Mario Draghi, President of the ECB and Chair of the European Systemic Risk Board shows, again, he has dangerous little understanding about the true nature of systemic risks.

“Systemic risk refers to the risk of a breakdown of an entire system rather than simply the failure of individual parts. In a financial context, it captures the risk of a cascading failure in the financial sector, caused by interlinkages within the financial system, resulting in a severe economic downturn.”

I refer to Mario Draghi’s welcome remarks at the third annual conference ofthe European Systemic Risk Board (ESRB), September 27, 2018

1. “The need for high-quality data: Policymakers’ ability to act hinges crucially on the availability of high-quality data. Data allow policymakers to identify, analyse and quantify emerging risks. Data also provide policymakers with the necessary knowledge to be able to target and calibrate their tools and to be aware of possible spillovers, or attempts to circumvent regulations”

a. The more you believe you are in possession of “high-quality data” the more you set yourself up for a systemic risk, like when banks were led by their regulators to believe that risk of assets rated AAA were minimal.

b. The more regulators might be tempted to “target and calibrate their tools” without considering how the markets might already have calibrated and targeted that “high-quality data”, the more they might generate the systemic risk of giving that “high-quality data” excessive consideration. Like when bank regulators, ignoring the conditional probabilities, based their risk weighted capital requirements basically on the same credit risk bankers were already perceiving and clearing for.

2. “Reflecting the targeted nature with which macroprudential policy can be applied, some countries have considered varying implementation by geographical area, to strengthen the impact on local hotspots. These policy actions have helped mitigate movements in real estate prices.”

But trying to contain “hotspots” and not allowing the market to determine the movements of real estate prices contains the clear and present systemic risk of pushing credit into “weak-spots” and not where it could be mots useful for the economy. Like when bank regulators by giving preferential risk weights to the “safe” sovereign and “safe” houses, negates credit to the “risky” entrepreneurs.

3. “Non-bank finance is playing an increasingly important role in financing the economy. Policymakers need a comprehensive macroprudential toolkit to act in case existing risks migrate outside the banking sector or new risks emerge.And that means widening the toolkit so that policymakers are able to effectively confront risks emerging beyond the banking sector.”

No, regulators who have not been able to regulate banks, and caused the 2008 crisis, and caused the tragedy of Greece, have not earned the right to expand their regulatory franchise anywhere.

4. “Conclusion: Policymakers across Europe have proven willing to use macroprudential policy to address risks and vulnerabilities. These measures have helped counter the build-up of risks”

NO! Regulators who still use risk weighted capital requirements based on that what is perceived as risky is more dangerous to our bank system than what is perceived as safe, have no idea about basic macroprudential policies.

NO! Regulators who still believe that with their risk weighted capital requirements for banks they can distort the allocation of credit without weakening the real economy; and who do not understand how dangerously pro cyclical the risk weighted bank capital requirements are, have no idea about basic macroprudential policies.

PS. My views on some systemic risks, as expressed at the Board of the World Bank in 2003.

PS. Here is an aide memoire on the mistakes in the risk weighted capital requirements for banks.

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

Basel III - sense and sensitivity”? No! Much more “senseless and insensitivity”

I refer to the speech titled “Basel III - sense and sensitivity” on January 29, 2018 by Ms Sabine Lautenschläger, Member of the Executive Board of the European Central Bank and Vice-Chair of the Supervisory Board of the European Central Bank.

“Senseless and insensitive” is how I would define it. It evidences that regulators have still no idea about what they are doing with their risk weighted capital requirements for banks.

Ms Lautenschläger said: With Basel III we have not thrown risk sensitivity overboard. And why would we? Risk sensitivity helps align capital requirements with actual levels of risk and supports an efficient capital allocation. It prevents arbitrage and risk shifting. And risk-sensitive rules promote sound risk management.

“Risk sensitivity helps align capital requirements with actual levels of risk and supports an efficient capital allocation” No! The ex ante perceived risk of assets is, in a not distorted market aligned to the capital by means of the size of exposure and the risk premium charged. Considering the perceived risk in the capital too, means doubling down on perceived risks; and any risk, even if perfectly perceived, if excessively considered causes the wrong actions.

“It prevents arbitrage” No! It stimulates arbitrage. Bankers have morphed from being diligent loan officers into too diligent equity minimizers. 

“It prevents risk shifting.” No! It shifts the risks from assets perceived as risky to risky excessive exposures to assets perceived as safe.

“It promote sound risk management” No! With banks that compete by offering high returns on equity, allowing some assets to have lower capital requirements than other, makes that impossible.

Ms Lautenschläger said: “for residential mortgages, the input floor increases from three basis points to five basis points. Five basis points correspond to a once-in-2,000 years default rate! Is such a floor really too conservative?”

The “once-in-2000 years default rate on residential mortgages!” could be a good estimate on risks… if there were no distortions. But, if banks are allowed to leverage more their capital with residential mortgages and therefore earn higher expected risk adjusted returns on residential mortgages then banks will, as a natural result of the incentive, invest too much and at too low risk premiums in residential mortgages… possibly pushing forward major defaults from a “once-in-2000 years default” to one "just around the corner". That is senseless! Motorcycles are riskier than cars, but what would happen if traffic regulators therefore allowed cars to speed much faster?

I guess Basel Committee regulators have never thought on how much of their lower capital requirement subsidies are reflected in higher house prices?

Then to answer: “Does this mean that Basel III is the perfect standard - the philosopher's stone of banking regulation? Ms Lautenschläger considers “What impact will the final Basel III package have on banks - and on their business models and their capital?”

Again, not a word about how all their regulations impacts the allocation of bank credit to the real economy… as if that did not matter… that is insensitivity!

Our banks are now financing too much the “safer” present and too little the “riskier” future our children and grandchildren need and deserve to be financed.

PS. In 2015 I commented another speech by Ms Lautenschläger on the issue of “trust in banks”.

The Finalization of Basel III’s is just a photo-op for the Committee members to go home for Christmas with, as it does nothing to correct the fundamental flaws of current bank regulations.

The Basel Committee’s “Finalizing Basel III” brief states: 

1. “What is Basel III? The Basel III framework is a central element of the Basel Committee’s response to the global financial crisis. It addresses a number of shortcomings in the pre-crisis regulatory framework and provides a foundation for a resilient banking system that will help avoid the build-up of systemic vulnerabilities. The framework will allow the banking system to support the real economy through the economic cycle.”

Since the risk weighted capital requirements are kept, that is simply not true! The global financial crisis was a direct consequence of regulations that allowed banks to leverage immensely their capital as long as they kept to “safe” assets: limitless leverage with exposures to friendly sovereigns, 62.5 times with private sector exposures rated AAA to AA, and 35.7 times with residential mortgages. 

The exaggerated demand these regulations created for residential mortgages and highly rated securities, which caused serious deteriorations in their quality, and of loans to low risk decreed sovereigns, like Greece, explains 99.9% of the financial crisis.

In contrast when lending to an entrepreneur or an unrated small or medium size enterprise, as that was (is) considered risky, banks were only allowed to leverage 12.5 times. The differences in potential risk adjusted returns on equity between “safe” and “risky” assets hindered, and hinders, the banking system from adequately supporting the real economy

2. “What do the 2017 reforms do? “The 2017 reforms seek to restore credibility in the calculation of risk-weighted assets (RWAs) and improve the comparability of banks’ capital ratios. RWAs are an estimate of risk that determines the minimum level of regulatory capital a bank must maintain to deal with unexpected losses. A prudent and credible calculation of RWAs is an integral element of the risk-based capital framework.”

But the fundamental question of why it should be prudent to require banks to hold more capital against what is perceived risky, when the real dangers to the bank system is when something perceived as safe turns out risky, remains unanswered.

3. “Credibility of the framework: A range of studies found an unacceptably wide variation in RWAs across banks that cannot be explained solely by differences in the riskiness of banks’ portfolios. The unwarranted variation makes it difficult to compare capital ratios across banks and undermines confidence in capital ratios. The reforms will address this to help restore the credibility of the risk-based capital framework. 

Internal models should allow for more accurate risk measurement than the standardised approaches developed by supervisors. However, incentives exist to minimise risk weights when internal models are used to set minimum capital requirements. In addition, certain types of asset, such as low-default exposures, cannot be modelled reliably or robustly. The reforms introduce constraints on the estimates banks make when they use their internal models for regulatory capital purposes, and, in some cases, remove the use of internal models.” 

Where do regulators get the idea that if there are less-variations in RWAs, the standardized RWAs, based on how regulators perceive risks, are any more accurate? Excessive hubris? Have they forgotten their own “Standardized” risk weights? Alzheimer? 

Also, since banks should clear for perceived risks in the size of the exposures and interest rates, making them clear for those same risks in the capital too, causes an excessive consideration of perceived risks. The regulators clearly keep on ignoring that any risk, even if perfectly perceived, causes the wrong actions, if excessively considered.

That regulators now, at long last, have understood that “incentives exist to minimise risk weights when internal models are used to set minimum capital”, serves little as consolation, as it just evidences their original naiveté.

PS. As an aide memoire for the regulators to take home for Christmas here’s a list of their mistakes. Am I being nasty? No! How many millions of entrepreneurs have over the years been negated access to the life changing opportunities of a bank credit, only because of these regulators? How many young must live in the basement of their parents houses without jobs, only because regulator think it is safer to finance houses than job creation opportunities? Let’s pray all the Ebenezer Scrooge in the Basel Committee will see light one day... or at least have the decency to fade away.  

“If you see something say something”. Yes, but it’s not easy to be a whistleblower on our too inept bank regulators.

Sir, never ever has a bank crisis of any important magnitude resulted from excessive exposures to something that was perceived as risky when placed on the balance sheets of banks.

These have always resulted from unexpected events, like major devaluations, criminal behavior or excessive exposures to something that was perceived as safe when incorporated in the balance sheets of banks but that ex post turned out to be risky.

So when bank regulators, like with their Basel II of 2004 set the risk weights for what is rated AAA at 20%, and that of the below BB- rated at 150%, then this is a too serious clue of them not knowing what they’re doing.

And the above is far from being their only mistake or the only proof of that.

I have been shouting my lungs out about this basically since 1997, but it is very difficult for an ordinary citizen, even for someone who for some years was an Executive Director at the World Bank, to have someone to listen to him, when he holds that our supposed expert bank regulators left a bomb in our real economy.

PS. I will send the above letter to as many editors I can.

Financial Times

New York Times

Wall Street Journal

Washington Post

Svenska Dagbladet

The Economist

And here is my letter to the Financial Stability Board, March 2019

The litmus test any aspiring central banker or bank regulator should have to pass

Fact: Banks are allowed to leverage more with assets considered safe, like loans to sovereigns, the AAArisktocracy and mortgages, than with assets considered risky, like loans to SMEs and entrepreneurs.

So ask the candidates:

Does that mean “the safe” have even more and easier access to bank credit than usual; and “the risky” have even less and on more expensive terms access to bank credit than usual?

If the answer is no, disqualify the candidate.

If the answer is yes, then ask: 

Do you think that might dangerously distort the allocation of bank credit to the real economy? Or impede QE stimulus flow to where it could be most productive?

If the answer is no, disqualify the candidate.

If the answer is yes, then ask: 

In terms of what can pose the greatest risk to the bank system, would you agree with Basel II’s risk weights of 20% for what is rated AAA to AA and 150% for what is rated below BB-?

If the answer is yes, disqualify the candidate.

If the answer is no, then ask: 

Do you agree with a 0% risk weighting of sovereigns?

If the answer is yes, the candidate should be classified as an incurable statist, not independent at all, and accordingly dismissed.

If the answer is no, then one could proceed applying any other criteria considered relevant.

As a relevant criteria, the way the world looks, being a lucky person seems a quite valid one.

PS. How many of those currently in central banks, or in the Basel Committee for Banking Supervision, or in the Financial Stability Board would pass this test?

@PerKurowski

Even perfectly perceived risks cause wrong decisions if excessively considered

Should banks consider risk factors, such as the probability of default (PD) and the expected loss given a default (LGD), when setting the interest rates it charges clients? Of course, higher perceived risk-higher interests, lower risks-lower interest rates. 

But regulators curiously decided that these risks should also be cleared for in the capital requirements for banks, and decreed: higher perceived risk-higher capital, lower risks-lower capital.

So now banks clear for these risks both with risk adjusted interest rates and risk adjusted capital. That’s a real serious problem because any risk excessively considered, will produce the wrong decision, even if the risk is perfectly perceived.

Now a higher interest rate perfectly set in accordance to a perfectly perceived higher risk translates, because of higher capital requirement, meaning a lower leverage, into a lower risk adjusted expected return on equity. 

Now a lower interest rate perfectly set in accordance to a perfectly perceived lower risk translates, because of a lower capital requirement, meaning a higher leverage, into a higher risk adjusted expected return on equity.

So now banks, even when the risks are perfectly perceived, lend too little to the risky, or in order to compensate for lower ROEs, at too high risk adjusted interest rates; and lend too much to the safe, or thanks to higher ROEs, at too low risk adjusted interest rates.

This is insane! It produces dangerous misallocation of bank credit to the real economy. Too little financing of the "riskier" future and too much refinancing of the "safer" present.

PS. There is a possibility of credit being allocated efficiently to the real economy, but that requires that what is perceived as safe to be much safer and what’s perceived as risky to be much riskier. What credit rating agencies could guarantee us such mistakes?

Regulators and bankers looking out for the same risks 

AI Watson, would you ever feed robobankers those algorithms current bank regulators feed human bankers?

The normal real world rules banks had to follow for about 600 years before 1988, in order to become and remain successful bankers, was to while carefully considering their portfolio, to lend or invest in whatever they perceived would produce them the highest risk adjusted returns on equity. One dollar of equity lost in an operation perceived as risky would hurt just as much as a dollar lost in an operation perceived as safe. 

And even though bankers in general suffered from a risk aversion bias, expressed well by Mark Twain’s “a banker is one to lend you the umbrella when the sun shines and wanting it back when it seems it could rain”, that obviously served our economies well. 

As John Kenneth Galbraith argued, even when in some cases “Banks opened and closed doors and bankruptcies were frequent, as a consequence of agile and flexible credit policies, the failed banks left a wake of development in their passing.”

But then came the Basel Committee for Banking Supervision, and out of the blue decided to assume bankers did not perceive risks; and so came up with their risk weighted capital requirements. These instructed banks, with no consideration to their portfolio, to hold more capital (equity) against what is perceived risky and less against what is perceived safe.

As a consequence of this bankers had to morph from being mainly risk perceivers into also having to be capital (equity) minimizers. Being able to leverage more the “safe “ than the “risky” allowed them to obtain higher risk adjusted returns on equity lending with the safe than with the risky.

As a consequence we have already suffered major bank crisis resulting from excessive exposures to what was erroneously perceived, decreed or concocted as safe, like AAA rates securities and sovereigns like Greece.

As a consequence of not enough lending to the “risky”, like SMEs and entrepreneurs, development is coming to a halt.

Since regulators refuse to listen to little me, I can’t wait for IBM’s Watson developing lending and investment algorithms for robobankers. These would help show bank current regulators how dangerously wrong they are.

Watson would understand that with current distortions banks go wrong even if they perceive the risks absolutely correct.

Watson would understand that what is perceived risky ex ante becomes by that fact alone less dangerous ex post; and that what is perceived safe ex ante becomes by that fact alone more dangerous ex post.

“May God defend me from my friends, I can defend myself from my enemies” Voltaire.

Regulator Watson, in contrast to the Basel Committee, would not be looking in the same direction the bankers look

PS. Here on the regulators' confirmation bias

PS. Here my letter to the Financial Stability Board

Ten years ago ECB decided to ignore the benefits of a hard landing and go for kicking the can down the road

In August 2006, when we were already hearing worrisome comments about complex securities linked to mortgages, I wrote a letter to FT titled “The Long Term Benefits of a Hard Landing”. At that moment I had not yet been censored by FT and so they published it.

One year later, when panic about the AAA rated securities backed with mortgages to the subprime sector impacted the financial markets, ECB (and the Fed earlier) decided to ignore that option and go for the politically more convenient short-termish option of kicking the can down the road, with QEs and ultralow interest rates.

It could have worked, if only what had caused the crisis and what hindered the stimuli to flow in the correct directions had been removed. But no, the regulators refused to admit their mistake with the risk weighted capital requirements.

And so here we are, a full decade later, still allowing banks to multiply the net margins obtained more when it relates to assets perceived, decreed or concocted as safe, than with assets perceived as risky, and so obtain higher expected risk adjusted returns on their equity financing the safe than financing the risky.

In a historic analogy, regulators still believe the sun to be circling around the earth; in this case that what is perceived as risky is more dangerous to the banking system than what is perceived as safe.

As a result “safe” sovereigns, AAArisktocracy and residential houses still dangerously get way too much bank credit, while “risky” SMEs and entrepreneurs, way too little to keep our economies dynamic.

Every day we allow regulators like Mario Draghi to regulate based on a flawed theory, the worse for all of us.

But what are we to do when there are so many vested interests in shutting up this the mother of all bank regulation mistakes?

With Basel II, how many times could banks multiply net risk adjusted margins, so as to obtain their returns on equity?

The expected pretax return on equity for banks is the amount of net risk adjusted margins they earn over the capital they need to hold.

For instance if banks had to hold the 8% basic capital requirement defined in Basel II, they could leverage (multiply) those net risk adjusted margins 12.5 times. And so if a bank wanted to earn a 20% pre tax ROE, it would need to collect an average net risk adjusted margin of 1.6% (20%/12.5) on assets equivalent to 12.5 times its capital.

Clearly, the more banks can leverage (multiply) those net risk adjusted margins, the higher the expected return on its equity, or the lower do those margins need to be.

For instance if banks had to hold only 1.6% in capital they would be able to leverage (multiply) those net risk adjusted margins 62.5 times. And so if banks wanted to earn the same 20% pre tax ROE as before, they would need to collect an average net risk adjusted margin of only 0.32% (20%/12.5) on assets equivalent to 62.5 times its capital. If the bank was abled to collect the same 1.6% average net risk adjusted margins, then its expected ROE would be a whopping 100%. 

The problem (for us) though, of Basel II, is that it, based on credit ratings, risk adjusted the capital requirements. And so, according to Basel II’s standardized risk weights, the banks were allowed to multiply their net risk adjusted margins the following way: 

SOVEREIGNS:

AAA to AA = Unlimited

A+ to A = 62.5 times

BBB+ to BBB- 25 times

BB+ to B- = 12.5 times

Below B- = 8.3 times

Unrated = 12.5 times

CORPORATES:

AAA to AA = 62.5 times

A+ to A = 25 times

BBB+ to BB- = 12.5 times

Below BB- = 8.3 times

Unrated = 12.5 times

Residential mortgages = 35.7 times

Anyone who does not immediately understand how this distorts the allocation of bank credit; in favour of those who can have their net margin offers multiplied more by banks; and against those who have these multiplied less, does not understand finance, or has a vested interest in not wanting to understand it.

Can there be any question that these regulations pushed banks overboard with exposures to AAA rated securities and loans to sovereigns, like to Greece?

But, someone might say, this is all in order to make banks safer. Bullshit! There has never ever been a major bank crisis resulting from excessive exposures to something perceived as risky when placed on banks’ balance sheets.

Of course with Basel III, which has a leverage ratio that is not risk depended, the differences in the times net risk adjusted margins can be multiplied are smaller, but that does not mean for one second that the Basel discrimination keeps on being kicking and alive.

God help our young… God help our Western civilization. These idiotic risk-adverse regulators are hindering banks from financing our young ones’ riskier future, and have banks only refinancing their parents’ (and their regulators’) safer present and past. 

Risk-taking is the oxygen of development. God make us daring!

ECB Working Paper 2079, as is standard, also suffers from confusing ex ante perceived risks with ex post realities.

Jonathan Acosta Smith, Michael Grill, Jan Hannes Lang have produced a paper titled “The leverage ratio, risk-taking and bank stability”, ECB Working Paper 2079, June 2017, which analyzes the non-risk based leverage ratio (LR) that has been introduced in Basel III to work alongside the risk-based capital framework.

I quote: “The main concern relates to the risk-insensitivity of the LR: assets with the same nominal value but of different riskiness are treated equally and face the same capital that an LR has a skewed impact, binding only for those banks with a large share of low risk-weighted assets on their balance sheets, this move away from a solely risk-based capital requirement may induce these banks to increase their risk-taking; potentially offsetting any benefits from requiring them to hold more capital.” 

Unfortunately this paper suffers from the usual and tragic mistake of confusing ex ante perceived risks with ex post realities.

Basel Committee bank regulators acted like bankers and not like regulators, when they got fixated on the risk of the assets of the banks, and not on the risk those assets posed for the banking system. Had they done some empirical research on what caused previous bank crises, they would have seen that what was ex ante perceived as risky never played a mayor role.

As is Basel II’s risk weighted capital requirements allow banks to earn higher risk adjusted returns on equity with assets ex ante perceived (decreed or concocted) as safe, than with assets perceived as risky. That results in banks building up dangerous exposures, against little capital, to assets that though ex ante perceived were perceived as very safe, could ex post turn out very risky. E.g. the AAA rated securities backed with mortgages to the subprime sector.

The clearest way I have found to illustrate the regulator’s fundamental error is by referencing Basel II’s standardized risk weights:

It allocates a meager 20% risk weight to corporates "dangerously" rated AAA to AA, while assigning a 150% risk weight to the "innocuous" below BB- rated, that which banks would never touch with a ten feet pole.

And, with their risk weighting the regulators, with serious consequences, are also distorting the allocation of bank credit to the real economy. Since the introduction of Basel II, millions of “risky” SMEs and entrepreneurs have not been able to access bank credit, or have had to pay extra compensatory interest charges, precisely because of this pillar.

Bank capital requirements should not be based on what is perceived but on the possibilities that the perceptions are wrong, that the perceptions are right but not adequately managed or that unexpected events could happen. 

In this respect I am all for one single capital requirement for all assets (including of course sovereign loans).

So does the introduction of the leverage ratio partly fulfill what I want? Unfortunately not! The more a leverage ratio translates into banks finding it difficult to meet regulatory bank capital requirements, the more will the risk-weighted requirements distort on the margin. I often refer this to the Drowning Pool simile.

Here is a more detailed list of the mistakes with risk weighting.

Task Force on Climate Related Financial Disclosures is clueless about the allocation of resources to the economy.

The Task Force on Climate Related Financial Disclosures begins the summary of its “Final TCFD Recommendations Report” with: 

“One of the essential functions of financial markets is to price risk to support informed, efficient capital-allocation decisions. Accurate and timely disclosure of current and past operating and financial results is fundamental to this function, but it is increasingly important to understand the governance and risk management context in which financial results are achieved. The financial crisis of 2007-2008 was an important reminder of the repercussions that weak corporate governance and risk management practices can have on asset values. This has resulted in increased demand for transparency from organizations on their governance structures, strategies, and risk management practices. Without the right information, investors and others may incorrectly price or value assets, leading to a misallocation of capital.”

Efficient credit and capital allocation to the real economy is indeed the most essential function of financial markets, but let me here inform TCFD that bank regulators, like the Basel Committee and the Financial Stability Board gave zero importance to that. Had they done so, they would never ever have come up with the risk weighted capital requirements for banks, which make that impossible. 

“The financial crisis of 2007-2008 was an important reminder of the repercussions that weak corporate governance and risk management practices can have on asset values”

No! It was an important but ignored reminder of what dangers lie in allowing regulators to regulate within a mutual admiration club breeding intellectual incest. 

When you allow banks to leverage more their equity with what is ex ante perceived, decreed or concocted as safe, so that banks can earn higher risk adjusted returns on equity on what’s “safe”, then you will end up, sooner or later, with dangerous excessive bank exposures, against little capital, to what’s “safe”, like AAA rated securities backed with mortgages to the subprime sector and loans to sovereigns like Greece, but that ex post can turn out to be very risky.

Who the hell authorized regulators to direct (distort) the allocation of bank credit that way?

Listen up Mark Carney, Michael Bloomberg and you other! Any risk, even if perfectly perceived, if excessively considered, causes the wrong actions. Let banks be banks!

Let me end this comment by just asking: How many profiteering climate-change consultants will now banks have to employ in order to fulfill what is requested by this report?

Want some more detailed objections to the idiotic current bank regulations? Here!

Sadly the Basel Committee did not perform a Gedankenexperimente before regulating banks.

I just read about "Gedankenexperimente" in The Economist of June 10, 2017 "Quantum mechanics and relativity theory: Does one thing lead to another?" 

So, if the Basel Committee had done a Gedankenexperimente before regulating banks, then, if also applying Werner Heisenberg's uncertainty principle, they would have understood that the better current risks are perceived and the more you want banks to go for what is now safe, the riskier the future becomes.

First, because risk taking is the oxygen of development and a better future is built at least as much upon failures than upon successes. 

Second because what would be perceived as safe in the present would then get too much access to bank credit and thereby at one point in the future become very risky.

And so the regulators would have realized that with their risk weighted capital requirements for banks, they would be setting up the bank system for the worst kind of explosion imaginable, namely huge exposures to something very safe, turning very risky, against little capital, and with a real economy that has gone soft. 

PS. July 2011 I wrote twice to the Financial Times about Basel Committee’s regulations and Heisenberg’s uncertainty principle but, since I have been censored by FT, the editor was not interested. 

http://teawithft.blogspot.com/2011/07/bank-regulators-should-read-up-on.html

http://teawithft.blogspot.com/2011/07/arbiters-under-fire-should-be-bank.html

Fortunetellers’ bankers' bad-luck weighted capital requirements for banks would be better than Basel Committee’s risk weighted

We have the Basel Committee’s risk weighted capital requirements for banks. More ex ante perceived risk more capital, less perceived risk less capital. These are loony. First since it considers that was is already perceived as risky, is riskier for the bank system than what is perceived as safe; and second because it distorts the allocation of bank credit to the real economy, hindering banks from the much needed financing of the riskier future, making them concentrate on refinancing the safer past and present. 

Now, if we were to weigh the capital requirements for banks based on the fortunetellers reading bankers' hands, to ascertain bankers' bad-luck, then we would at least have one capital requirement against all assets; something that would at least not distort the allocation of bank credit to the real economy. And since this procedure would be based on bad-luck, and not on good luck, we could expect that capital requirement to be fairly high.

And if the fortunetellers got it all wrong, since they did not distort credit allocation, that would be less dangerous when compared to the credit rating agencies being wrong.

I challenge any of all current bank regulators to, in public, defend their risk weighting against that of my fortunetellers.

My opening question to them would be: What do you think of that Basel II assigned a risk weight of only 20% to the so dangerous AAA rated, and one of 150% for the so innocuous below BB- rated?

PS. Of course fortunetellers could be captured... but so can credit rating agencies be too.

PS. Now, what I would not suggest to do, is to allow big banks to use their own internal fortunetellers, as they currently use their own internal risk modellers to weigh the risks, and thereby set the capital they are required to hold.

PS. Of course, if we land ourselves a fortuneteller that wants to show-off, and for instance insists on that bad-luck depends on the day of the week a credit is approved, we better look for a less sophisticated one.