Thomas Hoenig of the FDIC, please indicate your colleagues, the right non-Taliban way of regulating banks.

In a speech of November 5, Thomas Hoenig, the Vice Chairman of the FDIC in a speech titled "Post-Crisis Risks and Bank Equity Capital", spelled out correctly and clearly the problem with current bank regulations.

Hoenig stated: “Global banks are not as well capitalized as some within the industry would have you believe. The fact is they remain highly leveraged and highly complicated, and should one fail, it would have systemic, destabilizing consequences. There are two different ways to address these concerns. One would require detailed rules to control firms' behaviors, structure their balance sheets, and direct their activities…

The other way to promote stability would be to simply demand more equity capital to enable banking firms to better withstand a crisis, while allowing them to run their businesses with less government direction.

The first option would require regulators to predict what activities and investments might cause future crises. It also would require them to calibrate rules in a manner that wouldn't give rise to subsequent crises. In other words, regulators would have to successfully anticipate the source of future crises, which as you know could arise from a number of activities, but mostly likely will come from something we fail to predict.

The second approach is based on equity capital and thus would not require such extraordinary insight from regulators. By design, it acknowledges that regulators cannot predict events and it ensures a safer system because well capitalized institutions are better able to withstand shocks and survive crises. Using simple leverage measures instead of risk-based capital measures eliminates relying on the best guesses of financial regulators to guide decisions.” End of quote.

Since the safer something is perceived the larger the potential for it to deliver an unexpected shock, it is of course only the second approach that can be the valid one… and the only thing we would pray for, is for that very careful attitude and steady hand required for getting us from here to there, without making it all so much worse.

Mr. Hoenig. Show your colleagues very carefully the right very careful way! There are more than enough regulatory Taliban out there.

Just asking for 20-30 percent capital requirements for banks is just playing for the galleries.

PS. Personally I would gladly settle for a goal of 8-12% of capital against all assets thereby getting rid of the worst part of current regulations, namely how the risk-weighing distorts the allocation of bank credit. How to get there? I have my ideas and the one I most like is inspired by how Chile capitalized their banks in 1985.

If the US stops distorting the allocation of bank credit to the real economy… does Europe dare to be left behind?

For 6.000 (out of 6.400) traditional US banks those that hold, effectively, zero trading assets or liabilities; no derivative positions other than interest rate swaps and foreign exchange derivatives; and whose total notional value of all their derivatives exposures - including cleared and non-cleared derivatives - is less than $3 billion...

Thomas M. Hoenig, the Vice Chairman of the FDIC is proposing the following:

“A bank should have a ratio of GAAP equity-to-assets of at least 10 percent. The substantial majority of [US] community banks already have equity-to-asset ratios of 10 percent or higher, and the number is in reach for those that do not.”

“Exempting traditional banks from all Basel capital standards and associated capital amount calculations and risk-weighted asset calculations.”

If approved, that would effectively mean the US begins to distance itself from the pillar of Basel Committees bank regulations, the credit-risk-weighted capital requirements.

Since those capital requirements odiously discriminate against the fair access to bank credit of borrowers deemed “risky”; and thereby distorts bank credit allocation, that would mean that most US banks would be able to return to real lending to the real economy.

Does Europe dare to be left behind in such development?

PS. Its about time the US suspended such regulatory discrimination, which should never have been allowed, according to the Equal Credit Opportunity Act (Regulation B)

Risk-weighted capital requirements creates a competitive disadvantage for community banks; as well as for their clients usually perceived as "riskier" .

In as much the clients of the community banks (main-street banks) belong more to the category of “risky”, like medium and small businesses, entrepreneurs and start-ups, whose fair access to bank credit is discriminated against, by banks being required to hold more capital against them that against the “safe”… and inasmuch larger banks have more access to borrowers perceived as "safe", or can easier structure operations as “safe”, and therefore benefit from lower capital requirements... which means being able to leverage their equity much more…. we can indeed argue that current regulations place community banks in a competitive disadvantage.

And so if community banks want to survive, they need to protest and fight against the whole concept of risk weighted capital requirements… and that should not be so difficult since the de-facto discrimination against the fair access to bank credit of “the risky”, should not be permitted under Equal Credit Opportunity Act (Regulation B).

And besides, community banks, ask your regulators to show you evidence of when excessive bank exposures to those ex ante perceived as "risky" have ever set off a major crisis. They will not be able to do so!

And agreeing in much from different perspectives with Thomas Hoenig of the FDIC, I guarantee that letting the Too-Big-To-Fail-Banks roam within regulations different from that of the community banks, will only, medium term, condemn the latter, and their loan officers, to extinction.

Frankly... in the "Home of the brave"... who came up with the idea of discriminating against the "risky" risk-takers who have made this country, so that they do not have any longer a fair access to bank credit? 

Will there be a mega bank run January 2015?

On January 1, 2015, the Basel Committee has indicated that banks should report their leverage ratio, not based on risk-weighted assets, but simply on total assets, and as of course, the banks should have done all the time.

And that would mean that a lot of banks which have presented themselves to society with an acceptable 8 /15 to 1 asset to capital ratio will, unless they take precautions, then have show that naked, without risk weighting, their real leverage might well be in the 20/40 to 1 range. 

And that should scare the hell of a market that, day by day, like in Cyprus, is seeing more signs reading “bank creditors, caveat emptor, you won’t be bailed out like before”.

The US banks, thanks to FDIC requiring more capital, are on the way of being able to show the lowest leverages. Most European banks, being more firmly in the hands of the Basel Committee, or vice-versa, seem will not be so lucky.

Go back over the last five years, and you will find innumerable comments, by experts, including regulators, referring to the low leverages of banks, without them having the faintest idea of how the modern Basel II leverages had been construed, and without the faintest idea that current leverages, after risk-weighting, can in no way be compared with the historical leverages based on un-weighted assets. 

At least it looks like the time of funny leverages is soon over.