The Basel Committee, FSB and other bank regulators know dangerously little about risks. Why? Here it is!

What many perceive as very safe can lead to the build up of very large exposures that could threaten the bank system.

What many perceive as very risky never leads to the build up such large exposures that it could threaten the bank system.

Yet the Basel Committee, in Basel II of 2004, assigned a risk weight of only 20% to what rated AAA to AA and therefore so dangerous to the banking system, and one of 150% to what is rated below BB- and therefore so innocuous to the banking system.

The Basel Committee has refused to explain why they did so, and the only document purported to explain it, is pure GroupThink mumbo jumbo.

Additionally, risk weighted capital requirements for banks allow banks to leverage their equity differently with different assets, which produces quite different expected risk adjusted returns on equity than would have been the case in the absence of such regulations, and therefore this dramatically distorts the allocation of bank credit to the real economy. It introduced rampant risk aversion that have our banks no longer financing the riskier future, only refinancing the safer past.

Additionally, without obtaining due permission, the Basel Committee assigned a risk weight of 0% to a set of friendly sovereigns and 100% for the We the People of such sovereigns. This introduced rampant statism. As if government bureaucrats could use bank credit better than the private sector.

I have tried by all means possible to get explanations from the Basel Committee, even by using their formal consultation procedures, but all to no avail.

Please, you in the media who have more access to bank regulators ask them: Why do you think the below BB- rated are more dangerous to the bank system than the AAA rated?

Have you never heard of Voltaire’s “May God defend me from my friends, I can defend myself from my enemies”?

We also have John A Shedd (1850-1926) with his: “A ship in harbor is safe, but that is not what ships are for.”

With respect to that the Basel Committee is not only not allowing our banks to sail to explore riskier but perhaps more profitable bays, but it is also assuring to turn safe havens into overpopulated death traps. 

For our children and grandchildren’s case, help me to get rid of those dangerously incapable regulators.

P.S. Like during the Oscar it seems that at the Basel Committee there was also a mix-up of envelopes, in this case of those containing the names of what is the most and the least risky for our bank system. The saddest fact is that at the Oscar they got it fast, 2 minutes and 30 seconds, but in Basel they have yet to discover it after more than a decade.

The governments must stop their bureaucrats/technocrats from meddling dangerously with banks and the real economy.

The Basel Committee first published their Core Principles for effective banking supervision in 1997, their “de facto minimum standard for sound prudential regulation and supervision of banks”. The latest version, from 2012, now includes 29 Core Principles. 

It makes for a harrowing read. Of the 29, 16 have explicitly to do with what the supervisor “determines”, “sets”, “defines” or “requires”. And Principles 8 and 9, on the Supervisory Approach Techniques and Tools to be used when regulating banks, reads like an arrogant meddling bureaucrat’s wet dream.

There is not one single reference to the possibility that regulations could, with tragic consequences, interfere with the allocation of bank credit to the real economy. 

Consider their Principle 16 – on capital adequacy: “The supervisor sets prudent and appropriate capital adequacy requirements for banks that reflect the risks undertaken by, and presented by, a bank in the context of the markets and macroeconomic conditions in which it operates. The supervisor defines the components of capital, bearing in mind their ability to absorb losses.” 

That lead to the pillar of current regulations the risk weighted capital (equity) requirements for banks. The higher ex ante perceived or deemed risk of assets the higher the capital requirement; the lower the ex ante perceived risk of assets the lower the capital requirement.

And that means banks can leverage their equity more with assets perceived as safe, than with assets perceived as risky; and that results of course in that banks earn higher expected risk adjusted returns on their equity on assets perceived as safe, than on assets perceived as risky.

And so that favored more than what was normal bank lending to The Safe, like sovereigns, the AAArisktocracy and housing; and hindered more than what was normal, any bank lending to The Risky, like to SMEs and entrepreneurs.

And since excessive bank lending, against too little capital, to what was ex-ante perceived as very safe but that ex post turns out as very risky, is precisely the stuff major bank crises are made of, bank regulators have set the whole bank system on course to major disasters. 

And since insufficient lending to those who on the margin are most likely to move the economy forward, so as it will not stall and fall, like the SMEs and entrepreneurs, bank regulators have set the economy on course to major disasters. 

Here an example of what the distortion produces in terms of houses and jobs

And consider their Principle 17 – on credit risk: “The supervisor determines that banks have an adequate credit risk management process that takes into account their risk appetite, risk profile and market and macroeconomic conditions. This includes prudent policies and processes to identify, measure, evaluate, monitor, report and control or mitigate credit risk (including counterparty credit risk) on a timely basis. The full credit lifecycle is covered including credit underwriting, credit evaluation, and the ongoing management of the bank’s loan and investment portfolios.”

And the question is… how can you have adequate credit risk management when regulators also force you to clear in the capital the perceived credit risk you already clear for when deciding the risk premium and the size of the exposure?

And also ask yourselves… Why should the risk adjusted expected net margin paid by the risky to the banks be worth less than that paid by the safe? And then you will begin to understand how this regulation curtail opportunities to access bank credit and thereby increases inequality.

In other words regulators, insufflated with exaggerated estimates of their own abilities, are leading our banks and our economies to disaster.

Here (when I find the list) I will place the names for those responsible for these so that may be duly ashamed.

Global Association of Risk Professionals (GARP) Have you no comments on bank regulators’ risk management?

One of the few and perhaps even only risks that banks clear for, with risk premiums and size of exposures, is the ex ante perceived credit risks, that quite often expressed in credit ratings.

But regulators did not find that sufficient and decided that banks should also clear for the same ex ante perceived credit risk, in their capital.

And as far as I understand any perceived risk, even if it is perfectly perceived leads to the wrong action if it is excessively considered. Would you agree GARP?

And if I was a bank regulator I would be much more interested in why banks fail than in why their borrowers fail. Wouldn’t you be too GARP?

And knowing that bank capital is to be there to cover for unexpected losses, then the last thing I would do would be to base the capital requirements on some expected losses… especially when we know that the safer something is perceived the larger its potential to deliver some truly nasty unexpected losses. Would you not agree with that GARP?

And, if I was a bank regulator, managing risks, the first thing I would do is to be certain about the purpose of banks. That would indicate me that probably the risk we least can afford banks to take, is that of not allocating bank credit efficiently to the real economy. And that is something that becomes impossible when allowing banks to leverage differently with different assets, and thereby earning different and not market based expected risk adjusted returns on equity. Would you not agree with that GARP?

Right now the world is becoming a sad place, especially for coming generations, since regulators having given banks the incentives to stop financing the riskier future, and to make their profits by concentrating on refinancing the safer past. 

GARP do you not have a responsibility is speaking up against the Basel Committee’s and the Financial Stability Board’s particularly harmful and lousy way of managing risks?

I ask because your stated mission is: “As the leading professional association for risk managers, the Global Association of Risk Professional's mission is to advance the risk profession through education, training, and the promotion of best practices globally.”

And also because in “What we do” you state: “GARP enables the risk community to make better informed risk decisions through “creating a culture of risk awareness®”. We do this by educating and informing at all levels, from those beginning their careers in risk, to those leading risk programs at the largest financial institutions across the globe, as well as, the regulators that govern them.”

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

Mr. Stefan Ingves.

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

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

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

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

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

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

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

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

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

Mr. Stefan Ingves, may I suggest the following?

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

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

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

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

Yours sincerely,

Per Kurowski

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

Financial Stability Board, and Basel Committee, stop insulting our intelligence

The Financial Stability Board in its Peer Review on Risk Governance of February 12 states: 

“The recent global financial crisis exposed a number of risk governance weaknesses in major financial institutions, relating to the roles and responsibilities of corporate boards of directors (the “board”), the firm-wide risk management function, and the independent assessment of risk governance. Without the appropriate checks and balances provided by the board and these functions, a culture of excessive risk-taking and leverage was allowed to permeate in many of these firms.” 

Have these regulators no shame? They know perfectly well that it was they who intruded on the risk management functions of banks by imposing distorting differentiated capital requirements based on perceived risk, and authorized the excessive leverage to what was perceived as absolutely not risky, like to AAA to AA rated securities and sovereigns like Greece. 

The review sets out among its recommendations: “National authorities should strengthen their regulatory and supervisory guidance for financial institutions and devote adequate resources to assess the effectiveness of risk governance frameworks.” 

Forget it! Our problem is not with our national authorities, our problem is with YOU, Financial Stability Board and Basel Committee. 

Regulators go home and please stop insulting our intelligence, as is you’ve done enough damage.

Who do bank regulators think they are, unqualified and unauthorized, with immense hubris, playing risk managers for the world and destroying our economies?

Do conservatives and progressives not know or care about how regulators, with their silly risk weights based on perceived risk which determine the capital requirements for banks, so fundamentally distort the markets? 

Do conservatives and progressives not know or care about how regulators, with their silly risk weights based on perceived risk which determine the capital requirements for banks, so fundamentally increase the inequality between the “risky” and the “not-risky”? 

Does the Congress not know or care about how the regulators, with their silly risk weights based on perceived risk which determine the capital requirements for banks, effectively intrude in its domain and create subsidies for the “not-risky” and taxes for the “risky”? 

Are the current bank regulators really unqualified as risk managers? Absolutely yes!

The number one rule in any risk management must be to identify what risks you cannot risk not to take.

Regulators who do not define the purpose of what they are regulating cannot know one iota about risk-management. Or is it that they don’t care about our economies falling to pieces, as long as the banks stand there in shining armors among the rubble? 

Regulators who care about the perceived risks of bank assets, and not about how bankers react to the perceived risk of assets, have no idea of what they are up to. 

Regulators who give banks immense incentives to hold assets perceived as “not-risky” ignoring that all bank crisis ever have resulted, exclusively, from banks holding excessive assets that had erroneously been perceived as absolutely “not-risky”, have no idea of what they are up to. 

Regulators who do not know that when they allow a bank to hold less capital when an asset is perceived as “not-risky” discriminates against the access to bank credit of the “risky” like small businesses and entrepreneurs, and fundamentally distort the markets, have no idea of what they are up to. 

Regulators who do not understand that helping the “risky” to access bank credit is a fundamental part of building a growing and strong economy and jobs, and that favoring bank lending excessively to what is perceived as “not-risky” will only make for a flabby and imploding economy, have no idea of what they are up to. 

Risk managers who do not understand that risk-taking is a fundamental part of building a flexible and sturdy system, and that going excessively solely for what is perceived as “not-risky” makes for a

fragile system, have no idea of what they are up to.

Unauthorized? Yes! You tell me who authorized them to do what they did. Any volunteer?

What did the regulators really do? Scared witless by the possibility that bankers would expose themselves too much to assets deemed as “risky”, something that bankers never or very rarely do, they created huge incentives for banks to concentrate on assets that were, ex ante, perceived as “not risky”. In doing so, they fomented an incredible dangerous highly leveraged bank exposure to the “not risky”, and a truly anorexic exposure to the “risky”, like to the small businesses and entrepreneurs, something which has placed us almost over the brink of disaster.

What did the regulators really do? They created the prime cause for why now the US and other sovereigns are saddled by immense, almost unserviceable public debt burdens.

What did regulators really do? As I see it, by excessively promoting bank credit to “super-safe” sectors, like real estate in Spain, and to “infallible” sovereigns, like Greece, they have almost singlehandedly taken the eurozone down.

Sincerely, I am sick and tired of regulators who do not seem to care where they are taking our Western World, as long as they keep their “important” bureaucratic posts within their little mutual adoration club, apparently not accountable to anyone. 

Sincerely, I am sick and tired of those incapable of grasping the possibility of our current bank regulators being so fundamentally wrong, so that they, even when they proclaim “Without fear and without favor” do not even dare to ask the questions that needs to be asked.

Sincerely I am sick and tired, and anguished, about my children and grandchildren having to grow up in a world were so much de-facto power lies in the hands of some petit bank regulating bureaucrats.