Here follows my linked four tweets to bank regulators

The ex post risk of Basel Committee’s bank capital requirements, based on models based on ex ante risk perceptions, is huge!

All these capital requirements do is to seriously distort the allocation of bank credit to the real economy, for no good purpose at all.

Bank capital requirements should be based on ex post risks that considers the risks of models based on ex ante risks perceptions.

Mario Draghi, Mark Carney, Stefan Ingves, Janet Yellen, Martin Gruenberg...  Capisci?

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

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

But he should also have asked:

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

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

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

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

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

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

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

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

A public letter to Mr. Stefan Ingves, the chair of the Basel Committee for Banking Supervision

Mr. Stefan Ingves.

There are cowards and there are braves, ranging from extreme cowards to stupidly foolish braves, but that has less to do with how these perceive risks, and much more to do with how they assume and manage risks.

And then there are those blind to risks… so blind they do not even see a credit rating.

The Basel Committee’s risk weighted capital requirements for banks, based on precisely the same perceived risks (credit ratings) that seeing banks can already see, have clearly been designed for blind bankers.

I do not know how many such blind bankers there are, and if they exist they should not even be allowed to be in business. But, your risk weighted capital requirements, sure poses a big problem for all other banks, and for the economy in general.

Since non-blind banks already clear for any perceived credit risk, by means of interest rates and size of exposure, to force them to again, now in the capital, clear for exactly the same perceived credit risk, gives credit risk perceptions a double weight.

And any perceived risk, even if perfectly perceived, if excessively considered, leads to the wrong action.

In the case all credit risk ratings were perfect… that would then mean banks would lend more than what they should, to what is perceived “safe”, and less than what they should, to what is perceived "risky". And that misallocation of bank credit must be bad for all, especially for the real economy.

Also if credit ratings indicate a “safe” asset to be safer than what it really is, then of course a bank could collapse. Indeed this is precisely the stuff all major bank crises have been made of. No crisis has resulted from too much exposures to something ex ante perceived as risky.

Of course, if a credit rating is imperfect, in the way of informing the asset to be less risky, or less safe, than what it really is, then you might have helped banks to nail it. I doubt though your intention was really to base it on credit ratings being adequately wrong.

Mr. Stefan Ingves, may I suggest the following?

For once think of the purpose of banks being that of allocating credit efficiently to the real economy; and then go back to the drawing board, to see what non-distortionary capital requirements for banks you can come up with.

While doing so, may I suggest you remember that the purpose of the capital requirements for banks, is to cover for some unexpected losses, and not like now, for the expected credit losses?

You could still use credit ratings, if that helps you to save face… but, instead of basing it until now on those credit ratings being correct, why not require banks to have for instance 8 percent of capital against all assets, based on the risks of credit ratings, and other risk perceptions, being wrong... and other risks like that of cyber-attacks.

Please Mr. Ingves... wake up! The risk with banks has nothing to do with the risk of their assets, and all to do with how they manage the risk of their assets… Don’t make it harder than it already is for banks to manage credit risks correctly.

Yours sincerely,

Per Kurowski

PS. Could you please send a copy of this letter to Marc Carney, the current chair of the Financial Stability Board? It could also be of interest  to BIS's Jaime Caruana, ECB's Mario Draghi, and Fed's Janet Yellen. 

Janet Yellen, are you really so unaware you are also one of the equal opportunities killers?

On October 17, 2014 Federal Reserve Chair Janet Yellen spoke about “Perspectives on Inequality and Opportunity” In it she said: 

“Owning a business is risky, and most new businesses close within a few years. But research shows that business ownership is associated with higher levels of economic mobility. However, it appears that it has become harder to start and build businesses. The pace of new business creation has gradually declined over the past couple of decades, and the number of new firms declined sharply from 2006 through 2009… One reason to be concerned about the apparent decline in new business formation is that it may serve to depress the pace of productivity, real wage growth, and employment. Another reason is that a slowdown in business formation may threaten what I believe likely has been a significant source of economic opportunity for many families below the very top in income and wealth.” 

Unbelievable! Janet Yellen, even though she is extremely connected to bank regulations, seems not to have the faintest idea of how these effectively block the creation of new businesses, by unfairly discriminating the access to bank credit of those who are perceived as risky… like new businesses. 

Janet Yellen (and others at the Fed), let me explain it for you: 

The pillar of current bank regulations is credit risk weighted capital (equity) requirements for banks… more-perceived-credit-risk more equity – less-perceived-credit-risk less equity. 

And that translates into banks being allowed to earn much much higher risk adjusted returns on equity when lending to the “absolutely safe” than when lending to the risky” 

And that translates directly into that those who are perceived as “risky”, like new businesses, and who, precisely because they are perceived as “risky”, already have to pay higher interests and have lesser access to bank credit, will then have to pay up twice for that perception…and so will then need to pay even higher interests and then get even less access to bank credit. 

And that is odious discrimination, a great driver of inequality… and a killer of the equal opportunities the poor so much need in order to progress. 

And of course, let us not even think of what the Fed’s QE’s have done in terms of un-leveling the playing fields. The fact is that had it not been for how the financial crisis management favored foremost those who had most, Thomas Piketty’s "Capital in the Twenty-First Century”, would have remained a manuscript. 

And Janet Yellen thinks: “it is appropriate to ask whether this trend [of widening inequality] is compatible with values rooted in our nation's history, among them the high value Americans have traditionally placed on equality of opportunity.” 

Frankly to hear someone who favors regulatory risk-aversion, daring to speak about American values, in the “home of the brave”, in the land built up on the risk-taking of their daring immigrants… is sad.

I am sure that the US Congress would never ever approve what you bank regulators are up to, if aware of it, and much less if asked formally

What would the reactions be if capital requirements for banks discriminated against gays, sick, black people or women?

PS. To me it is amazing how bank regulators in America can so blitehly ignore the Equal Credit Opportunity Act (Regulation B)

Fed Chair Janet Yellen has not been briefed on the real implications of current risk-weighted capital requirements for banks.

I refer to Fed Chair Janet L. Yellen speech At the 2014 Michel Camdessus Central Banking Lecture, International Monetary Fund, Washington, D.C. July 2, 2014 on Monetary Policy and Financial Stability.

From it I deduct that she has not yet been fully briefed about the real implications of the pillar of current bank regulations namely the risk-weighted capital requirements for banks.

I will illustrate this with two examples:

First Yellen states: “A smoothly operating financial system promotes the efficient allocation of saving and investment, facilitating economic growth and employment. A strong labor market contributes to healthy household and business balance sheets, thereby contributing to financial stability. And price stability contributes not only to the efficient allocation of resources in the real economy, but also to reduced uncertainty and efficient pricing in financial markets, which in turn supports financial stability.”

Absolutely, the problem though is that by means of risk-weighing the capital banks are required to hold, you allow banks to earn different risk-adjusted returns on equity something which stops in the tracks any possibility of efficiently allocating bank credit in ways that permit sturdy economic growth. In essence current requirements, by allowing banks to earn more on the “absolutely safe” it has stopped banks to lend sufficiently to the risky, like medium and small businesses, entrepreneurs and start-ups. And, an economy with insufficient risk-taking, is doomed to recede.

But also, from the perspective of financial stability the current risk weights are completely wrong, since never ever do big bank crises erupt from too much bank exposure to what is ex ante considered risky, they always result from too much bank exposures to what ex ante is considered absolutely safe, but that ex post turns out very risky.

Second Yellen states: “Tools that build resilience aim to make the financial system better able to withstand unexpected adverse developments. For example, requirements to hold sufficient loss-absorbing capital make financial institutions more resilient in the face of unexpected losses.”

Absolutely, the problem though is that the current risk weights have nothing to do with unexpected losses, and all to do with the expected losses derived from the perceived credit risks which are already cleared for in interest rates, size of exposures and other contractual terms.

And the consequence of that is that expected losses get cleared for twice, while the unexpected losses are not considered, and huge distortions ensue.

In the remote possibility that Janet Yellen would read this, let me end here by assuring her that if banks had had to hold the same capital against any asset, for instance the basic Basel II's 8 percent, something else might have happened… but not the current crisis.

PS. Here is a link to a fuller list of the Basel II mistakes.

Janet Yellen why are bank capital requirements based on credit ratings and not on job creation ratings?

Bank lending to small businesses has never had anything to do with causing the latest or any other financial crises for that matter; and risk-weighted capital requirements for banks makes it impossible for “the risky” small businesses to access bank credit in a fair way… 

Now knowing that, as Federal Reserve Chair Janet L. Yellen must know, how can you give a speech such as that delivered at the National Small Business Week Event at the U.S. Chamber of Commerce in May 2014?

She speaks much of the importance of job creation. Indeed, if I had been invited and allowed to make a question, that one would be… why do you base capital requirements for banks on perceived credit risk ratings and not on job creation ratings?

When are small businesses going to ask regulators why banks need to hold more capital when lending to them?

Read Fed’s Chair Janet L. Yellen’s speech “Small Businesses and the Recovery” delivered at the National Small Business Week Event, U.S. Chamber of Commerce, Washington, D.C. on May 15, 2014

And then reflect that even though never ever has a bank crisis detonated because of excessive bank exposures to “risky” small businesses, nevertheless the regulators require the banks to hold much more capital when lending to them than when lending to the “infallible sovereign” the AAAristocracy or the housing sector.

And that means that banks can obtain much higher risk-adjusted returns on equity when lending to the “infallible sovereign”, the AAAristocracy or the housing sector, than what they can obtain lending to “risky” small businesses.

And that means that small businesses will have access to less bank credit, or to more expensive bank credit, only in order to make up for this competitive disadvantage imposed by regulators.

When are the “risky” medium and small businesses, entrepreneurs and start-ups ask for the why of this regulatory nonsense?

If asked by Janet Yellen about risk-weighted bank capital requirements, how would Margaret Thatcher have answered?

Although I am sure Janet Yellen fulfills all the formal qualifications, I really do not know sufficient about her so as to be able to provide any credible input as to her chances of doing a good job as the new Chair of the Fed. What I am sure of though, is that Yellen will need to show a type of Margaret Thatcher type of character strength, if she is going to be able to stand a chance against what is to come.

And in this respect I would also have liked, if Janet Yellen had been able to pose the following question to Margaret Thatcher:

By requiring banks to hold much more capital against what is perceived as risky than against what is perceived as absolutely safe, banks earn higher risk-adjusted returns on equity when lending to The Infallible Sovereign and to the AAAristocracy than when lending to The Risky. This causes of course banks to lend less than what they would ordinarily do, and more expensively so, to all “risky” medium and small businesses, entrepreneurs and start ups. Margaret do you think this is sane? Do you think this makes our banks safer? Do you think this helps the economy to grow muscular and sturdy?

And though certainly uttered in some much better way than what my poor British English allows me, I can almost hear Margaret Thatcher answering something as follows:

“No Dear Janet, that is as insane as it comes. We the western world did not become what we are by foolishly telling risk-adverse bankers to avoid taking risks, or by allowing bankers to binge profitably on what we for now, in shortsighted blissful ignorance, believe to be absolutely safe.”

Here is THE QUESTION for Janet Yellen during her US Senate confirmation hearings as Chair of the Federal Reserve

Ms. Janet Yellen

Is it not a fact that, with the sole exceptions of when pure fraud was present, all major bank crises have always resulted from excessive exposures to what was ex ante perceived as “absolutely safe”, and never ever from excessive exposures to what was ex ante perceived as “risky”?

And, if so, can you please explain to us the rationale behind the pillar of current regulations, the risk weighting of the capital requirements, which allow banks to hold much much less capital against what is ex ante perceived as “absolutely safe” than against what is perceived as risky?

Could it not be that in reality it should perhaps be the complete opposite?

Is it correct that in the “home of the brave” we impose this type of bank regulations which discriminate against those perceived as “risky”? And by the way, is such thing really allowed under the Equal Credit Opportunity Act, “Regulation B”?

Finally, do not these regulations created such distortions that it makes it impossible for the banks to allocate credit efficiently in the real economy? 

PS. Oh I almost forgot. I remember the Constitution of the United States of America, in Section 8 states “The Congress shall have the power to…fix the Standard of Weights and Measures.” Can you please refresh our minds as to when we delegate fixing the risk-weights to the Fed?

PS. Oh and I almost also forgot too. The US Constitution in its section 9 states: “No Title of Nobility shall be granted by the United States”. Now, is that not something that de facto happens when we sort of recognize the existence of an AAAristocracy or AAArisktocracy?

Four things the next Fed chair should absolutely know, and that the candidates most probably don’t know, yet.

The Fact: Current capital requirements for banks are much much lower for exposures to the “infallible sovereigns” and the AAAristocracy, than for exposures to small and medium businesses, entrepreneurs and start-ups.

The next Fed chair, whoever it is, should know that such different capital requirements for banks, based on perceived risks already cleared for by other means, produce different expected risk-adjusted returns on bank equity, and therefore completely distorts the process of allocating bank credit in the real economy, making it unreal.

The next Fed chair, whoever it is, should know that a financial transmission mechanism, when distorted as described above, stands no chance of producing a sturdy economic growth or generate sustainable employment. And, as a result, any quantitative easing becomes just a big waste.

The next Fed chair, whoever it is, should know that lower capital requirements for banks for what is perceived as “absolutely safe” than for what is perceived as “risky”, do not make any sense from a bank safety point of view. This is so because only exposures of the first kind can grow large enough to take the system down. And also because, when something ex-ante perceived as absolutely safe, ex-post turns out to be risky, as will happen sooner or later, then regulators will find the bank there with little or no capital at all.

The next Fed chair, whoever it is, should know that since banks need to hold much less capital when lending to the “infallible sovereign” than when lending to “risky” citizens, this translates into a subsidy of government borrowings, which means that current Treasury rates are not comparable to historical rates. In other words, the usual proxy for the risk-free rate is subsidized and distorted.