30 years after the introduction of risk weighted capital requirements for banks, the European Commission's Action Plan, finally spills the beans on that these can distort the allocation of bank credit, for a good (or for a bad) purpose.

The European Commission's Action Plan for a greener and cleaner economy, of March 8, 2018 includes the following statement:

“Incorporating sustainability in prudential requirements: banks and insurance companies are an important source of external finance for the European economy. The Commission will explore the feasibility of recalibrating capital requirements for banks (the so-called green supporting factor) for sustainable investments, when it is justified from a risk perspective, while ensuring that financial stability is safeguarded.”

To my knowledge this is the first time in 30 years, since the introduction in 1988 of risk weighted capital requirements for banks, that an official entity has recognized that by distorting the allocation of bank credit, in favor or against something, regulators can make banks serve a purpose different from safeguarding financial stability.

PS. Sadly though not even “safeguarding financial stability” was well served as all this regulation did was to doom banks to dangerously overpopulate safe-havens holding especially little capital

PS. In October 2013 I discussed this issue on my "Our-piead-a-terre blog"

PS. And on Earth Day 2015 I made a proposal exactly like what the EC will now study, namely to base the capital requirements for banks based on the Sustainable Development Goals SDGs, which of course include environmental sustainability.

@PerKurowski

It behooves us to revise the purposes of our banks, as these are defined by current capital requirements

The lower a capital requirement is, the higher can a bank leverage its equity, the higher is the risk adjusted return on equity it can obtain.

Risk weights of: sovereign 0%, AAA rated 20%, residential housing 35% and unrated SMEs 100%, clearly indicate that the de facto purpose regulators have imposed on banks, is to finance sovereigns, those who already enjoy the lowest risk-premiums, and those buying houses and therefore implicitly house prices. 

Regulators have told us this is so that our banks are made safe. Silly! Our bank systems are never threatened by “risky” SMEs and entrepreneurs, only by that perceived ex ante as very safe and that ex post turns out to be very risky. 

I would expect much more from our banks, like financing development, sustainability and job creation; and I would assume many would agree with me.

If we want that produced by banks, by means of allocating credit as efficiently as possible to the real economy, then we should make sure every single bank asset, except for cash, generates exactly the same capital requirement.

Now if regulators absolutely insist on nudging, so to be perceived as earning their pay, then perhaps they could base their capital requirements on how the asset helps to finance development, sustainability and job creation.

And, if regulators want to be really sophisticated about it, then the could even fill each box of a purpose/credit risk matrix with individual capital requirements… always of course remembering the golden rule of the riskier it seems ex ante the safer it is ex post. 

PS. Perhaps the capital requirements could even be slightly based on gender, so as to give women some compensation for all the disadvantages we are told they suffer. (Psst some tell me that loans to women also carry less risk)

Should not science matter to bank regulators, at least a little?

I ask because though I am no scientist, far from it, have never really understood Einstein’s relativity theory, I know that if I were asked to regulate banks there would be two basic questions I would have to ask:

First, what is the purpose of our banks? Quite early someone would have mentioned John A Shedd’s “A ship in harbor is safe, but that is not what ships are for” and I would have ascertained that purpose to be, to allocate credit to the real economy, carefully but efficiently. 

Second, what has caused major bank crises? a. Unexpected events, like devaluations, b. criminal behavior, like lending to affiliates; and c. dangerously large exposures to something ex ante perceived as very safe but that ex post turned out to be very risky. Surely someone would have also cited Voltaire’s “May God defend me from my friends, I can defend myself from my enemies” as a reminder that what is perceived as risky is, precisely because of that perception, quite innocuous.

After that initial mini research, the last thing I would have come up with is the current risk weighted capital requirements, more risk more capital – less risk less capital, that which distorts the allocation of bank credit, for no stability purpose at all... much the contrary.

So again… should not science matter to bank regulators, at least a little?

Mme Lagarde. I don’t agree with that IMF is “Building a More Resilient and Inclusive Global Economy”.

On April 12, Christine Lagarde, Managing Director of IMF gave a speech titled “Building a More Resilient and Inclusive Global Economy”

Mme Lagarde stated: “We have found that technology has been the major factor behind the relative decline of lower- and middle-skilled workers’ incomes in recent years, with trade contributing to a much lesser extent” So where was IMF with this argument during the recent walls against foreign workers debate? Jobs are of course important but is it not also time to start thinking about the need for decent and worthy unemployments?

Mme Lagarde also stated: “Financial stability requires that we complete the reform of global financial regulations. These rules—especially on bank capital, liquidity, and leverage” Hah! With capital requirements for banks that are especially low for what can cause bank crises, namely what’s perceived as safe? Like the ultra low risk weighted assets of the AAA rated securities and a sovereign like Greece? IMF has to be joking.

Mme Lagarde spoke about IMF’s efforts for “avoiding protectionist measures as well as distortive policies that give rise to competitive advantage.” So why then does IMF keep silence on capital requirements for banks that make it harder than it already is for those perceived as risky, to access bank credit, like the SMEs and entrepreneurs?

Mme Lagarde holds that “today’s policies should not disadvantage future generations, who would be left to pay for the imprudent actions of today’s generation.” Hold it there! The current imprudent risk adverse bank regulations that give banks incentives to stay away from financing the riskier future and just keep to refinancing the safer present, does precisely disadvantage future generations.

Mme Lagarde, let me assure you that the current Basel Committee’s bank regulations do not live up to any of the three principles proposed by the great Roman architect Vitruvius:

Durability: No! “May God defend me from my friends, I can defend myself from my enemies” Voltaire”.

Utility: No! “A ship in harbor is safe, but that is not what ships are for” John A Shedd.

Beauty: No! Besides perhaps delighting some anxious nannies that regulation raises no one’s spirits. God make us daring!

@PerKurowski

That banks allocate credit efficiently to the real economy is more important than avoiding bank failures

We read:

“THE MINNEAPOLIS PLAN reduces the risk of financial crises and bailouts to as low as 9 percent, at only a modest economic cost relative to the typical cost of a banking crisis. 

The Minneapolis Plan will (a) increase the minimum capital requirements for “covered banks” to 23.5 percent of risk- weighted assets, (b) force covered banks to be no longer systemically important—as judged by the U.S. Treasury Secretary—or face a systemic risk charge (SRC), bringing their total capital up to a maximum of 38 percent over time, (c) impose a tax on the borrowings of shadow banks with assets over $50 billion of 1.2 percent for entities not considered systemically important by the Treasury Secretary and 2.2 percent for shadow banks that are systemically important, and (d) create a much simpler and less burdensome supervisory and regulatory regime for community banks”

NO! Except for (d) “a simpler and less burdensome supervisory and regulatory regime for community banks” the Minneapolis plan suffers from the same fundamental mistake of current bank regulations. 

It fixates itself on avoiding bank failures, while entirely ignoring the much more important social purpose of the banks, that of allocating credit efficiently to the real economy.

To achieve that is impossible, while using risk weighting based on ex ante perceived risks to determine capital requirements. 

Would the Minneapolis Fed be able to provide me the answers to those questions the Basel Committee and the Financial Stability Board refuse to even acknowledge?

PS. And in any adjustment plan grandfathering existing capital requirements for the existing assets held by the banks would be required, so as to not risk contracting the credit market excessively. 

Bank regulators, don’t try now to hide your responsibility for failures behind sophistications. It was pure hubristic ineptitude.

I refer to Andy Haldane’s “The Dappled World” 

Bank regulators don’t try now to sophisticate the reasons you all got it so very wrong. These were very simple.

You did not define the purpose of banks before regulating these.

You ignored to study why banks fail and kept to why bank assets fail, which of course is pas la meme chose.

You ignored that banks look to maximize their risk-adjusted returns on equity, before distorting the allocation of bank credit with your risk-weighted capital requirements for banks.

You ignored the monstrous systemic risks that putting so much decision power into the hands of so human fallible credit rating agencies implied.

You imposed you statist ideological preferences with the risk weights of 0% for the Sovereign, and 100% for We the People.

No! Anyone who has ever walked on main-street, and seen the difficulties those perceived as risky have in accessing bank credit would have understood how loony these regulations were. Frankly, you do not have to be a PhD for that 

Luckily credit rating agencies got it wrong and put a temporary stop on it. Otherwise we would have been much worse off

Few can really evidence having warned so much against the use of credit rating agencies in bank regulations, as I can. So I believe that should give me the right to dare to opine that the fact that the credit rating agencies got it wrong, was and is not the worst part of the current bank regulation horror story.

As for examples of the first, in January 2003 the Financial Times published a letter in which I wrote: “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds. Friends, as it is, the world is tough enough.”

And, as an Executive Director of the World Bank, in April 2003, at its Board I formally stated: “Ages ago, when information was less available and moved at a slower pace, the market consisted of a myriad of individual agents acting on limited information basis. Nowadays, when information is just too voluminous and fast to handle, market or authorities have decided to delegate the evaluation of it into the hands of much fewer players such as the credit rating agencies. This will, almost by definition, introduce systemic risks in the market and we are already able to discern some of the victims, although they are just tips of the icebergs.”

And of course, when then the credit rating agencies later messed it up, and got it so amazingly wrong with the AAA rated securities backed with truly lousy mortgages to the subprime sector, it was a real disaster. But, I tell you, it could have been much worse, like if they had rated correctly for a much longer period.

The reason for that lies in the malignant error of the Basel Committee’s risk weighted capital requirements for banks; more ex ante perceived credit risk more capital – less risk less capital.

Perceived credit risk is the risk most cleared for by banks; they do so by means of interest rate risk premiums and size of exposures. And so when regulators decided to clear for exactly the same risk, now in the capital, that perceived credit risk got to be excessively considered. And any risk, no matter how correctly it is perceived, if it is excessively considered, will cause the wrong actions.

For instance banks were (and are) allowed to leverage much more when financing the purchase of residential houses, or when investing in AAA rated securities backed with mortgages, “The Safe”, than what they are allowed to leverage when lending to the core of the bank credit needing part of the economy, the SMEs and entrepreneurs, those who help create the new generation of jobs, “The Risky”.

And that has resulted in that banks earn much higher expected risk adjusted returns on The Safe than on The Risky; which results banks will finance much more The Safe than The Risky.

So, had it gone on (oops it still goes on) we will all end up in houses with no more houses to be built, and without that new generation of jobs that could help us, or foremost our children and grandchildren, to service mortgages and pay utilities.

So let’s be thankful the credit rating agencies got it wrong, but, please, let us also correct for the regulators' mistakes. Thinking on my grandchildren, I would in fact prefer lower capital requirements for banks when financing unrated SMEs and entrepreneurs than when financing the purchase of a house.

But how did this happen and how could it have been avoided.

Well perhaps it would have been nice if the regulators, before regulating the banks ,had defined their purpose. Then perhaps John A. Sheed’s “A ship in harbor is safe, but that is not what ships are for”, could have come to their mind.

And also it would have been nice if the regulators had done some empirical research on what causes bank crisis; and then they would have discovered that never ever excessive exposures to what is perceived as risky; and then they might have thought of Voltaire’s “May God defend me from my friends [AAA rated]: I can defend myself from my enemies [the unrated]”

The regulatory powers of our bank regulators need to be urgently regulated, at least those of the Basel Committee.

What do you think the world would have said if the Basel Committee had informed it that it would regulate the banks, without considering the purpose of the banks? 

What do you think the world had said if the Basel Committee had informed that in order to make the banks safer, they were going to distort the allocation of credit to the real economy?

What do you think the world would have said if the Basel Committee had informed it that even though all major bank crises have always resulted from excessive exposures to something ex ante erroneously perceived as safe, they would allow for especially low capital requirements against bank exposures to what ex ante was perceived as safe.

What do you think the world would have said if the Basel Committee had informed it that even though the society considered that banks giving credit to SMEs and entrepreneurs was very important, they would saddle the banks with especially large capital requirements on account of those “risky” being risky.

What do you think the world would have said if the Basel Committee had informed it that it was going to assign a zero risk weight to sovereigns and a 100 percent risk weight to the citizens, and which indicated their belief that government employees could make better use of other people’s money than private citizens could use theirs. 

What do you think the world would have said if the Basel Committee had informed it that even though banks already cleared for credit risks with interest rates and size of exposure they would also require banks to clear for that same risk in the capital; and that even though any risk that is excessively considered leads to the wrong actions even if perfectly perceived.

What do you think the world would have said if the Basel Committee had informed it that because they could not estimate the unexpected losses that bank capital is primarily to cover for, they would use expected credit risks as a proxy for the unexpected.

What do we think about that even when the 2007-08 clearly evidenced the failure of the regulators, they go on as if nothing, using the same regulatory principles? I just know that neither Hollywood nor Bollywood would ever have permitted those creating the box-office flop of Basel II, to go on working on Basel III.

Sincerely, are we really sure all these regulators in the Basel Committee, and in the Financial Stability Board, are just not some Chauncey Gardiner characters?

John D. Turner’s “Banking in Crisis” truly evidences a mind-blowing "Regulations in Crisis"

Turner writes: “If the rationale of bank regulation is to prevent banks from risk shifting and the banking system from collapsing, then the Basel approach to capital regulation failed dramatically”

That might seem like a correct statement but it is not. The true rationale of bank regulations is to assure banks serve their social and economic purpose of allocating bank credit to the real economy, without of course incurring excessive risks that could lead to the collapse of the banking system.

And in this respect the Basel approach, as it completely ignored that purpose of banks, and even went so far as to de-facto base its prime pillar, the risk-weighted capital requirements, on distorting the allocation of credit, fails even more dramatically.

Turner writes: "One reason for this failure was regulatory arbitrage… whereby capital regulations perversely incentivized banks to become riskier”

Absolutely wrong! The capital regulations perversely incentivized banks to create dangerous large exposures to what was perceived or deemed to be safe”

Turner writes: "Indeed, much bank lending to the residential-property market could have been partially due to the regulatory arbitrage because such lending had a 50 percent weighting in a Basel risk-weighted asset calculation, compared to 100 per cent for a commercial loan”

What regulatory arbitrage? Regulator set the weights that allowed banks to leverage twice as much on residential-property market loans than on commercial loans. Banks did not arbitrage, they did what they were instructed.

Turner writes: "To increase their return on equity, banks engaged in ’cherry-picking’ by shifting the composition of their loan portfolios towards riskier credits.”

What? In order to increase their expected risk-adjusted returns on equity they shifted the composition of their loan portfolios towards those credits that perceived or deemed as safer, allowed them to hold less capital. That is NOT ’cherry-picking’, that is something healthy banks are supposed to do to remain healthy, or does Turner believe it is good banks should on purpose try to lower their risk-adjusted returns on equity?

Of course with this type of regulations, there was much vested interest in hiding the risks. The pressures on the credit rating agencies to provide Potemkin AAA ratings were immense.

No! This current bunch of regulators, trying to avoid their own mental monsters, confusing ex ante risk with ex post realities, have distorted all common sense out of the allocation of bank credit. And so now banks no longer finance the riskier future they just keep on refinancing the for the time being safer past.

Our children and grandchildren will pay for their hubris.

The risk-weighted capital requirements clear in the capital for risks that have already been cleared for by means of risk premiums and size of exposures. And any perceived risk, even if perfectly perceived, if excessively considered, guarantees wrong actions.

“A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926

And regulators also forgot that even the safest harbors could turn into dangerous traps, if excessively populated.

We must completely clean the bank regulatory slate, which of course begins with retiring all current regulators who are suffering from the credit risk adverse Basel frame of mind.

PS. All the discussion here were limited to pages 195-199 of John D. Turner's "Banking in Crisis" 

Hyman P Minsky stated the purpose of banks, but all Basel Committee regulators care about is avoiding credit risk.

John Lounsbury, having in his turn been informed by Joe Bongiovanni, has made us aware of a working paper by Hyman P Minsky, from October 1994, titled “Financial Instability and the Decline (?) of Banking: Public policy considerations” 

Lounsbury writes: “Minsky was concerned in the early 1990s that what he thought were the two roles of banking in a capitalist society were being performed to a decreasing extent by organizations that were chartered as banks.

The two primary functions of banking he describes as supplying the means of payments; and channeling resources into the capital development of the economy.

Minsky argued that this separation of banking from the real economy would diminish the role of central banks in influencing the economy in the traditional manner through monetary policy. Given this loss of influence through the traditional tools of "changing the availability or cost of financing". He felt that the variable remaining would be management of "uncertainty".

He argued that the changes in banking required regulation to be rethought”

And I ask, for the umpteenth time. What has the pillar of current bank regulations, the risk weighted capital requirements, to do with banks fulfilling efficiently those two primary functions?

The answer absolutely nothing but it is even worse than that, since the risk weighing totally distorts the allocation of bank credit to the real economy.

The current bunch of regulators holed up in that small mutual admiration club known as the Basel Committee for Banking Supervision, regulated our banks without even asking themselves what the purpose of our banks is.

They must be held accountable for that, and publicly paraded down our avenues wearing dunce caps.

It seems like it all started during a dinner in London on September 2, 1986

http://econintersect.com/pages/opinion/opinion.php?post=201603140225

Wake up! Our banks are regulated by highly unprofessional technocrats; all members of a small mutual admiration club

Could there be something more dangerous to the real economy, and to banks, than distorting the allocation of credit? Not really.

And yet that is what the current batch of bank regulators did, without even considering that possibility a factor. They did not even care about it.

They imposed risk weighted capital (equity) requirements for banks. More ex ante perceived risk more capital – less risk less capital.

With that they allowed banks to leverage their equity more when lending to ”the safe” than when lending to ”the risky”.

With that they caused banks to be able to earn higher risk adjusted returns on equity on assets perceived as safe than on assets perceived as risky.

And so of course the banks are lending more than normal to those who already had easier and cheaper access to bank credit, ”The Safe”, like the sovereigns (governments) and members of the AAArisktocracy.

And so of course banks are lending less and relatively more expensive than usual to those who already found it harder and more expensive to access bank credit, ”The Risky”, like the SMEs and entrepreneurs.

And you ask how the hell did this happen? There are many explanations but the most important one was that they regulated without even asking themselves what was the purpose of those banks they were regulating.

And if that is not unprofessional what is?

“A ship in harbor is safe, but that is not what ships are for” John Augustus Shedd, 1850-1926

And to top it up they have not made our banks safer, since never ever do major bank crises result from excessive exposures to something perceived risky, these always result from excessive exposures to something perceived or deemed to be safe when booked... you see even the safest harbor can become dangerously overpopulated.

We must rid ourselves from these lousy and already very proven failed bank regulators. Urgently!

Lord Adair Turner’s awakening as a bank regulator has at least begun, and that’s good news.

In June 2010, during a conference given by Adair Turner at the Brookings Institute, I asked him the following: 

"Big companies in consolidated sectors, like BP in oil, tend to have much better credit ratings than those participating in developing markets, like wind energy. Do you really think the banks will perform better their societal capital allocation role if regulators allow them to have much lower capital requirements when lending to the consolidated sectors than when lending to the developing? Do you think we can reach a meaningful financial regulatory reform without opening up the discussion on the issue of risk in development?"

Lord Turner responded: "The point about lending to large companies development, I'm not sure. I'm trying to think about that. I mean we try to develop risk weights, which are truly related to the underlying risks. And the fact is that on the whole, lending to small and medium enterprises does show up as having both a higher expected loss but also a greater variance of loss. And, of course, capital is there to absorb unexpected loss or either variance of loss rather than the expected loss. I think, therefore, it's quite difficult for us to be as regulators, skewing the risk weights to achieve, as it were, developmental goals. There are some developmental goals, for instance, in a renewable energy, which I'm very committed to wearing one of my other hats on climate change, where I do think you may need to do, you know, in a straight public subsidy rather than believing that we can do it through the indirect mechanism of the risk weights. So I may have misunderstood your question, but I'm sort of cautious of the sort of the leap to introducing developmental roles into -- I thinks we, as regulators, have to focus simply on how risky actually is it?"

Lord Turner did not understand what I was referring to, and what was wrong:

Lord Turner: “we try to develop risk weights which are truly related to the underlying risks”. No! The real underlying risk with banks is not the risk of their assets, but how banks manage the perceived risks of their assets.

Lord Turner: “capital is there to absorb unexpected loss or either variance of loss rather than the expected loss”

Yes “capital is there to absorb unexpected loss”, and that is why it is so ridiculous to base the capital requirements for banks on something expected, like the perceived credit risks.

Now Lord Turner in his recent book, “Between Debt and the Devil”, though he still evidences he does not understand the distortions in the allocation of bank credit to the real economy the risk weighted capital requirements produce, he seems to become more flexible about using other criteria. From the “I think we, as regulators, have to focus simply on how risky actually is it” he now states: “We need to manage the quantity and influence the allocation of credit bank create… Capital requirements against specific categories of lending should ideally reflect their different potential impact of financial and macroeconomic stability. 

Though Turner has not yet reached as far as banks actually having a social purpose more important than that of just not failing, like financing job creation and the sustainability of our planet, this is a good and welcome start. And I say so especially because Lord Turner’s awakening might reflect what hopefully might be going on in other regulators' minds.

Lord Turner even though he gets it that “it is rational for banks to maximize their own leverage, increasing the returns on equity”, still fails to understand how allowing different leverages, much higher for safe assets than for risky, make banks finance more than usual what is perceived as safe, and much less than usual what is perceived as risky… which is precisely why banks finance so much houses and so little the SMEs and entrepreneurs, those that help create the jobs needed to pay mortgages and utilities.

Lord Turner also mentions in his book the issue of inequality. For the hopefully revised and corrected sequel to his book, I would suggest he thinks about the following quote from John Kenneth Galbraith’s “Money: Whence it came where it went” 1975. 

“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.”

But clearly Galbraith was referring to credit to producers and not to consumers. 

And of course I wish Lord Turner, like so many other, stops referring to the financial crisis as a result of free markets running amok. Free markets would never ever have authorized banks to leverage over 60 to 1 when investing in AAA rated securities, or when lending to Greece. Markets were not free. Banks were not deregulated. Banks were utterly misregulated.

PS. Cross your fingers. There might be something there that wasn't there before :-)

Per Kurowski’s (that’s me) Paris COP21 action plan, would have much more immediate environmental (and job creating) impact

Regulators currently tell banks: “More credit risk, more capital (equity) – less credit risk, less capital. 

And so right now our banks earn much higher risk adjusted return on equity on what is perceived or made out to be safe, than on what is perceived as risky. All for no good reason at all. 

Q. What has credit risk to do with the worthiness of something having access to bank credit? A. Nothing! 

Q. What assets are least likely to detonate major banks crises? A. Those ex ante perceived as safe!

In Paris, during COP21, I would have suggested that we tell bank regulators to stop favoring the access to bank credit of The Safe, and quit discriminating against the access to bank credit of The Risky.

Instead they should base their capital requirements of banks on sustainability and job creation – Sustainable Development Goal’s (SDGs) ratings. That way banks would earn higher risk adjusted returns on equity when financing what we most need and want them to finance. Otherwise, why on earth should society support banks so much?

Of course SDGs ratings could be gamed, as credit risk ratings often are, as carbon trading often is. But yet there would be much more oversight about the SDG ratings of projects than what there currently is of the credit risk ratings produced by 3 human fallible credit rating agencies.

Friends, would it not be nice to put some much needed worthy social impact purpose back into our banks?

Please help me stop our banks from mostly refinancing our safer past, and make them work harder on our sustainable future.

A dangerous regulatory madness descended upon our banks. To my despair it is still mostly unnoticed

When any borrower pays a bank interests, that payment contains an expected net profit margin for the bank, and of course, that margin, is after taking into account all expected credit risks.

And it used to be that all borrowers competed on equal terms for access to bank credits, by offering banks their respective, equally valued, net profit margins.

But that was before. Beginning 1988, with the Basel Accord, and exploding in 2004, with Basel II, bank regulators, in order to make banks safer, so they thought and still think, came up with credit risk weighted capital requirements for banks.

This signified banks had to hold more capital against what was perceived as risky, than against what was perceived as safe; meaning banks could leverage their equity (and the support they received from society) much more when holding assets perceived as safe that when holding assets perceived as risky.

And so, suddenly, the net profit margins offered by those perceived as safe, were and are worth to banks, much more than the net profit margins offered by those perceived as risky.

And that leads of course that those perceived as safe, and who therefore already enjoy more and cheaper access to bank credit, are favored even more; while those who because they are perceived risky already suffer less and more expensive access to bank credit, are even more disfavored.

The consequence is tragic.

Since major bank crisis never result from excessive exposures to something ex ante perceived as risky, but always from excessive exposure to something wrongly believed to be safe, it guarantees that when crisis occur, banks will stand there with especially large exposures and especially little capital to cover themselves up with.

And by distorting the allocation of bank credit in favor of what is perceived as safe it impedes banks from sufficiently financing that which is perceived as risky, like SMEs and entrepreneurs. And that denies the real economy the kind of risk taking it needs in order to move forward and not stall and fall.

And of course, by denying "the risky", usually those with less, fair access to the opportunity of bank credit, it is a major driver of inequality.

How did this happen? The clearest explanation is that bank regulators full of hubris, never cared to concern themselves with defining the purpose of banks before regulating these.

Though not a bank regulator, I have been objecting, in a thousand ways, for soon two decades, these credit bank regulations; but I have yet not been able to extract one clear or unclear explanation, one valid or invalid justification, or anything that looks like a public answer to my objections by any regulator. I know some of them are concerned, but seemingly it is a too hot potato for them to handle.

Our current bank regulators simply do not have the courage to stand up for what they have done.

Our banks have a purpose that is much more important than just being safe, and that is to help finance a good future for our children and grandchildren. God make us daring!

PS. And all those on the road of becoming the oldies of turn, they should never forget that the most important part of any pay-as-you-go pension system, is the how-it-goes-part.

PS. Since in Basel I the risk weight for sovereigns (governments) was set as zero percent, while the risk weight for that private sector that gives the sovereign its strength was set to be 100 percent, another explanation is that these regulators are just simple statist or communist infiltrators.

Our current bank regulatory tragedy: Interference without a purpose

Bank regulators have two choices. They can allow everyone to compete equally for the access to bank credit; or they can interfere in the allocation of bank credit by favoring one group’s access, which of course affects negatively those not favored.

And of course interference, though arrogant and dangerous, could be justified if it was done with the purpose of trying to make the real economy stronger... like for instance when financing projects that have special potential to deliver job creation, or the sustainability of our planet.

Unfortunately, current bank regulators, with their credit risk weighted capital requirements for banks, are interfering with the allocation of bank credit without a real purpose. The only thing they achieve with that, is allowing those who because they are perceived as safe already have ample access to bank credit, to find even more generous conditions; and to make it even more difficult for those who because they are perceived as risky already find it harder to access bank credit.

And by doing so regulators are not making banks any safer either, since all-major bank crises result from excessive financial exposure to something ex ante believed safe but that ex-post turned out to be risky.

And so too much credit, in too generous terms, against too little bank capital is given to those perceived as safe, like governments and corporates with high credit ratings; and too little credit, in too expensive terms, to those perceived as risky, like our absolutely vital SMEs and entrepreneurs.

What a tragedy! Let us pray the Basel Committee, the Financial Stability Board and the IMF wake up in time, before our stalling economies really fall into pieces.

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.

My bank regulator went to Basel, and all he brought me was this lousy credit risk weighted capital requirements

I sent my bank regulator to learn with the big boys in the Basel Committee for Banking Supervision about how to regulate banks. Among what he was supposed to pick up was an idea of how much capital he should require banks to hold, primarily against any unexpected losses.

He could have come back with capital requirements that considered all type of events that unexpectedly could blow a hole in a banks solvency like: cyber-attacks, a weather event with disastrous consequences, a major earthquake, the central banks or even the regulators themselves not knowing what to do, inflation suddenly popping up, crazy governments (I am from Venezuela), a set of important companies suddenly turning up engaged in some hanky panky, Systemic Important Financial Institutions (SIFIs) going belly up, internal or external fraud, a major loss from an authorized or unauthorized position in a speculative trading, unexpected consequences from new regulations and thousand of other things… BUT NO all he brought me was this silly risk weighted capital requirements based on expected credit risks, about the only risks banks are supposed to really take care of on their own.

If only it had been based on the risk that banks were not able to manage expected credit risk, then I could have accepted it… but that had of course nothing to do with the credit risk per se, in fact usually it is what is perceived as safe that could pose the biggest dangers for a bank. 

And, to top it up, these credit risk based capital requirements were portfolio invariant, meaning independent of the size of the exposures, only because otherwise it would be too hard for him and his regulating colleagues to handle.

And, to top it up, these credit risk based capital requirements also smuggled in the absurd statist notion that sovereigns were infallible, de facto implying government bureaucrats knew better what to do with bank credit than "the risky" SMEs and entrepreneurs.

And to top it up, during his whole stay with the Basel Committee, and during his study visits to the Financial Stability Board and the IMF, not one single word was said about the societal purpose of banks.

And, so these credit risk based capital requirements guarantees to dangerously distort the allocation of bank credit to the real economy... which they did, look at how much credit Greece got... which they do, look at how little credit SMEs get.

And so these credit risk based capital requirements now guarantee that the next time a bank crisis results from excessive exposures to something that was erroneously perceived as very safe, which is precisely the stuff major bank crisis are made of, then banks will stand there with their pants down and no capital to cover themselves up with.

No! I will surely never ever send my bank regulator to Basel again.

Forget it, I at least trust banks and bankers much more than their current regulators.

I quote from a recent speech by Ms Sabine Lautenschläger, Member of the Executive Board of the European Central Bank and Vice-Chair of the Supervisory Board of the Single Supervisory Mechanism given September 28, 2015, titled Reintegrating the banking sector into society – earning and re-establishing trust 

"Ladies and Gentlemen, esteemed audience,

How can bankers regain the trust that was lost during the crisis? 

How can the banking sector be reintegrated into society? 

There is no doubt that banks, bankers and the whole industry are experiencing one of the worst crises of confidence ever. The turmoil of 2008 and 2009 played a major role in this loss of public trust, but the problem did not end after the most acute phase of the crisis. Even seven years later, confidence in the banking sector is still very low. 

Numerous scandals, like the manipulation of LIBOR rates…have reinforced the perception that wrongdoing is widespread in the banking sector. 

But mistrust is not only confined to banks themselves. Investors and clients also have less confidence in the correct functioning of the banking sector and in the ability of supervisors and regulators to prevent excessive risk-taking. 

We should worry about this loss of trust in the banking sector: 

   It impairs the proper functioning of banks to reallocate resources. 

   It hampers growth. 

   It leads to instability and costly crises. 

But how can trust in the banking sector be restored? Who are the key players in this process? Is it enough to reform the regulatory and supervisory framework, as we have done in recent years?

But are the efforts of regulators and supervisors enough? Can trust be rebuilt simply by having better and more credible rules? 

No! Rebuilding trust in the banking sector requires the active engagement of bankers and their stakeholders. Regulatory and supervisory reforms are necessary, but not sufficient to restore people’s trust in banks. 

My view is that, while regulatory reform and supervisory action were certainly necessary to lay the foundations on which banks can restore trust, regulators and supervisors are not the key players in this process."

My comments: 

Bank regulators told banks: “We allow you to hold much less capital against assets perceived as safe than against assets perceived as risky, so that you can earn much higher risk adjusted returns on equity when lending to the safe than when lending to the risky.

That’s it! Just avoid the credit risks and you earn more, not a word about a purpose for banks, like helping to generate jobs for the young or making the planet more sustainable. Anyone regulating without defining the purpose of what he is regulating is as loony as they come.

And to top it up, the regulators assigned a risk weight of zero percent to the sovereigns (governments) and of 100 percent to the citizens and private sectors on which that sovereign depends. Which means they believe government bureaucrats can use bank credit more efficiently than SMEs and entrepreneurs.

And of course those regulations distort completely the allocation of bank credit to the real economy and, by diminishing the opportunities of the risky to gain access to bank credit, increases inequalities.

The manipulation of Libor rates is pure chicken shit when compared to the manipulation of the credit markets done by regulators with their credit risk weighing.

And here many years after it was clearly seen that the regulators efforts to prevent excessive risk taking only produced excessive risk taking in what was perceived as safe, here they are still talking about the need of “the ability of supervisors and regulators to prevent excessive risk-taking”. Without their regulations banks would have never ever been able to leverage as much as they did.

So forget it, I at least trust banks and bankers much more than their current regulators.

Dumb bank regulators clearly evidence we need artificial intelligence, at least as a backup

Banks fail because: they cannot perceive the risks correctly, they cannot manage the correctly perceived risks correctly, or suddenly something truly bad an unexpected happens… like the economy falling to pieces.

So if banks should be required to hold equity, in order to build up a buffer before they need help from taxpayers, those equity requirements should be based on: the credit risks not being correctly perceived, the bankers not being able to manage perceived risks, and something truly not expected happening, like an asteroid hitting their borrowers.

But, the Basel Committee for Banking Supervision, based its equity requirements for banks on the ex ante credit risks being correctly perceived… and that is nothing but loony... seemingly they all missed the lecture on conditional probabilities.

Besides they regulate banks in thousand of pages, without defining what the purpose of banks is… and that is nothing but absolutely irresponsible.

Any artificial intelligence worthy of its name would have made two simple questions.

What is the purpose of banks?

What has caused major bank crisis?

And how different and better the world would then have been. We could surely have had other type of problems, but definitively not the current crisis, caused by excessive lending to what was ex ante perceived as safe; nor the current lousy economy, caused by the lack of lending to those perceived as “risky”, like the SMEs, precisely the tough we need to get going when the going gets tough.

Our grandchildren will damn current bank regulators, for not allowing banks to take the risks their future needs.

PS. Here is an updated list on the many mistakes with risk weighted capital requirements

“Reasoned Audacity”

There, in “Berthe Morisot, or, reasoned audacity”, a book published by the Denis and Annie Rouart Foundation and the Marmottan Monet Museum (2005), is where I first saw the term “reasoned audacity”. And it took the breath out of  me, as did, of course, Edouard Manet’s portrait of his sister in law. 

Yes, absolutely, that´s it, I said to myself. If I was a regulator, “reasoned audacity” is what I would try to inspire the banks with, and not with the dysfunctional unreasonable risk-aversion current regulators are imposing, with their mindless capital requirements for banks based on perceived risks.

God make us daring!