Wake up! Banks should be banks. Not an ever-growing source of jobs for regulators and supervisors.

A comment on the FED, FDIC and OCC proposed rules to strengthen capital requirements for large banks. 

Let me begin by quoting Paul Volcker in his autography "Keeping at it" of 2018, penned together with Christine Harper.

“The US practice had been to asses capital adequacy by using a simple “leverage ratio”-in other words, the bank’s total assets based compared with the margin of capital available to absorb any losses on those assets. (Historically, before, the 1931 banking collapse, a ten percent ratio was considered normal)"

[Then 1988 Basel I introduced the risk weighted bank capital requirements.]

“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. The American “overall leverage” approach had a disadvantage as well in the eyes of shareholders and executives focused on return on capital; it seemed to discourage holdings of the safest assets, in particular low-return US government securities."

On July 27, 2023 the Board of Governors of the Federal Reserve System; the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency, requested comments on proposed rules to strengthen capital requirements for large banks. 

To print it out I downloaded their main document “Basel III endgame proposal (PDF)”  What!!! It contained 1.087 pages. Really? 1988 Basel I = 33 pages - 2004 Basel II = 228 pages 

When are you going to stop digging yourself (and our banks) deeper and deeper into the hole? How could bank regulations gotten so out of control? Could it be because bank regulation, employing regulators, supervisors and regulation-risk-managers in the banks, have become a profitable industry on its own?

Are we better off? I sure doubt it. In "Against the Gods" Peter L. Bernstein wrote "the boundary between the modern times and the past is the mastery of risk." Mastery? Did we not leave out God’s hand a bit too much?

Ground Control to Basel's bank regulator Major Tom

With “Curvature charge for Group 2a crypto assets”

We know you’ve really made it into outer space.

We keep our fingers crossed, you’ll return to earth

We know you’ve really made it into outer space. 

With something we ordinary humans can understand.

https://www.bis.org/bcbs/publ/d576.pdf

https://x.com/PerKurowski/status/2077412538812096679

Recently I dialogued with ChatGPT – OpenAI about bank regulations. 

As you can read, AI and I think a much more fundamental discussion about bank regulations is about 35 years overdue.

The document you really should think to put out for comments (a Plan B that longtime ago should have been Plan A) is: What strategy can be used for getting back to bank capital requirements anyone understands with a 10-minute glance of the balance sheet, without being required to read hundreds of footnotes?

The transition from here to there is not going to be easy. As a starter here is a (Chile inspired) proposal I have toyed around with for a couple of years.

By the way, invite e.g., small businesses and smaller banks for comments. Unwillingly, with regulations for the larger banks, you might discriminate even more against them.

Please: Let’s rescue our banks from dangerously creative capital minimizing/leverage maximizing financial engineers and hand them back to loan-officers dedicated to knowing their client and what their purpose for the credit is.

Add to the above the risk weights of: 0% Federal Government – 100% We the People. I believe that, if you respect your Founding Fathers, you should give the US Constitution some serious considerations.

Are you to ignore this comment and its observations? Just in case I'm not a newcomer on all this.

And, before #AI gets censored or overly regulated, I do feel I have in ChatGPT – OpenAI a strong ally, willing to back up much, probably not all, of what I argue.

A final question: How many banks, regulators and supervisors had USA in 1988. How many in July 2023?

PS. These 1.087 pages so reminded me of the Colombian “Peace Accord” document which President Juan Manuel Santos in 2016 sent to a referendum, a plebiscite. It contained 267 pages for many citizens who could barely read to understand.

PS. July 2024, inviting comments the Basel Committee on Banking issued a document on Technical Amendments. On e.g., “SCO60.80: Curvature charge for Group 2a crypto-assets”, I challenge you to draft a comment that an economist like me could understand

Sincerely,

Per Kurowski

@PerKurowski

https://subprimeregulations.blogspot.com

http://perkurowski.blogspot.com

Here are 7 questions on bank capital regulations that US Congressmen and Governors should ask the Fed, FDIC and OCC.

Gentlemen 

We have been made aware that currently banks are required to hold more capital, meaning equity, when lending to those perceived as safe from a credit risk point of view, like many sovereigns and private entities with good credit ratings, than what banks need to hold in capital when lending to those perceived as more risky, like SMEs and entrepreneurs.

Notwithstanding that sounds intuitively as quite reasonable, one can also argue the following:

Those perceived as safe from a credit point of view, without these regulations, already count with the benefit of larger loans and lower interest rates; while those perceived as risky have less access to bank credit and have to pay higher interest rates. Mark Twain’s saying that a banker is he who lends you the umbrella when the sun shines, but wants it back when it looks like it is going to rain, comes to mind.

So these capital requirements allow banks to leverage more their equity, and the support they in many ways receive from society, many times more when lending to The Safe than when lending to The Risky; and so banks can earn much higher risk adjusted returns on equity when lending to The Safe than when lending to The Risky.

As a result, these capital requirements enlarge the natural differences in access to bank credit between The Safe and The Risky. For instance we could say these regulations artificially favors American banks lending to European sovereigns and highly rated corporations, over lending to American small businesses and entrepreneurs.

And so we must ask you:

Q. Is such regulatory risk-aversion, which distorts the allocation of bank credit, a valid principle for regulating banks in the Land of the Free and the Home of the Brave?

Q. Do we not owe our descendants the same willingness to take risks as that which our fathers allowed our banks to take to get us here?

Q. Cannot it be said of such regulations, by creating incentives for these to refinance the safer past, impede banks from financing the riskier future?

Q. Is not fair access to bank credit an indispensable part of generating the opportunities that helps to reduce inequalities?

Q. Do we not have something called the Equal Credit Opportunity Act, Regulation B, which would seem to forbid this type of regulatory discrimination?

Q. Since the purpose of capital requirements for bank is to shield it against unexpected losses, how can it be you base these on the expected credit losses?

Q. Since what is perceived as risky never generate dangerous excessive financial exposures, that honor goes to what is perceived as safe but ends up being risky, do these regulations really help to build up a safer banking system?

Thank you... oh by the way, since I also heard that your capital requirements are portfolio invariant it just occurred to me to also ask: Should we not require banks to hold capital against the risk of their exposures instead of the credit risk of their assets?

Who supervises that FDIC, Fed, OCC, with their risk-weights, do not distort allocation of bank credit to the real economy?

The FDIC writes: “The Federal Deposit Insurance Corporation (FDIC), the Federal Reserve Board (Board), and the Office of the Comptroller of the Currency (OCC) (collectively, the agencies), under the auspices of the Federal Financial Institutions Examination Council (FFIEC), are requesting comment on proposed revisions to the risk-weighted assets [used to determine the regulatory capital banks should hold].”

And in a reference material titled “New Capital Rule: Community Bank Guide” we read:

“This guide summarizes significant changes from the current general risk-based capital rule for exposures commonly held by community banking organizations, and it provides relevant information regarding the treatment of more complex exposures such as securitization exposures, equity exposures, and exposures to a foreign government or bank. Community banking organizations become subject to the new rule on January 1, 2015. 

The new rule takes important steps toward improving the quality and increasing the quantity of capital for all banking organizations as well as setting higher standards for large, internationally active banking organizations. The agencies believe that the new rule will result in capital requirements that better reflect banking organizations’ risk profiles, thereby improving the overall resilience of the banking system. The agencies have carefully considered the potential impacts on all banking organizations, including community banking organizations, and sought to minimize the potential burden of these changes where consistent with applicable law and the agencies’ goals of establishing a robust and comprehensive capital framework.”

All of which leads us to ask again, for the umpteenth time… who is in charge to supervise that the risk- weighing of bank assets does not distort the allocation of bank credit to the real economy?

How can anyone think of "a robust and comprehensive capital framework" that does not even consider the consequences of distortions which could be much more dangerous for the overall safety of the economy than the presence of unsafe banks?

Do these risk weights really consider any unexpected events and losses banks could suffer or are they based on the same risk perceptions used by the banks to clear for expected risks? 

Regulators, please, your only problems with banks begin when their risk models stop to function.

Now we read that “Under rules being implemented by the Federal Reserve and the Office of the Comptroller of the Currency, the biggest U.S. banks will use their own models for judging their riskiness.”

Are they nuts? 

Bank regulators should have no problems whatsoever when banks own internal models which determine the “expected losses” function well.

The regulators only serious problems begin when these models do no function well... and “unexpected losses” result.

And so, frankly, it seems utterly absurd to allow for regulations which are based on trusting the bank models to function well.

And in this case, trusting primarily those banks which because of their systemic significance most can hurt if their risk models do not work... is like doubling up on the mistake.

If anything, trust the small banks which, if and when they fail, do not hurt us as much.