Basel I, II, III, Crashlanding and perhaps…

Basel I: Politics!

http://subprimeregulations.blogspot.com/2015/07/just-before-fall-of-berlin-wall.html

Basel II: Mumbo-Jumbo        

https://subprimeregulations.blogspot.com/2013/02/basel-committee-please-no-more-mumbo.html

Basel III: Lost in a wilderness full of weeds.

https://subprimeregulations.blogspot.com/2023/07/wake-up-banks-should-be-banks-not.html

Basel IV: Crashlanding! And perhaps…

https://subprimeregulations.blogspot.com/2021/08/zero-dividends-buy-backs-and-big.html

Just in case, on all this I’m not a Monday Morning Quarterback.

http://subprimeregulations.blogspot.com/2004/11/some-of-my-early-public-opinions-on.html

To help moor (my) inflationary expectations, get rid of what facilitates it.

Paul Volcker, in his autography “Keeping at it”, penned together with Christine Harper in 2018, wrote: “The assets assigned the lowest risk [in 1988], for which capital requirements were therefore low or nonexistent, were those that had the most political support: sovereign credits and home mortgages… The American ‘overall leverage’ approach had a disadvantage as well in the eyes of shareholders and executives focused on return on capital; it seemed to discourage holdings of the safest assets, in particular low-return US government securities."

Washington Post, in reference to your “Do not underestimate inflation” November 11 let me assure you that, just as lower bank capital requirements against residential mortgages fuels house prices; lower bank capital requirements against Treasuries, by artificially lowering the interest rate on these, sooner or later, are bound to facilitate those excessive injections of liquidity that fuels inflation.

I’m not an expert on the US Constitution, I’m not even an American citizen, but I cannot understand how Section 8’s "The Congress shall have the power to borrow Money on the credit of the United States" could be read as to include the assistance of a Federal Reserve quantitative easing; and bank capital requirements with risk weights: 0% the Federal Government, 100% We the People.

If I had a chance to be heard by the Fed, here’s a Basel IV I would suggest

PS. Fight inflation, from bottom up! Injecting liquidity while banks obtain higher risk adjusted returns on equity with Treasuries & residential mortgages (carbs) than with loans to small businesses & entrepreneurs (proteins), that favors demand over supply, something which can only help to inflate inflation.

PS. To top it up, are we really sure that the inflation that's pursued is the inflation that matters?

@PerKurowski

My very brief summary of Basel I, II, III history... and my hopes for a future Basel IV

1988 Basel I (30 pages) decreed risk weighted bank capital requirements with risk weights of 0% the sovereign and 100% citizens, which de facto indicates bureaucrats know better what to do with credit they’re not personally responsible for than citizens.

http://subprimeregulations.blogspot.com/2015/07/just-before-fall-of-berlin-wall.html

2004 Basel II (251 pages), (creative capital minimizing/leverage maximizing financial engineers, fooled regulators into believing that the buildup of those excessive exposures that could endanger our bank systems, is done with assets perceived as risky.

https://subprimeregulations.blogspot.com/2020/10/any-risk-even-if-perfectly-perceived.html

2010 Basel III (the current version has so many pieces it’s hard to say how many pages it contains but it's at least 1.600), some small gestures of rationality like a leverage ratio and countercyclical capital buffers BUT, on the margins of bank capital requirements, which is where it most counts, Basel I's and Basel II's distortions are alive and kicking.

http://subprimeregulations.blogspot.com/2019/03/my-letter-to-financial-stability-board.html

202X Basel IV, lets pray they throw Basel I, II and III out, and set a fix bank capital requirement of 10%-15% on absolutely all assets. That would allow the so much needed traditional bank loan officers to return to the banks

https://subprimeregulations.blogspot.com/2013/01/confessions-of-monstrous-banker.html

Again the Basel Committee for Banking Supervision evidences it is a clueless producer of systemic risks.

I refer to a speech by William Coen the Secretary General of the Basel Committee, given in Sydney on 5 April 2016 and titled “The global policy reform agenda: completing the job” Coen said: 

“A bridge is an apt metaphor for the Basel framework. Bridges must be safe and sound. A safe and sound banking system is exactly what the Basel framework aims to support. Bridges facilitate movement, commerce and trade. The financial system plays a crucial role in directing investment and funds between individuals and businesses…

For the past 25 years, the foundation of the international approach to the prudential regulation of banks has been a risk-based capital ratio.

The level of capital is a difficult question. There are many views on what the "right amount" should be”

So it is clear that the Basel Committee still does not understand the distortion they cause. Its risk-based capital ratios, which allows banks to leverage equity differently with different assets depending on their ex ante perceived risk, amounts to building some very wide bridges where banks and “the safe” can interact a lot with ease, and then some very narrow bridges that make the relations between banks and “the risky” much harder than they already were.

Coen confesses: “We have spent several years developing a framework to make sure that banks' capital and liquidity buffers are strong enough to keep the system safe and sound.” And that is precisely the problem; they only cared about the condition of the banks and not one iota about the fundamental social purpose of banks, which is allocating credit efficiently to the real economy.

And Coen also quoted the Dutch central bank with: "today's undesirable behavior in financial institutions is at the root of tomorrow's solvency and liquidity problems".

That is correct but I would also add: Today’s undesirable regulatory failure is and will be at the root of tomorrows problems with the real economy… and in the long run no bank system cam be safe and sound, if the underlying real economy is not safe and sound.

And by the way, the root of 2007-08’s solvency and liquidity problems, laid in those authorized leverages of over 60 to 1 for AAA rated securities and sovereigns like Greece.

What are we to do with this bunch of not accountable to any technocrats that have never walked on Main Street, and are incapable of understanding that risk-taking is the oxygen of all development? 

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

Please, give our banks one sole equal capital requirement for all assets, to protect banks not against expected credit risks already cleared for, but against unforeseen risks, such as the Basel Committee falling into the hands of clueless regulators.

Let us never forget that the most dangerous systemic risks can easily be introduced by the regulators.

God make us daring!

My sincere Christmas wish: That our bank regulators wake up and understand what they are doing to our children.

On December 24, 1941, in Washington DC, Winston Churchill ended his Christmas speech to war torn England with: “By our sacrifice and daring, [our] children shall not be robbed of their inheritance or denied their right to live in a free and decent world.”

I absolutely do not pretend being something like Winston Churchill but, here in Washington, on December 24, 2015, 74 years later, I assure you all that: By us not daring to allow our banks to dare, we are robbing our children of their inheritance and denying their right to live in a free and decent world.

I pray our bank regulators in 2016 wake up to understand how much their credit risk weighted capital requirements for banks, distort the allocation of bank credit to the real economy.

By allowing banks to earn higher risk adjusted returns on what is perceived as safe than on what is perceived as risky banks do not any longer finance the riskier future but only keep to refinancing the safer past.

In essence we are placing a reverse mortgage on our economies, which will extract its value, without allowing the risk taking needed for something new to take its place.

Understand what originated the bank crisis and what stops the economies from recovering in 157 words

Bank regulators told our credit risk adverse banks: 

“If you take on Safe assets, we will allow you to leverage your equity and the support you receive from the society more than 60 to 1 times but, if Risky assets then you cannot leverage more than 12 to 1.” 

And that of course meant banks would be earning much higher risk adjusted returns on equity on assets perceived or made out to be Safe, than on “Risky” assets. 

It was like telling children: “If you eat up your ice cream then you can have chocolate cake too but, if you eat spinach, then you must eat broccoli too. 

And so banks built up excessive dangerous financial exposures to “Safe” assets, like AAA rated securities and loans to Greece, which detonated the crisis. 

And so banks are reluctant to hold Risky assets, like loans to SMEs and entrepreneurs, which makes it impossible to get out of the crisis.” 

And, amazingly, most describe what happened and is happening with our banks in terms of deregulated entities and failed markets.

Our current bank regulatory tragedy: Interference without a purpose

Bank regulators have two choices. They can allow everyone to compete equally for the access to bank credit; or they can interfere in the allocation of bank credit by favoring one group’s access, which of course affects negatively those not favored.

And of course interference, though arrogant and dangerous, could be justified if it was done with the purpose of trying to make the real economy stronger... like for instance when financing projects that have special potential to deliver job creation, or the sustainability of our planet.

Unfortunately, current bank regulators, with their credit risk weighted capital requirements for banks, are interfering with the allocation of bank credit without a real purpose. The only thing they achieve with that, is allowing those who because they are perceived as safe already have ample access to bank credit, to find even more generous conditions; and to make it even more difficult for those who because they are perceived as risky already find it harder to access bank credit.

And by doing so regulators are not making banks any safer either, since all-major bank crises result from excessive financial exposure to something ex ante believed safe but that ex-post turned out to be risky.

And so too much credit, in too generous terms, against too little bank capital is given to those perceived as safe, like governments and corporates with high credit ratings; and too little credit, in too expensive terms, to those perceived as risky, like our absolutely vital SMEs and entrepreneurs.

What a tragedy! Let us pray the Basel Committee, the Financial Stability Board and the IMF wake up in time, before our stalling economies really fall into pieces.

16 tweet-sized fundamental mistakes with regulatory credit-risk weighted capital requirements for banks… and counting

The regulators are regulating the banks without having defined the purpose of the banks. 

Regulators ignored that banks need and should allocate credit efficiently to the real economy.

Regulators ignore that for the society, what is not on the balance sheet of banks, could be as important as what is.

To allow bank equity to be leveraged with net margins of assets differently, distorts the allocation of bank credit.

The scarcer the bank capital is, the greater the distortions produced by the risk weighted capital requirements.

Bank capital is to cover for unexpected losses, yet regulators base the requirements on expected credit risks.

The safer something is perceived the greater is its potential for unexpected losses.

The risk of a bank has little to do with perceived risk of assets, and much to do with how the bank manages risks.

Banks clear for credit risk with interest rates and exposures, so to also do in the capital double-counts that risk.

Any perfectly perceived risk causes the wrong actions if the risk is excessively considered.

The standard risk weights that determine the capital requirements for banks are, amazingly, portfolio invariant.

The undue importance given to few information sources, credit rating agencies, introduced a serious systemic risk.

That imposing similar and specific regulations on any system stiffens it and increases its fragility was ignored.

Any regulatory constraint that can be gamed will be gamed and benefit the worst gamers in detriment of lesser gamers.

A risk weight of zero percent for the sovereign, and of 100 percent for the private sector, is pure unabridged statism.

Impeding “the risky” to have fair access to bank credit blocks opportunities and thereby increases inequality

Consequences: Too much bank credit against too little capital to whatever is perceived or can be construed as being safe, and too little credit to what is perceived as risky. In other words banks that do not finance the “risky” future, but only refinance the “safer” past.

Questions: Of these mistakes how many have been sufficiently debated and corrected? How many of the responsible for these mistakes have been held accountable?

According to Winston Churchill I am clearly a fanatic “one who can't change his mind and won't change the subject.”

Yes! I have over the last 18 years written more than 3.000 comments, articles, blog-posts, and letters to the editor, about how flawed I know the portfolio invariant credit risk weighted capital requirements for banks are. And I won’t change my mind or change the subject. And so in Winston Churchill’s words I am a fanatic… I would say a really obsessive fanatic.

But, on the other hand, the silence on this problem by thousand of experts is equivalent to billions of comments, articles, blog-posts and letters to the editor from the opposite side; and so I am not sure about who is more obsessively fanatic, they or little me.

And of course, when compared to those statist regulators who came up with that crazy surreal nonsense of a zero percent risk weighting for the sovereign and a 100 percent risk weighting of those citizens the sovereign depends upon, I am just fanatic obsessive chicken shit.

What should the punishment be for those who risk Europe´s (and America's) unemployed youth to become a lost generation?

There are of course many who share the responsibility for risking that Europe´s (and America's) unemployed youth becomes a lost generation. But, in my opinion, the guiltiest party is regulators who came up with the absolutely lunatic criteria of making capital requirements for banks a function of the ex ante perceived risk which was already being cleared for by the banks, by means of interest rates (risk premiums), size of exposures and other contractual terms.

That distorted all common sense out of bank credit allocation in the real economy, and also caused that when something ex ante perceived “absolutely safe” turns out ex post to be “very risky”, the usual cause of all bank crises, that the banks ended up totally undercapitalized and at least temporarily unable to help out in any recovery.

These regulators have not been shamed sufficiently much less punished. In fact they were reauthorized to proceed to make a new set of regulations Basel III, conserving the same rotten apple of Basel II.

When I think about the pain and suffering these dumb regulators have and will be inflicting on millions of our young ones, then, parading them down avenues wearing dunce caps, seem to be sort of an absolute minimal social sanction.

We absolutely must hold these regulators accountable, but, until now, for around six years, they have been able to avoid taking any responsibility using a lot of distractive maneuvers. 

Many years ago, at a seminar, the facilitator asked the group to look at a video and try to keep count of how many times a group of persons passed a white ball among themselves. After one minute he asked around, getting answers like 13, 14, and 15. He then asked whether someone had noticed something strange. I, who had as it seems been distracted from looking at the ball (through luck or genes), had noticed the presence of a gorilla coming into the scene, pounding his chest and then leaving. 

So please, J'accuse...!, lookout for the Basel Committee's capital requirements for banks gorilla, who is pounding on our economies, and on the job prospects of our young

We need “The Risky” to access bank credit, competitively, especially in bad times, as “The Infallible” alone cannot pull us out of anything

If a bank charges a 3 percent risk premium to set of small and medium businesses, entrepreneurs and start-ups borrowers, then it is reserving for sustaining losses of about 30 percent on 10 percent of these borrowers, something which, as bankers do not give loans were they think they are going to lose, is a hell of a great reserve.

But, the higher risk premiums paid by “The Risky” was something completely disregarded by the regulators when setting those capital requirements for banks based on perceived risk and that so much favor bank lending to “The Infallible”, in essence sovereigns, housing and the AAAristocracy.

You see, our current set of bank regulators, they do not care one iota about the fact that their capital requirements utterly distorts the allocation of bank credit in the real economy, and in which, it is really the access to bank credit of “The Risky”, in competitive terms, what most needs to be assured.

You see our current bank regulators care only about the banks, and that is why they are so damn bad bank regulators.

You see our current bank regulators are so scared shit about all ex ante “risk”, they fail to understand that, ex post, only “The Infallible” cause major bank disasters.

There is nothing as risky for the banks, and for us, as not taking a risk on “The Risky” of the real economy.

God make us daring!

For Basel IV, what do I propose?

Ex ante perceived risks are already cleared for in the numerator, by means of interest rate (risk-premiums) size of exposure and other terms, and so it is just plain stupid to clear for the same risks in the denominator, with different capital requirements based on risk-weights. That only guarantees a distortion that makes nothing safer, and just causes banks to overdose on perceived risks. 

Therefore risk-weighted capital requirements are to be eliminated completely.

But, if bank regulators absolutely must meddle, in order to satisfy their egos, or show off their expertise, and there are going to be some higher capital requirements for some assets, those should be applied to what is ex ante perceived as “absolutely safe”, since all major bank crises ever, have originated in excessive bank exposures to this category of assets.

And, if bank regulators absolutely must meddle, in order to satisfy their egos, or show off their expertise, and there are going to be some lower capital requirements, to induce some higher returns on bank equity, those should be only accepted in as much as these stimulate the banks to better fulfill a social purpose, like basing it on potential for job creation ratings, or sustainability ratings.

And, in no way shall there be any discrimination that favors any short term financial instrument over a long term one.

And in this respect, the initial Basel IV proposition contains just one line, the following:

“Banks shall hold 8 percent in capital, as defined in Basel III, against all assets.”

The Basel IV capitalization can be reached by allowing each bank to apply its current capital to total assets ratio (including sovereigns), and then let it build up that ratio over a period of some years, with about 0.5 percent per year until reaching said 8 percent level. 

But, since the faster banks reach their final Basel IV capitalization, the better for the real economy, the regulators, accepting their full responsibility for the current extreme low capitalization of banks, should beg for some temporary important tax incentives on all bank capital increases taking place within one year of the Basel IV approval.