Tuesday, March 26, 2019

My letter to the Financial Stability Board was received.

http://www.fsb.org/wp-content/uploads/Per-Kurowski.pdf

From: Per Kurowski
Sent: 18 March 2019 19:16
To: Financial Stability Board (FSB)


I have not found sufficient strength to sit down and formally write up my comments, because I feel I would just be like a heliocentric Galileo writing to a geocentric Inquisition.

The Basel Committee’s standardized risk weights are based on the presumption that what is ex ante perceived as risky is more dangerous to our bank system.

And I hold a totally contrarian opinion. I believe that what is perceived a safe when placed on banks balance sheets to be much more dangerous to our bank system ex post than what is perceived ex ante as risky; and this especially so if those “safe” assets go hand in hand with lower capital requirements, meaning higher leverages, meaning higher risk adjusted returns on equity for what is perceived safe than for what is perceived as risky.

The following Basel II risk weights are signs of total lunacy or an absolute lack of understanding of the concept of conditional probabilities.

AAA to AA rated = 20%; allowed leverage 62.5 times to 1. Below BB- rated = 150%; allowed leverage 8.3 times to 1

The distortion the risk weighting creates in the allocation of credit to the real economy is mindboggling. Just consider the following tail risks.

The best, that which perceived as very risky turning out to be very safe. The worst, that which perceived as very safe turning out to be very risky.

And so the risk weighted capital requirements kills the best and puts the worst on steroids... dooming us to suffer an weakened economy as well as an especially severe bank crisis, resulting from especially large exposures, to what was especially perceived as safe, against especially little capital.

In relative terms all that results in much more and less (see note) expensive credit to for instance sovereigns and the purchase of houses, and less and more expensive credit to SMEs

I am neither a banker nor a regulator but I do believe that the following post helps to give some credibility to my opinions on the issue. And, as a grandfather, I am certainly a stakeholder.


And here is a more detailed list of my objections to the risk weighting


Now if by any chance you would dare open your eyes to the mistakes of your risk weighted bank capital requirements and want more details from me, you know where to find me.

Sincerely

Per Kurowski
A former Executive Director of the World Bank (2002-2004) 
@PerKurowski

Note: In the original letter I erroneously wrote "more and more expensive credit to sovereigns" and not "less expensive", but this should be easily understood as a mistake.


PS. FSB keeps avoiding the issue: June 7, 2019 FSB published a Consultative Document: “Evaluation of the effects of financial regulatory reforms on small and medium-sized enterprise (SME) financing” I quote two parts of it.

1. “For the reforms that are within the scope of this evaluation, post-crisis financial regulatory reforms, the analysis, does not identify negative effects on SME financing in general.” 

Comment: The scope of the analysis does explicitly not include pre-crisis financial regulatory reform, like Basel II. When compared to what was introduced in Basel II, the changes in Basel III produced not really that much “more stringent risk-based capital requirements”. Therefore to limit the analysis to the impact of Basel III changes to risk-based capital requirements, is basically to avoid the issue of how these have, especially since Basel II, profoundly distorted the allocation of credit, and negatively affected the financing of SMEs.

2. “There is some evidence that the more stringent risk-based capital requirements under Basel III slowed the pace and in some jurisdictions tightened the conditions of SME lending at those banks that were least capitalised ex ante relative to other banks.”

Comment: That the Basel III risk-based changes, which in my opinion are minor relative to their importance, “tightened the conditions of SME lending at those banks that were least capitalised ex ante relative to other banks” is something to be expected. There, close to the roof, on the margin, is where the risk weighting most affects; think of “The drowning pool

PS. A letter to the IMF: "The risk weights in the risk weighted bank capital requirements are to access to credit, what tariffs are to trade, only more pernicious.

Tuesday, March 5, 2019

Reading, little by little, Adam Tooze’s “Crashed: How a Decade of Financial Crises Changed the World” 2018


Chapter 14 “Greece 2010: Extend and pretend”

I read: “As recently as 2007 Greece’s bonds had traded at virtually the same yield as Gemany’s”

The credit rating of Greece in 2007 was A, and that of Germany AAA. According to Basel II’s risk weighted capital requirements Greece should have a risk weight of 20% while Germany 0%.

But, European authorities extended Sovereign Debt Privileges to all Eurozone nations, and assigned Greece also risk weight of 0%. All this even though these nations are all taking on debt in a currency that de facto is not their own printable one. 

When Greece’s crisis breaks lose Greece has still a risk weight of 0%... meaning European banks could lend to Greece against no capital at all... and it is still 0% risk weighted. 

How is Greece going to extract itself from that corner into which it has been painted is anybody's guess. And extract itself it must, as  must all nations. A 0% risk weight for the sovereign and 100% for the citizens is an unsustainable statist proposition.

It all makes me wonder how Tooze would have written this chapter had he considered this. Perhaps he could have been closer to opine this?