Monday, February 29, 2016

I found some qualified support for one of my ignored arguments against current credit risk weighted capital requirements for banks.

In Charles Goodhart’s “The Basel Committee on Banking Supervision: A History of the early years 1974-1997" I just discovered, tucked away in a small note right before the Epilogue and with no reference in the index, the following about “unexpected losses”

“In so far as capital is required against unexpected loss, since expected loss should be handled by appropriate rate margins, the use of credit ratings as a guide to risk weights for Capital Adequacy Requirement’s is wrong and inconsistent, since these give a measure of expected credit loss… If capital requirements had been based, as they logically should have been, on the uncertainty attending future losses, rather than their expected modal performance, the financial system might have avoided much of the worst disasters of the 2007/2008 financial crisis”

That is what I have argued of years. Does the fact that somebody knew it, and said it, and yet it was ignored not clearly reflect that something smells very rotten in the Basel Committee for Banking Supervision?

How on earth do we allow our banking system to be in the hands of such irresponsible regulatory charlatans? Have they not done enough damage as is?

And of course, this is but one of many regulatory mistakes/sins they have committed 

PS. On the specific issue of expected risks substituting for unexpected risks, I have written around 50 letters to the Financial Times, but they have all been ignored. Perhaps when now raised by one with much better standing than me, it will at long last be brought into the debate.

PS. For instance in 2001 the Fed, FDIC and OCC set the following risk weight depending on credit rating; AAA to AA 20 percent; A 50%; BBB (the lowest investment grade) 100 percent; and BB (below investment grade) 200%. If that’s not runaway nonsense what is?

Sunday, February 28, 2016

Regulators told banks: "Extract all value you can from the safer past, and forget about the riskier future." And so here we stand.

Nancy Birdsall in “Middle-Class Heroes”, Foreign Affairs March/April 2016 writes:

“The fear is that the new middle class will be hit hard if it turns out that global growth was built too much on easy credit and commodity booms and too little on the productivity gains that raise incomes and living standards for everyone”

That is precisely what happened, and the awful consequences of it are already to be seen.

When bank regulators decided on risk weighted capital requirements for banks, they allowed banks to leverage their equity, and the support they received from society, much more with assets perceived or deemed as safe than with assets perceived as risky.

And that meant that banks would earn much higher expected risk adjusted returns on equity with “safe” assets than with “risky” assets.

And what is the biggest source of safeness? What we already know it, what is already here, what comes from the past. 

And what is the biggest source of riskiness? What we still do not know, what is not here, what still lies in the future.

And so banks were given the incentives to refinance the safe past, like placing reverse mortages on what had already been achieved; and to forget to finance the riskier future.

And that is destroying not only the current middle class but, much worse yet, the of our young ones, who need a great dose of risk-taking in order to have a chance for a better future.

Thursday, February 25, 2016

Bank regulators cause price of credit for the safe to be lower than usual than that of the risky. It costs us a lot!

Lawrence H. Summers writes about “the concept of secular stagnation, first put forward by the economist Alvin Hansen in the 1930s. The economies of the industrial world, in this view, suffer from an imbalance resulting from an increasing propensity to save and a decreasing propensity to invest. [And that] it is natural to suppose that interest rates – the price of money- adjust to balance the supply of savings and the demand for investment in an economy” “The Age of Secular Stagnation” Foreign Affairs March/April 2016.

But the intermediation between savings and investment, when carried out by banks, has now been distorted by the fact that banks are allowed to earn higher risk adjusted returns on equity when holding “safe” assets, than when holding “risky” assets? That is the de facto result of the risk weighted capital requirement for banks.

And so now the difference in the price of bank money for the safe, and the price of money for the risky, will be much larger than what would be the case without these regulations. And, consequentially, the demand for investment of the safe will be larger than that in an undistorted equilibrium, and the demand for investment of the risky, much lower.

One way to explain it is with houses and jobs. As is, the financing of houses has been considered much safer by regulators than the financing of job creation through “risky” SMEs and entrepreneurs. And so society is, faster than little by little, getting stuck with too many houses and too few jobs.

@PerKurowski ©

Are banks really worthy of taxpayer support? Given current bank regulations the answer must be NO!

If banks by means of efficient credit allocation to the real economy assist in generating sturdy sustainable economic growth, and thereby banks were fulfilling what I consider to be its primary social function, then of course banks should be supported.

But since currently the allocation of credit is distorted by the risk weighted capital requirements for banks, imposed by regulators who only want to turn banks into safe mattresses in which to deposit money, and who do not care one iota about credit allocation, there is no reason to support banks.

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

Dare ask: How many millions of small bank loans to SMEs and entrepreneurs, has the Basel Committee’s regulations impeded worldwide?

The curious border between what finance professors can understand, and what they cannot understand

If with regulations you allow banks to leverage much more their equity, and all the support these receives from society, with assets type A than with asset type B, then banks will be able to obtain higher expected risk adjusted returns on equity with assets A than with assets B. 

That finance professors can understand.

And the above will cause the banks to exclusively hold assets A, unless assets B offers these a much higher risk adjusted return than what would have been the case in the absence of such regulations.

That finance professors can understand.

And that clearly signifies a distortion in the allocation of bank credit. 

And that finance professors can understand.

But if you just substitute “safe assets” for assets “type A”, and “risky assets”, like loans to SMEs and entrepreneurs, for assets “type B”, then suddenly finance professors no longer understand.

And that I know because no one of them is protesting the distortions in the allocation of credit produced by the risk weighted capital requirements for banks. 

Strange eh?

What behavioral theory explains that?

Tuesday, February 23, 2016

Shame on you bank regulators… you even dared lie to your own Queen, to her face!

November 2008, Her Majesty, Queen Elizabeth asked: why did nobody notice the “awful" financial crisis earlier?

But now I see that in December 2012, four years later the “Queen finally finds out why no one saw the financial crisis coming”. Interested I went to read about it and, not really unsurprisingly, they are shamelessly lying to their own Queen, in her face.

It states: “As she toured the Bank of England's gold vault, Sujit Kapadia, an economist and one of the Bank's top financial policy experts, stopped the Queen to say he would like to answer the question she had posed. And Kapadia went on to explain that as the global economy boomed in the pre-crisis years, the City had got "complacent" and many thought regulation wasn't necessary.

Kapadia told Her Majesty that financial crises were a bit like earthquakes and flu pandemics in being rare and difficult to predict, and reassured her that the staff at the Bank were there to help prevent another one. "Is there another one coming?" the Duke of Edinburgh joked, before warning them: "Don't do it again."

When the Queen was leaving the governor of the Bank, Sir Mervyn King, said: "The people you met today are really the unsung heroes, the people that kept not just the banking system but the economy as a whole functioning in the most challenging of circumstances.”

Holy moly what bullshit! If it was my Queen, I would never have lied to her that way,I would have asked her instead for her pardon.

Of course financial crisis are difficult to predict but, in this case it was a crises fabricated by bad bank regulations.

Kapadia explained: “the City had got "complacent" and many thought regulation wasn't necessary”. 

Absolutely not! The regulators intervened perhaps more than ever and in doing so completely distorted the allocation of bank credit to the real economy.

With their risk adjusted capital requirements they allowed banks to leverage immensely more on assets ex ante perceived or deemed as "safe", like AAA rated securities or loans to Greece, than with assets perceived as "risky", like small loans wit high risk premiums to SMEs and entrepreneurs. 

And that meant they allowed bankers fulfill their wet dreams of earning the highest expected risk adjusted profits on what’s safe. And if, as a regulator, you do a thing like that, something is doomed , sooner or later, to go very bad.

In January 2003 I had already warned in a letter to the Financial Times: “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. Friends, as it is, the world is tough enough.”

And worst of all is that basically the same regulators keep on regulating basically the same way, Basel I, II and III.

And all for nothing, since never ever have major bank crises resulted from excessive exposures to what was ex ante perceived as risky; these always resulted from excessive exposures to something ex ante perceived as risky, but that ex post turned out to be very risky.

The absolute truth is that had the regulators not regulated at all, banks would never have been leverage as much as they did.

Monday, February 22, 2016

To obtain loans sovereigns don’t need to threaten lenders with dungeons anymore. They now have the Basel Committee.

In Yuval Noah Harari’s “Sapiens: A brief history of humankind” we read: “The king of Spain desperately needs more money to pay his army. He’s sure that your father has cash to spare. So he brings trumped-up treason charges against your brother. If he doesn’t come up with 20.000 gold coins forthwith, he’ll get cast into a dungeon and rot there until he dies”

Nowadays sovereigns are much more intelligent and much less transparent. They appoint their expert technocrats to the Basel Committee for Banking Supervision and who, for the purpose of setting the risk weighted capital requirements for banks, assign a 100 percent risk weight to the private sector and a zero percent risk weight to the sovereign.

Read more about the horrors of the Basel Accord of 1988, and which no one protested.

Thursday, February 11, 2016

Patrick McHenry, next time ask Fed’s Janet Yellen about the legality of risk weighted capital requirements for banks

Patrick McHenry (R-North Carolina) asked Fed chair Janet Yellen about the Fed's legal authority to  implement negative rates… And seemingly it is a bit unclear. 

But he should also have asked:

Is it really legal for the Fed to support bank regulations that require banks to hold more capital against loans to The Risky than against loans to The Safe?

I ask since that allows banks to leverage more their equity and the support we gve them when lending to The Safe than when lending to The Risky.

And that allows banks to earn higher expected risk adjusted returns on equity when lending to The Safe than when lending to The Risky 

And therefore that favors the access to bank credit of those perceived as safe, and thereby discriminates against the fair access to bank credit of those perceived as risky.

Are not The Risky already discriminated enough by the sole fact they are perceived as risky and therefore receive less and more expensive credit?

Does not the real economy suffer when the allocation of bank credit is distorted this way?

Has this not introduce a regulatory risk aversion in The Home of the Brave?

And how does this make banks more stable? Are not the big bank crises always detonated by something perceived as very safe that later turn out very risky?

Tuesday, February 9, 2016

The Tier 1 Common Capital Ratio, to the Leverage Ratio, gives you the Hiding the Risks (in the bank) Ratio.

The Tier 1 common Capital Ratio uses in the denominator risk weighted assets, calculated with risk weights not assigned by me… the safer an assets is perceived to be or is deemed to be the lower its value.

The Leverage Ratio uses in the denominator the gross value (of most) assets.

Since I have always felt much more nervous about the assets a bank perceives as very safe compared to the assets it perceives as risky, I give much more importance to the Leverage Ratio, than to the Tier 1 Common Capital Ratio.

But the regulators would not allow me the data on the Leverage Ratio, because, in their opinion, that would not reveal the real leverage to me… it would only confuse me.

And so they decided to credit-risk weigh the assets, and came up with the Tier 1 Common Capital Ratio.

And that made many in the market feel very much more comfortable with that the banks were quite adequately capitalized.

But one has to adapt, and so I felt that there was a new very interesting Ratio to be found in the market whenever the Leverage Ratio was published. And that was the Tier 1 Common Capital Ratio to the Leverage Ratio Ratio, because that Ratio would represent the Hiding Risks Ratio.

Deutsche Bank reported at the end of 2015 Tier 1 Common Capital Ratio of 11.5% and a Leverage Ratio of 3.6%, and that would signify a 319 percent Hiding Risks Ratio. I am not sure it is the highest… but it is sure high enough to make me very nervous.

Monday, February 8, 2016

The governments must stop their bureaucrats/technocrats from meddling dangerously with banks and the real economy.

The Basel Committee first published their Core Principles for effective banking supervision in 1997, their “de facto minimum standard for sound prudential regulation and supervision of banks”. The latest version, from 2012, now includes 29 Core Principles

It makes for a harrowing read. Of the 29, 16 have explicitly to do with what the supervisor “determines”, “sets”, “defines” or “requires”. And Principles 8 and 9, on the Supervisory Approach Techniques and Tools to be used when regulating banks, reads like an arrogant meddling bureaucrat’s wet dream.

There is not one single reference to the possibility that regulations could, with tragic consequences, interfere with the allocation of bank credit to the real economy. 

Consider their Principle 16 – on capital adequacy: “The supervisor sets prudent and appropriate capital adequacy requirements for banks that reflect the risks undertaken by, and presented by, a bank in the context of the markets and macroeconomic conditions in which it operates. The supervisor defines the components of capital, bearing in mind their ability to absorb losses.” 

That lead to the pillar of current regulations the risk weighted capital (equity) requirements for banks. The higher ex ante perceived or deemed risk of assets the higher the capital requirement; the lower the ex ante perceived risk of assets the lower the capital requirement.

And that means banks can leverage their equity more with assets perceived as safe, than with assets perceived as risky; and that results of course in that banks earn higher expected risk adjusted returns on their equity on assets perceived as safe, than on assets perceived as risky.

And so that favored more than what was normal bank lending to The Safe, like sovereigns, the AAArisktocracy and housing; and hindered more than what was normal, any bank lending to The Risky, like to SMEs and entrepreneurs.

And since excessive bank lending, against too little capital, to what was ex-ante perceived as very safe but that ex post turns out as very risky, is precisely the stuff major bank crises are made of, bank regulators have set the whole bank system on course to major disasters. 

And since insufficient lending to those who on the margin are most likely to move the economy forward, so as it will not stall and fall, like the SMEs and entrepreneurs, bank regulators have set the economy on course to major disasters. 

And consider their Principle 17 – on credit risk: “The supervisor determines that banks have an adequate credit risk management process that takes into account their risk appetite, risk profile and market and macroeconomic conditions. This includes prudent policies and processes to identify, measure, evaluate, monitor, report and control or mitigate credit risk (including counterparty credit risk) on a timely basis. The full credit lifecycle is covered including credit underwriting, credit evaluation, and the ongoing management of the bank’s loan and investment portfolios.”

And the question is… how can you have adequate credit risk management when regulators also force you to clear in the capital the perceived credit risk you already clear for when deciding the risk premium and the size of the exposure?

And also ask yourselves… Why should the risk adjusted expected net margin paid by the risky to the banks be worth less than that paid by the safe? And then you will begin to understand how this regulation curtail opportunities to access bank credit and thereby increases inequality.

In other words regulators, insufflated with exaggerated estimates of their own abilities, are leading our banks and our economies to disaster.

Here (when I find the list) I will place the names for those responsible for these so that may be duly ashamed.

Basel Committee and you other scheming dumb regulators, “Thanks, Great Job! Next time please keep out of our banks.”

A bank would ordinarily require lower risk premiums for the purchase of a house by someone willing to make an important down payment, and who showed sufficient income to be able to service the mortgage, than the risk premium the bank would require for riskier ventures, like that of lending to SMEs or entrepreneurs... those who though risky, could best help us to create the next generation of decent jobs.

But now, ever since regulators allowed banks to leverage more their equity with “safe” housing loans than with loans to The Risky, that meant the risk premiums offered in the market for housing loans suddenly got to be worth much more in terms of risk adjusted returns on bank equity, than those offered by The Risky. 

The consequence? More loans to housing, and much less loans to SMEs and entrepreneurs than would ordinarily have been the case without this distortion. 

And so now we are doomed to live unsafely in our safe houses, because of the lack of jobs we need in order to repay mortgages and utility bills.

Thanks regulators! Great Job! Next time please keep out of our banks.

Governments, your prime responsibility is to profoundly distrust your own technocrats, and to block these from dangerously meddling with our real economies.

Friday, February 5, 2016

Obama, Republican and Democratic candidates, you should be very concerned with the mindset of your bank regulators.

The pillar of regulations designed to keep the banking system safe, is the risk weighted capital requirements for banks. 

These, with Basel II, set the risk weight for ‘highly speculative’ below BB- rated assets to be 150%, while the corresponding risk weight, for ‘prime’ AAA rated assets, was set at 20%. 

For a basic requirement of 8%, that meant banks needed to hold 12% in capital against ‘highly speculative’ below BB- rated assets, while only 1.6 percent for ‘prime’ AAA rated assets. 

That meant banks could leverage their equity, and all the support they receive from society, 8.3 times to 1 when holding highly speculative’ below BB- rated assets; and a mind-boggling 62.5 times to 1 with ‘prime’ AAA rated assets. 

That of course distorts the allocation of bank credit to the real economy and, by favoring the access to bank credit for "The Safe", odiously discriminates against that of "The Risky", like SMEs and entrepreneurs. 

As is that has banks earning higher risk adjusted returns on what is perceived as safe than on what is perceived as risky, which means banks no longer finance sufficiently the riskier future but mostly stick to refinancing the safer past. ,

And by negating The Risky their fair access to productive bank credit opportunities, inequality can only increase.

But, what I really cannot understand is: How come mature men (and women) can believe that what is rated below BB-, meaning is perceived as ‘highly speculative’, and therefore very risky, can be more dangerous to the banking system, than what is rated AAA, meaning ‘prime’, and therefore perceived as absolutely safe?

No! There has to be something fundamentally wrong with the current mindset of the bank regulators.

Such crazy risk aversion to perceived credit risk should, in The Home of the Brave, be deemed unconstitutional.

Wednesday, February 3, 2016

Basel global bank regulations: What blocked timely warnings from even being heard and much less considered?

Charles Goodhart has written “The Basel Committee on Banking Supervision: A History of the Early Years 1974-1997, 2011” For someone like me who became slightly aware of the existence of the Basel Committee in 1997 and who as an Executive Director of the World Bank 2002-04 questioned much of what it was up to, it is an extraordinary interesting book and I will comment it frequently… jumping all over it.

Close to the end, page 578, Goodhart writes. “The regulatory process itself is likely to exacerbate internal self-reinforcing dynamics… by introducing a single set of international standards, it tends towards making more banks behave in the same way at the same time (Alexander, Eatwell, Persaud and Reoch 2007). Thus it adds to the likelihood of crowded trades forcing major and sudden price readjustments”.

Precisely, in April 2003, a time during which Basel II was discussed, when commenting on the World Bank’s Strategic Framework 2004-06, I formally warned:

“Ages ago, when information was less available and moved at a slower pace, the market consisted of a myriad of individual agents acting on limited information basis. Nowadays, when information is just too voluminous and fast to handle, market or authorities have decided to delegate the evaluation of it into the hands of much fewer players such as the credit rating agencies. This will, almost by definition, introduce systemic risks in the market and we are already able to discern some of the victims, although they are just the tip of an iceberg. Once again, perhaps only the World Bank has the sufficient world standing to act in this issue. 

A mixture of thousand solutions, many of them inadequate, may lead to a flexible world that can bend with the storms. A world obsessed with Best Practices may calcify its structure and break with any small wind. Who could really defend the value of diversity, if not The World Bank?"

How do such comments become so totally ignored? Was it because I did not belong to any mutual admiration network of experts?

Monday, February 1, 2016

Is there anything more shortsighted short termism than credit risk weighted capital requirements for banks?

More ex ante perceived credit risk requires more capital – less ex ante perceived credit risk allows much less capital… that is the pillar of current bank regulations.

And that allows banks to leverage much more when lending to The Safe than when lending to The Risky; which means banks can earn much higher expected risk-adjusted returns on equity when lending to The Safe than when lending to The Risky.

And so banks do not any longer finance the riskier future, but keep to refinancing the safer past. If that is not short termism, what is?

Global Association of Risk Professionals (GARP) Have you no comments on bank regulators’ risk management?

One of the few and perhaps even only risks that banks clear for, with risk premiums and size of exposures, is the ex ante perceived credit risks, that quite often expressed in credit ratings.

But regulators did not find that sufficient and decided that banks should also clear for the same ex ante perceived credit risk, in their capital.

And as far as I understand any perceived risk, even if it is perfectly perceived leads to the wrong action if it is excessively considered. Would you agree GARP?

And if I was a bank regulator I would be much more interested in why banks fail than in why their borrowers fail. Wouldn’t you be too GARP?

And knowing that bank capital is to be there to cover for unexpected losses, then the last thing I would do would be to base the capital requirements on some expected losses… especially when we know that the safer something is perceived the larger its potential to deliver some truly nasty unexpected losses. Would you not agree with that GARP?

And, if I was a bank regulator, managing risks, the first thing I would do is to be certain about the purpose of banks. That would indicate me that probably the risk we least can afford banks to take, is that of not allocating bank credit efficiently to the real economy. And that is something that becomes impossible when allowing banks to leverage differently with different assets, and thereby earning different and not market based expected risk adjusted returns on equity. Would you not agree with that GARP?

Right now the world is becoming a sad place, especially for coming generations, since regulators having given banks the incentives to stop financing the riskier future, and to make their profits by concentrating on refinancing the safer past. 

GARP do you not have a responsibility is speaking up against the Basel Committee’s and the Financial Stability Board’s particularly harmful and lousy way of managing risks?

I ask because your stated mission is: “As the leading professional association for risk managers, the Global Association of Risk Professional's mission is to advance the risk profession through education, training, and the promotion of best practices globally.”

And also because in “What we do” you state: “GARP enables the risk community to make better informed risk decisions through “creating a culture of risk awareness®”. We do this by educating and informing at all levels, from those beginning their careers in risk, to those leading risk programs at the largest financial institutions across the globe, as well as, the regulators that govern them.