Comments on Basel Committee's “The regulatory framework: balancing risk sensitivity, simplicity and comparability” of July 8, 2013
Basel Committee for Banking Supervision
Sir,
These are comments made in reference to your July 8, 2013 consultation document “The regulatory framework: balancing risk sensitivity, simplicity and comparability”
I would like to begin by clearly stating that for a long time I have completely objected the capital requirements for banks based on ex ante perceived credit risks. I consider these capital requirements to be totally insane and much responsible for causing the current bank crisis, as well as for impeding us getting out of it.
And to that effect I enclose a short opinion recently published in the Journal of Regulation and Risk - North Asia, Volume V Issue II Summer 2013. The “Mistake” that shall not be named
That said I would also like, just as an example of what I criticize, refer to the following in the document.
“73. For example, in increasing ex ante risk sensitivity and expanding risk coverage, the framework has progressively sought greater alignment of regulatory capital with economic capital. This approach is implicitly premised on the suitability of economic capital as an appropriate measure for regulatory purposes. But the relationship between economic capital and regulatory capital may need reexamination in the light of the recent shift in the focus of regulation and supervision from ensuring the soundness of individual institutions to, additionally, safeguarding the stability of the banking system.”
First, what are you saying? That “safeguarding the stability of the banking system” was not understood to be the role of the Basel Committee for Banking Supervision before? Do those who appointed you really agree with that statement?
Second, your regulatory capital based on ex ante perceived credit risk, even in the case of an individual bank, is an utterly incomplete reflection of economic capital, since it does not consider facts like the size of the exposures, meaning the portfolio diversification/concentration, or the duration of those exposures, for instance the interest rate risk.
And then let me briefly and partially answer some of your specific questions
Q1. Does the current framework, with its reliance on the risk-based capital at its core, appropriately balance the objectives set out in paragraph 29?
No! The core of the current framework, risk-based capital is completely wrong.
For instance, when in 29 you write “These ideas should be assessed against the primary aims of the capital adequacy framework: that is, the capital adequacy framework should…. take into account the effects of capital requirements on banks' risk-taking incentives, eg when faced with regulatory constraints on their capital (and therefore the size of their balance sheet), to seek higher-risk assets as a means of boosting expected returns”, you do not seem to comprehend the real problem.
The fact is that banks, “when faced with regulatory constraints on their capital”, primarily seek assets which have a low capital requirement, in order to boost expected risk-adjusted returns on equity
Q2. Are there other objectives that should be considered in reviewing the international capital adequacy framework?
Yes, like the little matter of the purpose of the banks; like that the capital adequacy framework should not be allowed to distort the bank credit allocation to the real economy.
Q3. To what extent does the current capital framework strike the right balance between simplicity, comparability and risk sensitivity, given the costs and benefits that greater risk sensitivity brings?
To no degree at all, especially since the “greater risk sensitivity it brings” is only a quite arrogant ex-ante presumption.
Q4. Which of the potential ideas outlined in Section 5 offer the greatest potential benefit in terms of improving the balance between the simplicity, comparability and risk sensitivity of the capital adequacy framework?
In my opinion, a simple leverage ratio of 8 to 10 percent, complemented by a reporting requirement which includes; a report of risk adjusted leverage based on standardized risk-weights, and issued strictly for approximate comparative purposes; and some additional information on its portfolio diversification and duration, and that can be helpful for the market to get a sense of the risk structure of the bank.
The transition to such a reality though would have to be managed with a lot of intelligence in order not to make things worse.
Q5. Are there other ideas and approaches that the Committee should consider?
Yes!
How did Basel I, II and III evolve? How can we make sure that the serious mistakes in them and that I attribute to incestuous group-think within a mutual admiration club, are not repeated?
There is a need for a critical mass of qualified creditors in the market who know they will not be bailed out automatically from a bank problem.
Who authorized the Basel Committee to act as a risk-manager of our banks and the world?
If you want to do it right, you need to work with a whole set of new regulators who have no vested interest in defending what has been done in the past… remember, neither Hollywood nor Bollywood would ever dream of entrusting a Basel III to those responsible for Basel II flop.
Am I to harsh and impolite in my criticism? Considering the suffering and the millions of unemployed youth resulting directly from your faulty regulations, I do not think so.
Sincerely
Per Kurowski
Rockville, Maryland, USA
PS. If you want to download the whole journal from which my opinion was extracted you can go tohttp://www.scribd.com/doc/149858219/Journal-of-Regulation-Risk-North-Asia-Volume-V-Issue-II-Summer-2013
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