If you want your nation to prosper and become strong, what bank capital (equity) requirements would you prefer?

The current risk weighted ones, which have banks allocating their credit based on risk adjusted return on required equity (ROrE)? 

These imply e.g.:

Bureaucrats knowing better what to do with credit for which repayment they’re not personally responsible, for than small businesses and entrepreneurs.

Financing the purchase of houses with residential mortgages has priority over financing those who can create the jobs, the incomes, by which repay mortgages and service utilities. (Which makes houses become more investment assets than affordable homes)

Or, just one single capital requirement against ALL assets, a leverage ratio, which will have everyone compete for credit with risk adjusted interest rates, and banks allocating their assets based on maximizing their risk adjusted return on one single equity (ROE)?

Or, would you argue: “But, the risk weighted makes our bank system safer”  Sorry, No! It’s just another dangerous Maginot Line

The first nation to kick out Basel Committee regulations and return to one single bank capital requirement against all assets, has the best chance of getting back on the right track. How to transition from here to there? Not easy, but here’s one route.

PS. Why do those who with so much emotions argue against trade protectionism, with such ease ignore to argue against credit allocation protectionism?

A tweet to @imfcapdev April 5 2021

"Excess of carbs e.g., government loans, residential mortgages; insufficient proteins e.g., bank loans to entrepreneurs and lack of exercise e.g., no creative destruction/zombification, causes GDP obesity. Can IMF/WBG develop a Body Mass Index for GDP?"

If you go into that dark forest that looks horrible to you... then we will force you to eat broccoli and spinach.

But if you stay out on the fields where everything looks safe and beautiful... then we will allow you to eat as much chocolate cake and ice cream you want.

Here my dialogues with #AI ChatGPT - OpenAI about current bank capital/equity requirements.

How come we ended up with stupid portfolio invariant risk weighted bank capital requirements?

Which are based on:

That those excessive exposures that can really be dangerous to our bank systems are build up with assets perceived as risky and not with assets perceived as safe.

That the bureaucrats/politicians/apparatchiks know better what to do with credit they’re not personally responsible for than e.g., entrepreneurs

That so much of bank capital requirements can depend on the evaluation performed by some very few human fallible credit rating agencies.

That substituting risk adjusted returns on equity for risk adjusted interest rates, would not seriously distort the allocation of bank credit.

Well here is the seed “A Risk-Factor Model Foundation for Ratings-Based Bank Capital Rules"

And here is Basel Committee’s “An Explanatory Note on the Basel II IRB Risk Weight Functions"

Though Paul A. Volcker, in his autography “Keeping at it”, valiantly confessed “The assets assigned the lowest risk, for which capital requirements were therefore low or nonexistent, were those that had the most political support: sovereign credits and home mortgages”

And here my explanations:

All bank regulators faced/face a furious attack mounted by dangerously creative capital minimizing / leverage maximizing financial engineers, who, getting rid of traditional loan officers, those with their “know your client” and their “what are you going to use the money for?”, managed to capture the banks. (And, since less capital means less dividends, they can also pay themselves larger bonuses.)

Hubris! “We regulators, we know so much about risks so we will impose risk weighted capital requirements on banks, something which will make our financial system safer” Yep, what’s risky is risky, what’s safe is safe. What is there not to like with such an offer? And the world, for the umpteenth time, again fell for demagogues, populists, Monday morning quarterbacks and those who find it so delightful to impress us rolling off their tongues sophisticated words like derivatives.

In a world full of mutual admiration clubs, like the Basel Committee and Academia in general, you do not ask questions that can imply criticism of any of your colleagues or superiors, “C’est pas comme il faut», nor, if you are a high shot financial journalist, do you risk not being invited to Davos or IMF meetings.

"It is difficult to get a man to understand something, when his salary depends upon his not understanding it!" Upton Sinclair

Clearly there are many more jobs with ever growing thousands of pages of regulations than with just a one liner: “Banks shall have one capital requirement (8%-15%) against all assets”. And so, instead of getting rid of the extremely procyclical credit risk weighted capital requirements, they designed new insufficient countercyclical ones.

“The time spent on any item of the agenda will be in inverse proportion to the sum involved." Parkinson’s law

Since bank regulators must have heard of (supposedly) Mark Twain’s “A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it looks to rain” it is clear they all missed their lectures on conditional probabilities.

“There are some mistakes it takes a Ph.D. to make”, Daniel Moynihan.

“One has to belong to the intelligentsia to believe things like that: no ordinary man could be such a fool”, George Orwell, in Notes on Nationalism

And so now: 

“A ship in harbor is safe, but that is not what ships are for” John A. Shedd, something that should apply to banks too. Sadly, dangerously our bank systems, banks are overpopulating safe harbors and, equally dangerous for our economy, underexploring risky waters. 

“What gets us into trouble is not what we don't know. It's what we know for sure that just ain't so.” Mark Twain

And since current bank capital requirements are mostly based on the expected credit risks banks should clear for on their own; not on misperceived credit risks, like 2008’s AAA rated MBS, or unexpected dangers, like COVID-19, now banks stand there with their pants down.

Let us pray 2021 will not be too hurtful.

PS. Might “availability heuristic” “availability bias” help explain these loony risk weighted bank capital requirements?

My 2009 video on the 62.5 times to 1 authorized leverage

My 2019 letter to the Financial Stability Board

My 2019 letter to the Executive Directors and Staff of the International Monetary Fund

I’ve never been a regulator, but on the issue, neither am I a new arrival.

And the regulators’ mumbo jumbo, shows no sign it will stop.

The Basel Committee for Banking Supervision’s bank regulations vs. mine.

A tweet to: @IMFNews, @WorldBank, @BIS_org @federalreserve, @ecb @bankofengland @riksbanken @bankofcanada

"Should you allow the Basel Committee to keep on regulating banks as it seems fit, or should you not at least listen to other proposals?

Bank capital requirements used to be set as a percentage of all assets, something which to some extent covered both EXPECTED credit risks, AND UNEXPECTED risks like major sudden downgrading of credit ratings, or a coronavirus.

BUT: Basel Committee introduced risk weighted bank capital requirements SOLELY BASED ON the EXPECTED credit risk. It also assumes that what is perceived as risky will cause larger credit losses than what regulators perceive or decreed as safe, or bankers perceive or concoct as safe. 

The different capital requirements, which allows banks to leverage their equity differently with different assets, dangerously distort the allocation of bank credit, endangering our financial system and weakening the real economy.

The Basel Committee also decreed a statist 0% risk weight for sovereign debts denominated in its domestic currency, based on the notion that sovereigns can always print itself out of any problem, something which clearly ignores the possibility of inflation, but, de facto, also implies that bureaucrats/politicians know better what to do with bank credit they are not personally responsible for, than for instance entrepreneurs, something which is more than doubtful.

Basel Committee's motto: Prepare banks for the best, for what's expected, and, since we do not know anything about it, ignore the unexpected 

I propose we go back to how banks were regulated before the Basel Committee, with an immense display of hubris, thought they knew all about risks; which means one single capital requirements against all assets; 10%-15%, to cover for the EXPECTED credit risk losses and for the UNEXPECTED losses resulting from wrong perceptions of credit risk, like 2008’s AAA rated securities or from any other unexpected risk, like COVID-19.

My one the same for all assets' capital requirement, would not distort the allocation of credit to the real economy.

My motto: Prepare banks for the worst, the unexpected, because the expected has always a way to take care of itself.

PS. My letter to the Financial Stability Board
PS. A continuously growing list of the risk weighted bank capital requirements mistakes

PS. Risk-weights are to access to credit what protectionist tariffs are to trade, only more pernicious.

PS. I am no newcomer to this issue

My tweets on “How the Basel Committee doomed our bank systems and our economies”

The Basel Committee doomed our bank systems and our economies.

For around 600 years risk adverse bankers had, not always successfully, tried to do their best to clear for perceived credit risks, by means of risk adjusted interest rates and the size of bank exposures. 

When what bankers had perceived as risky turned out to be even more risky, since the exposures were generally quite small, it hurt but banks could manage. 

When what bankers perceived as safe turned out to be risky, since the exposures were then very large, big crises often ensued. 

But then, starting in 1988 with Basel I, and really exploding in 2004 with Basel II, risk adverse regulators decided they also wanted to clear for those same perceived credit risks, and to that effect introduced risk weighted bank capital requirements.

In the softest words I can muster, that was extremely dumb. As bank supervisors they should be almost exclusively concerned with bankers not perceiving the credit risks correctly. Instead they bet our bank systems on that bankers would perceive credit risks correctly.

Banks everywhere were then taken out of the hands of savvy loan officers, and placed in the hands of creative equity minimizing financial engineers, who then ably marketed the nonsense that more bank capital hindered bank lending and was therefore bad for the real economy 

The 2008 crisis caused by AAA rated securities backed with mortgages to the US subprime sector, with which European banks and US investment banks were allowed to leverage 62.5 times with these, should have loudly reminded them about the dangers of the “safe”. 

But regulators refused to admit their mistake and kept risk weighting in Basel III.

The result is an ever increasing dangerous overcrowding of “safe harbors” and the abandonment of the “riskier oceans. “A ship in harbor is safe, but that is not what ships are for.” John A. Shedd.

And those who used to populated safe harbors, like insurance companies, pension funds, personal saving accounts and other, have been expelled to the risky oceans, confronting loans to leveraged corporates, emerging markets and others for which they're less prepared than bankers

To sum it up, risk-weighted bank capital requirements guarantees especially large crises, resulting from especially large exposures to what’s perceived especially safe, and is held against especially little capital. 

Let’s get rid of these regulators… now!

http://perkurowski.blogspot.com/2016/04/here-are-17-reasons-for-why-i-believe.html

And not only are they dangerously bad regulators… by decreeing risk weights of 0% for the sovereign and 100% for the citizens, they also evidence being dangerous statist/communist regulators.

http://perkurowski.blogspot.com/2019/09/financial-communism.html

PS. My 2019 letter to the Financial Stability Board

PS. My 2019 letter to the IMF

My tweets to IMF and World Bank on risks and bank regulations during their Annual Meetings 2019

@IMFNews @WorldBank #IMFmeetings #WBGMeetings

The world needs the IMF and World Bank to hold a continuous and intensive back and forth debate, a give and take, on risk-taking. 

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

http://teawithft.blogspot.com/2009/10/please-free-us-from-imprudent-risk.html

The World Bank, as the world’s premier development bank should always make clear that risk taking is oxygen needed for moving forward.

And the IMF, as guardian of the world’s financial stability, is responsible for that risk taking not getting out of hands. 

http://subprimeregulations.blogspot.com/2003/03/financial-sector-assessments-program.html

That debate has sadly not been forthcoming.

That resulted in the acceptance of the credit risk weighted bank capital requirements. 

That introduced a regulatory risk aversion, dangerous both for the financial stability and for economic growth.

For financial stability, by creating excessive bank exposures to what’s perceived, decreed or concocted as especially safe, against especially little capital.

For the economy, by reducing the “risky” but vital SMEs’ and entrepreneurs’ access to bank credit.

A synchronized financialization: 

"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."

http://subprimeregulations.blogspot.com/2003/03/my-comments-on-world-banks-strategic.html

A synchronized disaster:

“Perceiving risks wrong: What happens when markets misprice risk?”

Wrong question! When markets see risks, it stays away 

Correct question! “Perceiving safety wrong: What happens when markets (and regulators) misprice safety?

http://subprimeregulations.blogspot.com/2019/07/risk-weights-are-to-access-to-credit.html

J’Accuse[d] the Basel Committee for Banking Supervision (BCBS) a thousands times, but I am no Émile Zola and there’s no L’Aurore

J’Accuse the Basel Committee of setting up our bank systems to especially large crises, caused by especially large exposures to something perceived as especially safe, which later turns into being especially risky, while held against especially little capital.

My letter to the Financial Stability Board

J’Accuse the Basel Committee for distorting the allocation of bank credit to the real economy by favoring the sovereign and the safer present, AAA rated and residential mortgages, while discriminating against the riskier future, SMEs and entrepreneurs.

My letter to the International Monetary Fund

A question to the Fed: When in 1988 bank regulators assigned America’s public debt a 0.00% risk weight, its debt was about $2.6 trillion, now it is around $22 trillion and still has a 0.00% risk weight. When do you think it should increase to 0.01%?

Risk weights are to access to credit what protectionist tariffs are to trade, only more pernicious.

A letter to the Executive Directors and Staff of the International Monetary Fund.

For decades now IMF has helped to spread around all developing countries the pillar of the Basel Committee’s bank regulations; the risk weighted capital requirements for banks.

Since risk taking is in essence the oxygen of any development, that piece of regulation is fundamentally flawed, especially for developing countries.

How do risk weighted capital requirements alter the incentives for banks? 

If banks hold the same capital against their whole portfolio, as they used do until some three decades ago, then with an eye on their overall portfolio and funding structure, banks lend in accordance to what produces them the highest risk adjusted interest rate; which would also provide them with the highest risk adjusted return on equity.

But, when different assets have different capital requirements, obtaining the highest risk adjusted return on equity will depend on how many times the risk adjusted interest rate for any specific loan or asset will depend on how many times it can be leveraged. The higher the allowed leverage is, the easier it is to obtain a high ROE; which means that “safe” highly leveregable loans could be competitive at lower risk adjusted interest rates than before, while “risky” lower leveregable loans would require paying higher risk adjusted interest rates. 

In essence the introduction of that regulation has caused banks to substitute savvy loan officers with equity minimizing engineers.

How do risk weighted capital requirements distort the allocation of bank credit?

The regulators based their decision on how much banks were allowed to leverage their capital with for the different assets, solely on the perceptions of credit risk. It never explicitly had one iota to do with banks fulfilling their obligation of allocating credit efficiently to the real economy.

So the introduction of that regulation simply distorts the allocation of bank credit; in favor of “the safer present” and against “the riskier future”. 

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

Specifically, a credit that is perceived as risky but that is directly related to helping reach a Sustainable Development Goal is much less favored by bankers, and now by bank regulators too, than a credit, perceived as safe, but which purpose could in fact be harmful to any SDG.

Specifically, safe credits for the purchase of houses are much more favored over credits to risky entrepreneurs, those who could create the jobs that would allow the income needed to service the mortgages and pay the utilities. 

Specifically, assigning lower risk weights to the sovereign than to citizens de implies de facto a statist belief that bureaucrats know better what to do with bank credit, than entrepreneurs who put their name on the line.

In other words these risk weight are to access to credit what tariffs are to trade, only much more pernicious. 

Do risk weighted capital requirements make our banks system safer?

If that regulation made the financial system safer there would at least be a favorable tradeoff. But it doesn’t, much the contrary. Too much easy credit can turn what is safe into something risky, like for instance morphing houses from being affordable homes into investment assets. 

The 2007/2008-bank crisis would never have happened or, if so, remotely had been of the same scale had regulators, for their risk weights, instead of perceived credit risk risks, used the probabilities of banks investing conditioned on how credit risks were perceived.

Many Eurozone sovereigns would not face current high levels of indebtedness had not EU authorities decreed a Sovereign Debt Privilege and assigned it a 0% risk weight, this even though they take on debt denominated in a currency that de facto is not their domestic printable one.

And so, at the end of the day, this regulation only guarantees especially large bank crisis, caused by especially large exposures to what was perceived (or decreed) as especially safe, which end up being especially risky, and are held against especially little capital.

Risk weighted capital requirements and inequality.

John Kenneth Galbraith wrote: “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… the poor risk… is another name for the poor man.” “Money: Whence it came where it went” 1975.

So I ask, how many millions of SMEs and entrepreneurs have not been given the opportunity to advance with credits over the last 25 years as a direct result of it?

IMF, please, wake up!

Should banks not be regulated? 

Of course these need to be regulated! I am only reminding everyone of the fact that the damage dumb bank regulators can cause when meddling without taking enough care, by far surpasses anything the free market can do. A free market would never have knowingly allowed banks to leverage 62.5 times their equity like regulators did, only because some very few human fallible credit rating agencies had assigned an AAA to AA rating to some securities backed with mortgages to the US subprime sector. 

A simple leverage ratio between 10 to 15% for all banks assets would be a much mote effective regulation than all those thousands of pages that currently exist.

And please, please, please, stop talking about "deregulation" in the presence of such an awful and intrusive mis-regulation. The regulators imposed the worst kind of capital controls.

Of course, just in case, all problems here referred to, are clearly applicable to developed economies too.

Sincerely,

Per Kurowski

@PerKurowski

PS. Basel Committee’s distortion of credit allocation explained to dummies, in just four tweets.

PS. “The assets assigned the lowest risk, for which capital requirements were therefore low or nonexistent, were those that had the most political support: sovereign credits and home mortgages. Ironically, losses on those two types of assets would fuel the global crisis in 2008 and a subsequent European crisis in 2011”, “Keeping at it” 2018, Paul Volcker

PS. My 2019 letter to the Financial Stability Board

PS. An ever growing aide memoire on Basel Committee’s many mistakes.

PS. The risk weighted bank capital requirements utterly distorted central banks’ monetary policy by directing way too much credit to what’s decreed or perceived as “safe”, sovereign/ residential mortgages/ AAA rated; and way too little to “risky” SMEs and entrepreneurs.

PS. Because it would also create distortions I am not proposing it, but would not risk weighted bank capital requirements based on SDGs ratings at least show more purpose for our banks? And, in the case of sovereigns, besides credit ratings, do we citizens not also need ethic ratings?

PS. “Are Basel bank regulations good for development?” a document presented at the High-level Dialogue on Financing for Developing at the United Nations, New York, October 2007.

PS. GDP growth based on too much carbs and too little proteins? Muscular or obese?

PS. Being creditworthy and being worthy of credit, c'est pas la même chose :-(

PS. And I am no newcomer to this issue

PS. Here AI - ChatGPT opining on risk weights and tariffs

IMF, your main role in supporting social spending, is helping to make sure the resources needed to be spent, are there.

I refer to IMF Policy Paper “A Strategy for IMF Engagement on Social Spending” dated June 2019.

The best strategy for IMF to engage on Social Spending is making sure the real economy, in a sustainable way, provides the most resources to it. That must at this moment begin by loudly protesting the risk weighted capital requirements for banks, something on which the IMF, sadly, has kept silence on for soon three decades.

Since 1988, with the Basel Accord, bank regulations have included, as its pillar, risk weighted capital requirements for banks. The higher the perceived credit risk is, the higher the capital banks need to hold and vice versa, the lower the perceived credit risk is, the lower the capital banks need to hold.

In Basel II of 2004 these risk weights ranged from 0% assigned to AAA to AA rated sovereigns, to 150% assigned to corporates rated below BB-. With a basic capital requirement of 8% that allowed banks to leverage their capital from, an infinite number of times till about 8.3 times.

By doing so that piece of regulation has seriously distorted the allocation of credit, putting both our bank systems at great risk and weakening the possibilities of our real economy to grow in a sustainable balanced way.

We already heard a canary clearly sing in the mine when a crisis exploded because of excessive demand for the securities backed by mortgages to the subprime sector. That demand resulted from that US investment banks and European banks, were allowed to leverage their capital with these securities a mind-boggling 62.5 times, if only a human fallible rating company had assigned it an AAA to AA rating. 

And all that “safe” financing of houses, have only caused these to morph from being homes into being investment assets, at great risk of causing future financial instability. 

And all those “risky” SMEs and entrepreneurs, who used to have their credit needs primarily serviced by banks, are now forced to fish in other less adequate waters. 

And what to say about the 0% risk weighting of all eurozone sovereigns that assume debt denominated in a currency that de facto is not their domestic printable one?

A lower risk weight assigned to the sovereign than to an entrepreneur implies the opinion that a bureaucrat knows better what to do with bank credit, than the entrepreneur who puts his own name to it. If that’s not statism what is? 

In summary: To favor the financing of the ‘safer present’ over the ‘riskier future’ only guarantees the weakening of the economy; and especially large bank crises, because of especially large exposures to what is especially perceived as safe, against especially little capital.

And sadly IMF has kept notorious silence on this.

Here, there is good money to be earned, by just explaining the risk weighted capital requirements for banks to me.

I will pay a US$ cash bonus to the first who manage to extract clear answers from any regulator on two questions that have had me intrigued for a way too long time… so much that many tell me I am obsessive about… which of course I am.

I start with US$ 100 for each one of the answers and increase it by U$10 each month... for some time

US$100 to the first who gets a clear answer from a regulator on: Why do you want banks to hold more capital against what, by being perceived as risky has been made quite innocous, than against what, because it is perceived as safe, is much more dangerous? 

http://perkurowski.blogspot.com/2016/04/here-are-17-reasons-for-why-i-believe.html

And also US$100 to the first who gets a clear answer from a regulator on: Why are banks allowed to leverage much more when financing homes, than when financing the entrepreneurs who could help create jobs needed to pay utilities and service the mortgages?

https://perkurowski.blogspot.com/2018/01/many-of-our-young-will-be-without-jobs.html

Current bank regulators should undergo a psychological test. They clearly seem to be afflicted by “false safety behavior”

I extract the following from “False Safety Behaviors: Their Role in Pathological Fear” by Michael J. Telch, Ph.D. 

“What are false safety behaviors? 

We define false safety behaviors (FSBs) as unnecessary actions taken to prevent, escape from, or reduce the severity of a perceived threat. There is one specific word in this definition that distinguishes legitimate adaptive safety behaviors - those that keep us safe - from false safety behaviors - those that fuel anxiety problems? If you picked the word unnecessary you’re right! But when are they unnecessary? Safety behaviors are unnecessary when the perceived threat for which the safety behavior is presumably protecting the person from is bogus.”

The risk weighted capital requirements for banks, more perceived risk more capital – less perceived risk less capital, fits precisely that of being unnecessary. If a risk is perceived the banker will naturally take defensive measures, like limiting the exposure or charging higher risk premiums. If there is a real risk that is of the assets being perceived ex ante as safe, but turning up ex post as risky.

The consequences of such false safety behavior by current bank regulators are severe:

They set banks up to having the least capital when the most dangerous event can happen, something very safe turning very risky. 

Equally, or even more dangerous, it distorts the allocation of bank credit to the real economy, it hinder the needed “riskier” financing of the future, like entrepreneurs, in order to finance the “safer” present, like house purchases and sovereigns.

It creates a false sense of security because why should anyone really expect that “experts” picked the wrong risks to weigh, the intrinsic risk of the asset, instead of the risk of the asset for the banking system.

I quote again from the referenced document:

“How do false safety behaviors fuel anxiety? 

There seems to be a growing consensus that FSB’s fuel pathological anxiety in several different ways. One way in which FSBs might do their mischief is by keeping the patient’s bogus perception of threat alive through a mental process called misattribution. Misattribution theory asserts that when people perform unnecessary safety actions to protect themselves from a perceived threat, they falsely conclude (misattribute) their safety to the use of the FSB, thus leaving their perception of threat intact. Take for instance, the flying phobic who copes with their concern that the plane will crash by repeatedly checking the weather prior to the flight’s departure and then misattributes her safe flight to her diligent weather scanning rather than the inherent safety of air travel.” 

In this respect stress tests and living wills could perhaps be identified as “unnecessary safety actions” the “checking of the weather”. 

Finally: “FSBs may fuel anxiety problems by also interfering with the basic process through which people come to learn that some of their perceived threats are actually not threats at all…threat disconfirmation…For this important perceived threat reduction process to occur, not only must new information be available but it also must be processed.”

The 2007/08 crisis provided all necessary information on that the risk weighting did not work, since all bank assets that became very problematic, had in common low capital requirements since they were perceived as safe. And this information has simply not been processed.

Conclusion, I am not a psychologist but given that our banking system operates efficiently is of utmost importance, perhaps a psychological screening of all candidates to bank regulators should be a must. Clearly the current members of the Basel Committee and of the Financial Stability Board, and those engaged with bank regulations in many central banks, would not pass such test.

I feel sorry for them, especially after finding on the web someone referring to "anxiety disorder" with: “I don’t think people understand how stressful it is to explain what’s going on in your head when you don’t even understand it yourself”

PS. Here is a brief summary of the mistakes of the risk weighted capital requirements for banks.

  

IMF, the Basel Committee’s procyclical risk weighted capital requirements puts financial cycles, global or local, on steroids

This year’s IMF Jacques Polak Annual Research Conference on November 2–3 is titled “The Global Financial Cycle.” 

It aims to bring together contributions by leading experts on the topic—from both within and outside the IMF—to improve the “understanding of a range of issues, including the causes and consequences of the global financial cycle, the transmission channels of global financial shocks, and the role of domestic policies in dampening the impact of global shocks.”

I wonder if, again, for the umpteenth time, the distortions produced by risk weighted capital requirements in the allocation of credit to the real economy will be ignored.

The following is the comment I posted on the IMF Blog

Risk weighted capital requirements, more risk more capital – less risk less capital, allows banks to earn much higher risk adjusted returns on equity with what is perceived decreed or concocted as safe, than on what is perceived as risky. 

That pushes more than ordinary the financial pursuit of “the safe” and the avoidance of “the risky”.

That de facto puts financial cycles, whether global or local, on steroids.

Will this comment be considered? I have not seen much action on the one I made last year.

PS. I have now read all the papers presented in the conference and the only one that makes somewhat of a reference to risk weighted capital requirements, is “Global financial cycles and risk premiums?” authored by Oscar Jorda, Moritz Schularick, Alan M. Taylor and Felix Ward, October 2017

It includes “If banks hold foreign assets on their balance sheets and mark them to market, price changes can synchronize the risk appetite and the trading behavior of banks around the world. For instance, if Federal Reserve policy affects U.S. equity prices, falling asset prices in the U.S. decrease (risk-weighted)-asset-capital ratios of U.S. as well as international banks, which start to cut down their risk-taking in sync with U.S. banks.

If no large risk-neutral player steps in to compensate for the lower risk taking of the leverage-constrained intermediaries, risk-spreads will increase.”

But as one can see that is how financial cycles or event affect “(risk-weighted)-asset-capital ratios”, but not how these risk weighted capital requirements affect the financial cycles.

For instance Greece would never ever have been able to obtain so much debt had it not been for the ridiculous low capital requirements on that debt.

What’s the similitude of World Bank and IMF? That the Basel Committee has fooled them both!

World Bank has the function of development… and has ignored that risk weighted capital requirements for banks kills the risk-taking that is the oxygen of development.

IMF has the function of stability … and has ignored that bank crises are caused by excessive exposures to what’s wrongly perceived as safe, and never to what is rightly perceived as risky.

Explaining to World Bank and IMF the horrific mistakes of Basel’s bank regulations, has not been an easy journey

http://live.worldbank.org/civil-society-townhall-2017

28:30, I am Per Kurowski, of New Rules for Global Finance

This is a question for the umpteenth time to the World Bank:

As the world’s premier development bank the World Bank must know that risk-taking is the oxygen of any development. So why is it still not speaking out against the risk-weighted capital requirements for banks that put a brake on risk-taking, like on the lending to SMEs small and medium sized enterprises…even though never ever has a major bank crisis erupted because of excessive exposures to something ex ante perceived as risky.

30:50, World Bank, Jim Yong Kim

On risk taking I am not sure I understood the question correctly, but there is, because of in many ways I think very much necessary prudential rules, the Basel process, one of the side effects of it is that it has been a systematic de-banking of many developing countries, especially in Africa. 

And so many banks Standard Chartered and others that had very strong presence in the developing world have for the most part left. And so we have a terrible time in terms of accessing capital markets in the way that they did before.

So it’s a huge concern for us, and we are continuing to engage with the Basel process and we are continuing to try to talk about some of the side effects. For example it is much more difficult and expensive to send remittances back now because these institutions don’t exist. 

And so the problem of insuring that the poorest countries have access to capital markets is very-very high on our agenda, and is really at the core of the major issue we talked about in spring meetings which is our cascade; and the cascade is essentially recognition that on the one hand it is very difficult for very good emerging markets infrastructure projects to get capital, and on the other hand there is more than 10 trillion dollars in negative interest bond, and 25 plus trillions in very low earning bonds and another 8 trillion in cash sitting in peoples safes, and they would like to get a higher return, but the perception of risk in the emerging market is so high, that the capital is just not moving.

So we are putting so much of our effort into mitigating this situation where you have great projects, great potential for building infrastructure that would lead to growth but that are not being financed; we are really focusing on filling that void on the problem I think you are pointing to.

My comment: It was not answering my real question but it was still a very valid answer. If given a chance my re-question would have been: Do you think Standard Chartered would have left those development markets had it had to hold the same capital against all its assets than what it is required to hold on loans to these markets? The answer to that is surely “No!”

35:25, IMF, Mme Christine Lagarde.

I am actually tempted to address also this question, is that okay?

Because I think it is an important point and one that has very complex ramifications. It has complex ramifications in the banking regulations business, in the banking supervision business, and in the accounting business.

And then it is at the very junction of between sort of self-established model by the banks versus models established by the supervisors. 

I think we both would agree that methods that would actually encourage the lending by banks and by insurance companies and by pension fund to SMEs, you know with the risk associated with it, should actually be very much in order.

At the moment the risk weighing methods and the models that are being used are discouraging from actually investing and taking risk to benefit the small and medium sized enterprises 

And that’s not necessarily the best avenue to support the economy and to support entrepreneurs who want to have access to financing.

My comment: Many thanks, but Mme Lagarde, it really behooves the IMF, and the World Bank, to understand why it took them about 15 years, Basel II, to see this problem.

30:50 World Bank, Jim Yong Kim

Just to add to that, we are now trying to come up with lots of different innovative approaches to de-risking those investments, taking first loss, using political risk insurance credit enhancements, lot of tools that we are using now to try to respond to the situation

My comment: That is good to hear, but beware, de-risking credits, against distorted and inadequate bank regulations, could have very bad unexpected consequences.

PS. Very much inspired by John Kenneth Galbraith’s “Money: Whence it came, where it went” (1975), I started my fight against Basel Committee’s regulations in 1997, in my very first Op-Ed “Puritanism in Banking”.

And in 2003, as an Executive Director or the World Bank, in a workshop for bank regulators I warned: “The other side of the coin of a credit that was never granted, in order to reduce the vulnerability of the financial system, could very well be the loss of a unique opportunity for growth. In this sense, I put forward the possibility that the developed countries might not have developed as fast, or even at all, had they been regulated by a Basel.”

In 2007, ten years ago, at the High-level Dialogue on Financing for Developing at the United Nations, as civil society, I presented the document: “Are the Basel bank regulations good for development?”

And since then I do not know how many times, I have tried and failed to draw IMF’s and World Bank’s attention to the many very serious mistakes that are imbedded in Basel’s risk-weighted capital requirements for banks.

Have I arrived at the end of my journey? I am not 100% sure, but I do see some light J