FSB reports: “G20 reforms are building a safer, simpler, fairer financial system”. What a triple lie!

FSB reports to G20 Leaders on progress in financial regulatory reforms, and it starts with: G20 reforms are building a safer, simpler, fairer financial system

“Safer”? Major bank crises do not result from excessive exposures against what is perceived risky, but always from unexpected events or excessive exposures to what was ex ante perceived, decreed or concocted as safe, but that, ex post, turned out to be very risky.

In the FSB video they say “A safe banking system needs enough capital to absorb unexpected losses” and so my question is: So why require capital based on expected risks?

“Simpler”? Don’t be ridicule! Just have a look at the Basel Committee’s absurdly obscure “Minimum capital requirements for market risk” of January 2016, and on its consultative document for a "simplification" of July 2017.

The FSB video does not really even dare to explain the "simpler" factor.

“Fairer”? Forget it! The discrimination in the access to bank credit in favor of those perceived, decreed or concocted as safe, like the Sovereigns and the AAA-risktocracy is still alive and kicking; just like that one against “the risky”, the SMEs and entrepreneurs. It is an inequality driver.

No wonder the FSB video has the comments disabled.

G20 you want to understand what is wrong with current bank regulations? Start here!

Why such hullabaloo about Trump’s at view of everyone conflicts of interest, while ignoring the bank’s hidden ones?

We all know that Trump is going to be subject to so much scrutiny that his “conflicts of interest” might even suffer. 

But on the large banks’ outrageous conflicts of interest, namely being able to use their own models to partially determine the capital they need to hold, on that everyone keeps mum. Why?

The lower the risk is calculated, the lower is the capital requirements, the higher is the allowed leverage, and so the better are the banks perspectives on obtaining high risk adjusted returns on equity. If that’s not a mother of a conflict of interest what is?

Dumb G20 ministers reiterated in Hangzhou their support of the inept Basel Committee on Banking Supervision (BCBS)

We read in the “G20 Leaders’ Communique Hangzhou Summit”

“We reiterate our support for the work by the Basel Committee on Banking Supervision (BCBS) to finalize the Basel III framework by the end of 2016, without further significantly increasing overall capital requirements across the banking sector, while promoting a level playing field”

Clearly the Ministers did not dare to ask the regulators some minimum minimorum questions like:

What do you believe is the purpose of banks? Should it not have something to do with what like John A Shedd opined: “A ship in harbor is safe, but that is not what ships are for” 

If the purpose of the banks includes that of allocating credit efficiently to the real economy, why then do you distort that with risk weighted capital requirements for banks?

Can you indicate us one single bank crisis derived from excessive exposures to what was perceived as risky when incorporated to the balance sheets of banks? Voltaire said “May God defend me from my friends. I can defend myself from my enemies”. 

So, could that lack of questioning by the ministers be explained by John Kenneth Galbraith’s “If one is pretending to knowledge one does not have, one cannot ask for explanations to support possible objections”?

Frankly, neither Hollywood nor Bollywood, would insist in supporting the work of someone producing such Basel I-II flop, as the 2007/08 crisis and the thereafter continued stagnation evidences.

PS. Here is a short aide memoire on some of the monstrous regulatory mistakes

The Basel Committee injected cowardice into our bank system and doomed us all to doom and gloom.

In 1988 with the Basel Accord, Basel I, and then in 2004, with Basel II, the Basel Committee on Banking Supervision introduced risk-weighted capital requirements for banks. More perceived risk more capital – less risk less capital.

That allowed banks to leverage their equity more with what was perceived, decreed or concocted as safe, than with what was risky. That allowed banks to earn higher expected risk adjusted returns on equity when lending to The Safe, the government, housing and the AAArisktocracy than when lending to The Risky, like SMEs and entrepreneurs.

Just look at these risk weights: Sovereign = 0%, AAArisktocracy = 20% and We the People = 100%

That effectively injected cowardice into the banking system, which prevents it from allocating credit efficiently to the real economy.

There is no chance in hell capitalism can function and deliver anything good with such regulations… the regulators doomed us all to doom and gloom.

And all for nothing! There has never been a major banking crisis that has resulted from excessive financial exposures assets perceived as risky when incorporated to banks’ balance sheets. These always result from unexpected events or from excessive exposures to something erroneously perceived as safe.

And the saddest part is that this regulatory distortion is not even acknowledged, much less discussed.

Current bank regulators have no moral right to address the misconduct of other in the financial sector.

The Financial Stability Board (FSB) published November 6 a progress report for the G20 on the FSB’s work on addressing misconduct in the financial sector. The progress report on the Measures to reduce misconduct risk sets out details about the FSB-coordinated work to address misconduct in the financial sector and the timeline for the actions.

For many years argued that the bank regulators themselves carried out the most serious misconduct in the financial sector.

With their portfolio invariant credit-risk weighted capital requirements for banks, imposed without the slightest evidence of having empirically studied why bank crises occur, and without defining what is the purpose of banks, they manipulated the world’s bank credit markets with serious consequences for millions.

Compared to that, the manipulation of of example the Libor rate, although clearly not to be excused in any way, is simply peanuts.

When we consider the millions of SMEs and entrepreneurs who have been impeded fair access to bank credit, and the loss of job creation for the coming generations that must have resulted from that; and the trillions of public bailout/stimulus debts hanging over us, the regulators should better retire in shame than preach about the misconduct of others.

G20, keeping our economies from stalling and falling might depend on unregulated shadow banks… a ‘Banca sommerza’.

On September 17, New Rules for Global Finance and the International Trade Union Confederation are hosting a seminar titled “Reducing Unemployment & Inequality: Policy Options for the G20”

And I wanted the participants, in preparation for it, to read the following which is quoted from John Kenneth Galbraith’s “Money: Whence it came where it went” 1975.

“For the new parts of the country [USA’s West]… there was the right to create banks at will and therewith the notes and deposits that resulted from their loans…[if] the bank failed…someone was left holding the worthless notes… but some borrowers from this bank were now in business...[jobs created] 

It was an arrangement which reputable bankers and merchants in the East viewed with extreme distaste… Men of economic wisdom, then as later expressing the views of the reputable business community, spoke of the anarchy of unstable banking… The men of wisdom missed the point. The anarchy served the frontier far better than a more orderly system that kept a tight hand on credit would have done…. what is called sound economics is very often what mirrors the needs of the respectfully affluent.

The function of credit in a simple society is, in fact, remarkably egalitarian. It allows the man with energy and no money to participate in the economy more or less on a par with the man who has capital of his own. And the more casual the conditions under which credit is granted and hence the more impecunious those accommodated, the more egalitarian credit is… Bad banks, unlike good, loaned to the poor risk, which is another name for the poor man.”

And then I wanted the participants to reflect on the fact that the pillar of current bank regulations, is the perceived-credit-risk capital requirements for banks, less risk less capital - more risk more capital.

That allows banks to earn much higher risk-adjusted returns on equity on what is perceived as safe than on what is perceived as risky. And this, as should easily be understood, kills the opportunities for SMEs and entrepreneurs to have fair access to that bank credit with which they could help generate the next harvest of decent jobs. As you should understand it also serves as a potent inequality driver.

Friends, or we free our formal banks from this loony regulatory risk aversion to credit risk already cleared for by risk premiums and size of exposures, or the interests of job creation and equality might be best served by unregulated banks operating in the shadows… a Banca Sommersa. 

You decide, personally I am surprised to see a big majority of progressives keeping silence on bank regulations that clearly serve best the interests of “the respectfully affluent”… or those of aging baby-boomers’ après nous le deluge.

Let us responsibly live up to our part in that intergenerational continuum of the past, the living and the unborn, that Edmund Burke spoke about.

And this issue is also relevant to many of those you would define as being as far away as possible from the progressives… but which is of course no reason to shy away from it... much the contrary.

As an example, Mark R. Levin initiates his “Plunder and Deceit” by asking: “Can we simultaneously love our children but betray their generations and generations yet born? 

G20, please, for the future of our descendants, let us pray together “God make us daring!”

Why on earth do regulators refuse to discuss the issue of how their bank capital requirements distort the allocation of credit to the real economy? I once again refer to Galbraith’s Money: “If one is pretending to knowledge one does not have, one cannot ask for explanations to support possible objections.”

What shall we do with regulators that have clearly failed? I once again refer to Galbraith’s Money: “We should be kind to those whose performance has been poor. But we must never be so gracious as to keep them in office.”

Frankly, what does for instance a Thomas Piketty from University Boulevard, know about unequal opportunities on Main Street?

@Per Kurowski

Am I a radical of the middle? Yes, or perhaps only an extremist of the center.

G20, the Financial Stability Board does not know what it is doing, or is simply hiding a monstrous regulatory mistake.

“In Washington in 2008, the G20 committed to fundamental reform of the global financial system. The objectives were to correct the fault lines that lead to the global crisis and to build safer, more resilient sources of finance to serve better the needs of the economy”

That is how FSB on November 14, 2014 introduces its report to the G20 leaders titled “Overview of Progress in the Implementation of the G20 Recommendation for Strengthening the Financial Stability”

And the letter that accompanies it states: “The job of agreeing measures to fix the fault lines that caused the crisis is now substantially complete.” 

But the sad fact is that the report does not even mention what in my opinion constitutes the most important fault line, and in not doing so, makes it also impossible for banks to serve the needs of the economy.

As I see it that "fault line" was the Perceived Credit Risk Weighted Equity Requirements for Banks. Here follows my explanation:

Banks already clear for perceived credit risks (in the numerator) by means of interest rates, size of exposure and other terms of contract.

And so, when regulators cleared for the same perceived risks in the equity (more risk more equity – less risk less equity) they allowed banks to earn much higher risk adjusted returns on equity when lending to those perceived as “absolutely safe”, than when lending to those perceived as “risky”

The following are some examples of risk weights and leverages based on the original 8% equity requirement and that are indicated in the Basel II approved in June 2004.

Infallible sovereigns: zero percent RW, allowing infinite leverage.

Members of the AAAristocracy: 20 percent RW, allowing a leverage of 62.5 to 1.

Financing of houses: around 25 percent RW, allowing a leverage of 50 to 1

Medium and small businesses, entrepreneurs and start-ups, and citizens: 100 percent RW, allowing a leverage of 12.5 to 1.

And there is a perfect correlation between the troubled bank assets that caused the crisis, and the presence of ultralow capital requirements.

And this monumental distortion in the allocation of bank credit is not even mentioned.

Either the FSB has not understood the problem, or it is hiding the truth about this horrendous regulatory mistake.

And even from the perspective of medium term stability of banks, these regulations are absolutely useless. That is so since all really serious bank crises never result from excessive exposures to what is perceived as risky, but always from excessive exposures to what has erroneously perceived as “absolutely safe”. And so, if anything one could even argue the equity requirements should be totally the opposite, higher for what is perceived as “absolutely safe” and lower for what is perceived as “risky”. 

And these risk weighted equity requirements are impeding bank credit from reaching where it is most needed and therefore wasting all the liquidity support provided by QEs and similar programs.

Yes regulators will tell you that Basel III has the Leverage Ratio which is not risk-weighted. What they do not understand though is that raising the floor, only increases the pressure of those living close to the roof... namely "the risky".

Bank regulators who as we all have prospered thanks to the risk-taking of the banks of our parents, are now negating that risk taking to our children.

As a consequence our banks are now not financing the risky future, only refinancing the safer past.

Risk taking is the oxygen of development, and these regulators have no right whatsoever to believe with astonishing hubris they can be the risk-managers of the word, and go behind our back, calling it quit, and so making our economy stall and fall.

Conclusion: Basel III has NOT fixed the distortions in the allocation of bank credit. In some ways it has even made it worse. And, to top it up the risk-adverse regulatory monsters also want to go after the insurance sector.

God make us daring!

20% credit risk weighted total loss-absorbing capacity (TLAC), is an assassination of the real economy

Mark Carney of the Financial Stability Board has just mentioned the possibility of 20% credit risk-weighted total loss-absorbing capacity for banks TLAC.

That, when lending to for instance one of the AAAristocracy who carries a risk weight of 20%, means the bank would need to hold 4% in TLAC.

But, when lending to a small business, which carries a risk weight of 100%, then the bank would need to hold 20% in TLAC... 5 times more! ...16% more!

This will of course mean that banks will lend too much to “the infallible” at too low interest rates, and never more to small businesses and other “risky” unless at extremely high relative interest rates.

That means in effect an assassination of the real economy

Why do bank regulators deny their children the risk-taking by banks that benefitted them?

“Mark Carney has pledged that taxpayer money should never again be used to prop up banks.” 

And the price for achieving that by discriminating against the "risky", will foremost be paid by the poor, increasing the inequalities. Good job!

Should not at least Australia understand that "the risky" deserve a chance too?

And a speech by Wayne Byres the Chairman of the Australian Prudential Regulation Authority APRA titled “Perspectives on the global regulatory agenda” fell into my inbox.

And again, as is usual nowadays there was not a word about what I consider is the absolutely most important, namely getting rid of those distortions in the allocation of bank credit to the real economy that the risk-weighted capital requirements for banks cause.

These make banks lend too much at too low rates to those perceived as “absolutely safe” and too little and in relative terms too expensive to those perceived as “risky”.

Having just come from Toronto and seen the play “Our Country's Good” advertised with “Thieves, murderers, prostitute, actors…this is what made Australia”… it struck me that one could at least have expected Australia’s APRA not to have swallowed such regulatory nonsense. 

And in case no one has explained the implications of the risk-weighting, here is the link to more fuller real version of the terminology:

http://subprimeregulations.blogspot.com/2014/09/basel-ii-and-iii-risk-weighted-capital.html

Great expert bank regulators of Europe, why do you believe in this regulatory nonsense?

Banks are now required to hold much much more capital when lending to SMEs than when financing houses; and so banks, because of a much much higher leverage, earn much higher risk-adjusted returns on equity when financing houses than when financing those who could create the next generation of jobs our young needs. 

What do you mean, are we all going to sit in or houses playing with our I-pads without jobs? 

Banks are now required to hold much much more capital when lending to citizens than when lending to the supposedly “infallible sovereigns”; and so banks, because of much much higher leverage, earn much much higher risk adjusted returns on equity when lending to governments than when lending to citizens.

What do you mean, what kind of back-door communism is this?

Do you really think you are making the world a safer and better place with this nonsense? Don’t you all see you are bloody killing the economy of Europe with this dumb risk aversion? Don't you see you are with no right whatsoever closing the horizons of our young?

John Augustus Shedd, 1850-1926 said: “A ship in harbor is safe, but that is not what ships are for.”... And that goes for banks too!

Q. Why do you agree with this regulatory nonsense, Mario Draghi, President of the European Central Bank and former Chairman of the G20s Financial Stability Board?

Q. Why do you agree with this regulatory nonsense Stefan Ingves, Governor of Sveriges Riksbank and current Chairman of the Basel Committee on Banking Supervision?

Q. Why do you agree with this regulatory nonsense Jaime Caruana, Chairman of the International Bank of Settlements and former Chair of the Basel Committee on Banking Supervision?

Q. Why do you agree with this regulatory nonsense Mark Carney, Governor of the Bank of England and current Chairman of the G20s Financial Stability Board?

PS. I am sorry... but somebody has to ask... and keep on asking. God make us daring!

Why is the President of the World Bank not informed about consequences of risk-weighted capital requirements for banks?

In Russia, September 6, 2013, Jim Yong Kim, the President of the World Bank Group, said the following in his statement issued at the end of the G20 summit.

“The G20 has pledged to achieve strong, sustainable, balanced and inclusive growth, and creating more and higher-quality jobs.”

Mr. Jim Yong Kim. As long as bank regulators allow banks to hold much much less capital when lending to "The Infallible", like some sovereigns, housing or the AAAristocracy; than what they are required to hold when lending to “The Risky”, like medium and small businesses, entrepreneurs and start-ups; and which means the banks will earn much much higher risk-adjusted returns on their equity when lending to the former than when lending to the latter... "strong, sustainable, balanced and inclusive growth" able to create more and higher-quality jobs” will just not happen. 

The odious and dangerous discrimination of "The Risky" does only increase, not reduce, the gap between those perceived as safe, the past, the developed, the haves, and those perceived as “risky”, the future, the developing, the have nots.

And the truly sad thing is that no one in the world’s premier development bank wants to inform its president about it.

Mr. Jim Yong Kim. I assure you, risk-taking is the oxygen of development. God make us daring!

Per Kurowski

A former Executive Director of the World Bank, 2002-2004

The Financial Stability Board, Mark Carney, is not telling the truth to the leaders of G20

Mark Carney, in the name of The Financial Stability Board (FSB), on September 5, 2013, reports to the G20 Leaders the following:

"In Washington in 2008, the G20 committed to fundamental reform of the global financial system. The objectives were to correct the fault lines that led to the global financial crisis and to build a safer, more resilient source of finance to serve better the needs of the real economy... FSB members have made major progress correcting the fault lines that caused the crisis.”

And that is just not true.

The major fault line that lead to the global financial crisis, were capital requirements for banks which allowed banks to earn much much higher risk-adjusted returns on equity on exposures that were perceived as “absolutely safe”, than on exposures perceived as” risky”. 

That consequentially stimulated the banks to build up excessive exposures to The Infallible, The AAAristocracy, and which later, in much as a result of it, when some of these exposures turned sour, it found the banks standing there naked with little capital to cover themselves up with.

And that problem, of how the capital requirements distort and makes it impossible for the banks to allocated bank credit efficiently to the real economy, has not even yet begun to be discussed, at least not in public.

The ridicule small capital requirements for some “ultra-safe” exposures also served as the most important growth-hormone for the “too big to fail” banks.

FSB also states in the document that “the risk models that banks use to calculate their capital needs show worryingly large differences” . And I ask,  what’s their problem? Do they want the whole world to use the same risk models, so that when these turn out wrong, as they will do sooner or later, everyone goes down the tube in a virtuous kumbayah like solidarity? 

When will these regulators understand their duty is not to assure the existence of the right risk-models, but to prepare for when the risk-models of bankers turn out to be wrong?

In case you wonder what possible credential would I have to dare to call out the bluff of the Financial Stability Board, let me just put forward, as one of many, that as an Executive Director of the World Bank, in a written statement delivered in October 2004, I warned that “We believe that much of the world’s financial markets are currently being dangerously overstretched though an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions.”

Leaders of the G20. It is your duty to stop the nonsensical and extremely risky risk-aversion of the Basel Committee for Banking Supervision and the Financial Stability Board. Our children and grandchildren deserve it.

Finance ministers of the world. How many of you believe risk-aversion is good for the economy? Raise your hands!

Our current bank regulators are dangerous fools.

Bank regulators foolishly allow banks to hold much less capital against assets which are perceived as “safe” than when holding assets perceived as “risky”. 

That means that bank regulators foolishly allow banks to leverage their capital many times more when holding assets which are perceived as “safe” than when holding assets perceived as “risky”. 

And that means that bank regulators foolishly allow banks to earn a much higher expected risk-adjusted return on equity when holding assets perceived as “safe” than when holding assets perceived as “risky”. 

And I say “foolishly” because with that bank regulators introduce a distortion that makes it absolutely impossible for banks to perform their vital social function of allocating resources efficiently. 

And I say “foolishly” because that guarantees that when something ex-ante perceived as safe, ex post turns out to be risky, bank exposures to it will be huge, and the bank capital to cover for it totally insufficient. 

And I hold our current bank regulators to be dangerous fools, because they don´t even understand the harm their capital requirements based on perceived risk of Basel II does to our banking system and that it caused the current crisis; and because they now want to dig us even deeper down into the hole with Basel III adding liquidity requirements which are also based on perceived risk. 

A bank is there to take intelligent risks on behalf of the risk-adverse society, and not to be treated as just another widow or orphan by some dumb overanxious nannies.

A perfect depiction of our bank regulators… looking out in the same direction of bankers for what is perceived as risky, forgetting that in banking, as in so much other, what is really risky is what is considered absolutely safe. (Thanks "Learning from dogs" for the heads up for the photo)

Capital requirements for banks based on job creation, makes more sense than those based on risk of default.

And there they are again, the G20, now in South Korea, lost for words, but yet babbling.

If I were to be given one minute of voice there, I would ask all of them to throw away the capital requirements based on the risk of default, because the risk of default is already being priced in the interest rates of the market, so there’s no need to discriminate through bank regulations against the unrated small businesses and other “risky” elements.

And, if the government official could just not resist meddling with the markets, then I would suggest them to impose capital requirements for banks based on the job creation potential of the borrower… more jobs less capital less jobs more capital… I mean, is not to help create job a primary function of banks?

But, of course, history has recently taught us that we need to be very careful with the job-creation-rating-agencies we empower.

What are we to do with the Financial Stability Board?

The Financial Stability Board (FSB) reported from their meeting in Seoul on October 20 ahead of the G20 Summit in Seoul and endorsed principles for reducing reliance on credit rating agency (CRA) ratings as follows:

“The goal of the principles is to reduce the cliff effects from CRA ratings that can amplify procyclicality and cause systemic disruption. The principles call on authorities to do this through:

Removing or replacing references to CRA ratings in laws and regulations, wherever possible, with suitable alternative standards of creditworthiness assessment;

Expecting that banks, market participants and institutional investors make their own credit assessments, and not rely solely or mechanistically on CRA ratings.”

Since FSB does not even mention the risk-weights we can only assume FSB feels that all what went wrong was the excessive reliance on the credit ratings. They have no clue. What went really wrong was the way the regulators arbitrarily assigned to the different credit ratings the different risk-weights which determined the capital requirements for banks… like the 20% risk-weight for any lending to private entities rated triple-A or 0% risk weight on any lending to sovereigns rated triple-A.

In other words the FSB is unable or unwilling to understand that the credit rating agencies could have been totally wrong and yet they would never have produces the damage they did with their faulty ratings, had they not been so incredible endorsed by the bank regulators.

And neither does FSB understand that their regulatory favors to what is perceived as having a low risk of default, amounts only to an odious discrimination of what is perceived as having a higher risk of default, and all for no real purpose at all, since we all know that what is perceived as risky does never carry the potential to turn into a systemic danger.

And so friends what are we to do with the thick-as-a-brick Financial Stability Board?

My response to the G-20 SME Finance Challenge

Friends,

The Group of 20 and Ashoka’s Changemakers, with support from the Rockefeller Foundation, launched the G-20 SME Finance Challenge, where competitors are to submit proposals on solutions or projects for how public finance can unlock private finance to small and medium enterprise on a sustainable and scalable basis. 

The goal is to identify catalytic and well-targeted public interventions to unlock private finance for SMEs. Maximizing leverage of scarce public resources is at the core of the Challenge.

The following is my proposal:

The taking of risks is the oxygen of any development!

We need to eliminate the regressive discrimination of SMEs caused by imposing different capital requirements on banks based on perceived risk of default. Its primary reason is that risk of default of a debtor is a natural, manageable and secondary degree risk that banks and society need to take. As a bonus it also corrects a huge regulatory error that only increases the possibilities of systemic disasters.”

Here follows some of the questions and answer given on the entry form:

What makes your innovative solution unique? 

It rejects completely the first pillar of the current regulatory paradigm developed by the Basel Committee, that of construing “safer” banks by means of discriminating precisely against those whom, because of their limited access to capital markets, the banks should most help with their lending, the SMEs. 

To discriminate against the more “risky” while favoring those who because of their good credit ratings most likely already have access to the capital markets, is nonsensical. 

It is like the handicap officials on a racetrack taking off weights from the stronger horses and placing them on the weaker. It could only have been thought up by regulatory zealots who, shortsightedly, have only the immediate safeness of the banks on their minds and care little or nothing about development and banks’ real long term purpose. 

If you consider how unelected officials are influencing in a quite non-transparent way how global finances operate, I also hope this proposal helps to open up a much needed debate on regulatory transparency.

How does your proposed innovation leverage public intervention in catalyzing private SME finance?

If a bank was required to hold the same capital requirement when lending to a triple-A rated company than it has to hold when lending to an SME, namely 8 percent, it could leverage its capital 12.5 times to 1. If the bank then made a margin of .5 percent when lending to the triple-A rated, it would obtain a total return on capital of 6.25 percent. 

But, since the regulators allow the banks to hold only 1.6 percent in capital when lending to the triple-A rated, and so that they could therefore leverage themselves 62.5 to 1, the total capital return on this lending for the banks becomes instead 31.25 percent. 

To make up for that difference of 25% of regulatory advantage awarded to the triple-A lending (31.25-6.25), and be able to compete for access to bank credit, the SMEs therefore need to pay an additional interest rate of 2 percent (25/12.5), on top of the higher risk premiums they are anyhow charged with because of their higher perceived and real risk. 

Leveling the playing field, by eliminating this arbitrary regressive and discriminatory regulatory tax on risk that affects many of those accessing bank credits, is the most important public intervention needed in order to catalyze private SME financing. 

As an important bonus it would also remove the regulatory incentives which caused the stampede after triple-As in the market and thereby originated the current crisis. 

What barriers does your proposed solution address? Describe how so? 

SMEs are more prone to be considered as risky. Therefore the elimination of the current regulatory de-facto tax on the perceived risk of default will help to decrease the disincentives for the banks to serve these clients; or, in other words, it will increase the competitiveness of SMEs in their race against all those perceived to represent lesser risk for access to bank credits.

In the same vein the natural higher transaction costs for financial intermediaries to lend to SME’s would cease to be further compounded by the costs derived from higher discriminatory capital requirements. 

Additionally it would help to fight the excessive asymmetrical empowerment of the credit rating agencies as credit information providers, and thereby help to reestablish banking as a truly accountable profession that is not induced to rely robotically on a general type of GPS guidance system. In other words, it will provide an opportunity for bankers to be bankers again.

Provide empirical evidence of your proposed solution’s success/impact at present: 

This should be superfluous. The genesis of the current financial crisis was the stampede after the incentivized and open to capture triple-A ratings; and which since there were naturally not enough of these AAAs to satisfy the demand, being the AAAs in many ways only fidgets of imagination, this led the markets to provide some Potemkin ratings instead. 

It suffices to know that since capital and bankers are by nature coward, the world would have even been better off, if totally opposite capital requirements had been imposed on the banks, meaning capital requirements which progressively discriminated against those who represent lesser perceived risk. In such a case there would have been less rush after AAAs, while the lending to “the risky” would never have occurred in volumes that could systemically endanger the system.

All banks crisis in history have always resulted from excessive lending to what is perceived ex-ante as not being risky and no bank crisis has ever occurred because of excessive lending to anything perceived ex-ante as risky. Do you need more empirical evidence than that?

In 1999 I wrote “The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause the collapse”… and indeed the AAA-bomb exploded.

How many firms do you expect to reach?

All SMEs, most of them are not even rated.

What is the volume of private SME finance you aim to catalyze? 

The current capital requirements stimulated trillions of dollars to finance triple-A rated securities collateralized with badly awarded subprime mortgages in the US. I would be satisfied if it could help to catalyze just a decent fraction of that amount in new lending to the SMEs.

What time frame will be required to reach these targets? 

The market lost their trillions in about three years, from mid 2004 until mid 2007. The speed of the proposed adjustment should be further studied carefully monitored in order to avoid any problems in the middle of an economic crisis. 

I envisage the possibility of an immediate reduction of the maximum capital requirements for banks on all lending from 8 percent to 4 percent and then, over a period of 4 to 6 years elevating it to a 8-10 percent capital requirement, on any lending to all type of private borrowers. 

The adjustment of the capital requirements for public debt, and which for triple-As currently amazingly requires no capital at all, could take longer time though. Where would interest rates on public debt be without this arbitrary and non-transparent regulatory subsidy?

Does your innovation seek to have an impact on public policy?

Yes it looks precisely to correct an utterly wrong public policy.

What might prevent your innovative solution from succeeding?

From success, nothing! Though from being implemented, the difficulties with thick-as-a-brick regulators who are unable to break free from their current regulatory paradigm and who have a vested interest of remaining in total control of their own mutual admiration club.

Tell us about the social impact of your innovation. 

Since among the small SMEs we probably have our best chance of finding our next generation of decent jobs, the social impact of this innovative regulatory stepping back cannot be overstated. 

How many SMEs are there and how many more could there be if regulators did not discriminate against them? That is the number of SMEs that will benefit!

Demonstrate how your proposed solution has the capacity to graduate from dependence on public finance. What is the time frame? 

Currently if a bank lends to a SME it is required to have 8 percent in capital but, if it lends to an A-rated government so that this government in its turn can lend or give stimulus to a SME, then it needs zero capital. Could there be a more direct way of decreasing the dependence on public finance…immediately?

Please tell us if your proposed solution aims to scale up through a high growth sector, expand immediately to multiple sectors, and/or scale up geographically.

Absolutely, it aims to be applied to all the countries which have fallen in the current Basel Committee risk-adverseness trap. The fact that many emerging countries did not suffer so much from these regulations has a lot to do with the absence in these countries of AAA rated clients.

Please tell us what kind of partnerships, if any, could be critical to the greater success and sustainability of your innovation. 

We need a complete new crew of bank regulators with diverse backgrounds and able to break out from the current paradigm. 

We also need legislators that dare to face the problem. The final statement of the recent G20 meeting in Toronto mentions the Basel Committee on Banking Supervision 11 times and the Financial Stability Board (FSB) 27 times. But, in the 2319 pages of the Financial Regulatory Reform approved by the US Congress, those entities are not mentioned even once. Such disconnect is unmanageable!

In these days many, including Nobel-prize winners, speak about the excessive risk-taking of banks, while turning a blind eye to the fact that the crisis originated entirely in triple-A operations and so that we could just as well speak about an excessive and regulatory induced risk adverseness. I acknowledge though that this proposal is indeed noisy and difficult to move forward… and so a decided support from sturdy and eager group of changemakers is of course much needed and also much appreciated.

Friends, as you know I have been shouting about this issue for years, to very little avail, since most prefer either not to criticize the regulatory establishment or, for their own piece of mind, to think the regulatory establishment incapable of being as thick-as-a-brick as I hold them to be. In this respect, as you can understand, I very much look forward to the comments from the qualified jurors and commentators… some of whom might have some conflicts of interest on this issue.

By the way, since I am not a PhD, not a financial operator, not a banker and not a bank regulator, and just in case you should think that my criticism, as often happens, is facilitated by a lack of deeper knowledge on the subject, let me just copy below one example of the many formal and informal statements that I gave at the board of the World Bank as an Executive Director (1 of 24) on the subject. In October 2004 I wrote:

“We believe that much of the world’s financial markets are currently being dangerously overstretched through an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions.”

Who knows, perhaps after this proposal even the World Bank will invite me to discuss my objections to Basel regulations. Last time I did so, in May 2003, what little I then told them, sort of sent me off to their own Siberia.

Regards,

Per