and let me share with you a little anecdote. 

Bank regulators come out of the world of central banks, and central banks will be the last bastion to fall in openness and transparency. When Pascal Lamy, who is head of the WTO, who has dealt with civil society groups for many years, as I did, starting in the trade area--and I met with Mario Draghi at that time, head of the Financial Stability Board--we shared with him a story that some union groups had come to Basel and tried to get in the door and talk to people, and they were met with screams of uncertainty. And we have suggested--and I'll just pass this along--that they also have to build some outreach mechanism through the Financial Stability Board and openness and transparency. And I will just share this from my own learned experience. Some institutions--central banks in particular because of the sensitive market information--build in cultures of this, and it is understandable, but then, on the policy level, as you suggest, people need to get used to being more open about it. And I just think that that is something, again, that we can try to work with you with as a general principle. I think the world will move more in this direction, but it will take some time on it. 

And I agree with Christine's response to you about the fact that the good news is, as the discussion in Britain showed, that people are starting to debate the exact purpose of banks.” 

PS. Here is my letter to the Ministers gathering in Washington for Spring Meetings 2013 on the issue of subprime banking regulations and their odious discrimination of "The Risky".