You want it darker… bank regulators killed the flame

The willingness to take risks was the flame that ignited the Western world’ free markets’ economic growth.

If I had had Leonard Cohen’s attention, I would have explained to him what the Basel Committee’s risk weighted bank capital/equity requirements, did to that flame.

If hearing it, he might have added what’s below to his “You want it darker”, though surely with much better words, 

If you’re the regulator, I'm out of the game

Deciding what banks need, kids will be broken and lame

If thine is the glory, theirs must be the shame

You want it darker

You killed the flame

It's written in regulations

It's not some nonsense claim

Basel Committee told banks

Keep refinancing our safer present

Don’t finance their riskier future

And that’s what our children got

You want it darker

They killed the flame

Please free us from imprudent risk-aversion and give us some prudent risk-taking

God make us daring!

#AI ChatGPT: If young and wanting a strong and healthy economy when you grow old, are current risk weighted bank capital requirements what you need?

I asked ChatGPT:

"If young and want to make sure that when old the economy is sufficiently strong and healthy to pay you decent pensions and social security, would you agree with bank regulators who, with risk weighted bank capital requirements, prefer your banks, over the years, to hold much more “safe” government debt and residential mortgages, than “risky” loans to small businesses and entrepreneurs?"

ChatGPT answered:

"Bank regulators often use risk-weighted capital requirements to ensure the stability and soundness of the banking system. These requirements aim to align capital levels with the perceived risk of different types of assets. Under risk-weighted capital requirements, "safe" assets like government debt and residential mortgages typically receive lower risk weights, while "risky" assets such as loans to small businesses and entrepreneurs receive higher risk weights.

The preference for banks to hold a larger proportion of "safe" assets, such as government debt and residential mortgages, can be attributed to their lower perceived risk and potential to provide stability to the financial system. These assets are generally considered less volatile and more liquid, which can enhance the resilience of banks during economic downturns.

However, it is important to note that risk-weighted capital requirements are not without their criticisms. Critics argue that these requirements can create distortions and unintended consequences. For instance, an excessive focus on risk weights for different asset classes can lead to a concentration of lending in certain sectors, potentially reducing the availability of credit to small businesses and entrepreneurs, which are considered riskier but vital for economic growth.

Balancing the need for financial stability and the promotion of economic growth is a key challenge for regulators. Recognizing the importance of small businesses and entrepreneurship in driving innovation and economic development, some regulators have taken steps to address the potential negative impacts of risk-weighted capital requirements on lending to these sectors.

In conclusion, while the preference for banks to hold more "safe" assets like government debt and residential mortgages under risk-weighted capital requirements aims to ensure financial stability, it is crucial to strike a balance that supports both stability and the necessary provision of credit to small businesses and entrepreneurs. Regulatory frameworks should continuously evolve to address these challenges and promote a robust and inclusive economy."

Note: The answers are copied exactly from those given to me by ChatGPT and Grok

PS. Please free us from imprudent risk aversion and give us some prudent risk-taking.

Here my many other questions to ChatGPT – Grok on bank regulations

ChatGPT- OpenAI: Credit rating agencies, empowered by bank capital/equity requirements, is that a systemic risk?

As an Executive Director at the World Bank, I often warned that assigning some few human fallible credit rating agencies so much power for deciding how much capital/equity banks needed to hold against assets, introduced a huge systemic risk in the financial sector. E.g.:

http://teawithft.blogspot.com/2003/01/credit-ratings-for-developing-nations.html

http://subprimeregulations.blogspot.com/2003/03/my-comments-on-world-banks-strategic.html

http://subprimeregulations.blogspot.com/2007/06/some-comments-made-at-risk-management.html

https://subprimeregulations.blogspot.com/2007/09/factors-in-financial-storm.html

Given now the opportunity to chat with ChatGPT – OpenAI, I asked:

"Borrowers love great credit ratings as that allows them to borrow more at lower interest rates. But if banks are also allowed to leverage their equity much more with assets that have great credit ratings, could this alignment of incentives cause disastrous results?"

OpenAI answered:

"The alignment of incentives between borrowers and banks regarding credit ratings can indeed create potential risks and contribute to financial instability if not properly regulated. While borrowers benefit from lower interest rates and increased borrowing capacity with excellent credit ratings, banks may be tempted to leverage their equity more with assets that have high credit ratings.

This situation can lead to several problems:

1. Excessive risk-taking: Banks may become overly confident in the safety of assets with high credit ratings and increase their leverage beyond reasonable levels. This behavior can result in a higher concentration of risk within the financial system.

2. Mispricing of risk: If banks rely too heavily on credit ratings without conducting their due diligence, they may underestimate the true risk associated with certain assets. This mispricing can create a false sense of security and lead to the accumulation of risky assets in the banking system.

3. Contagion effect: In the event of a downturn or a shock to the financial system, the interconnectedness of banks and their reliance on highly rated assets can amplify the impact and lead to contagion. If the credit quality of these assets deteriorates, multiple institutions could face severe losses simultaneously.

4. Systemic risk: When a large number of banks engage in excessive leverage based on assets with great credit ratings, the overall stability of the financial system may be compromised. If these assets were to experience a sudden decline in value or suffer from rating downgrades, it could trigger a broader financial crisis.

To mitigate these risks, regulatory measures are necessary. Regulators should ensure that banks have robust risk management frameworks in place and are not solely relying on credit ratings when assessing the quality and risk of assets. Strengthening capital and liquidity requirements can also enhance the resilience of banks and mitigate the potential negative effects of excessive leverage.

Moreover, improving the accuracy and transparency of credit ratings and reducing conflicts of interest in the rating process can contribute to a more reliable assessment of risk. This would help prevent a situation where banks overly rely on ratings without conducting their independent analysis.

Overall, it is crucial to strike a balance between encouraging lending and maintaining the stability of the financial system."

Here my many other questions to ChatGPT – OpenAI on bank regulations

Two questions to America’s economists, and one for its lawyers.

Bear with me.

Let me start with two passages from John Kenneth Galbraith’s “Money: Whence it came where it went” 1975.

First: “For the new parts of the country [USA’s West] … there was the right to create banks at will and therewith the notes and deposits that resulted from their loans…[if] the bank failed…someone was left holding the worthless notes… but some borrowers from this bank were now in business... [jobs created]

It was an arrangement which reputable bankers and merchants in the East viewed with extreme distaste… Men of economic wisdom, then as later expressing the views of the reputable business community, spoke of the anarchy of unstable banking… The men of wisdom missed the point. The anarchy served the frontier far better than a more orderly system that kept a tight hand on credit would have done…. what is called sound economics is very often what mirrors the needs of the respectfully affluent.”

Second: “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.”

Then, in Steven Solomon's “The Confidence Game” we read:

“On September 2, 1986, the fine cutlery was laid once again at the Bank of England governor’s official residence at New Change… The occasion was an impromptu visit from Paul Volcker… When the Fed chairman sat down with Governor Robin Leigh-Pemberton and three senior BoE officials, the topic he raised was bank capital…” 

Finally in his autobiography “Keeping at it” of 2018, penned together with Christine Harper, Paul Volcker wrote:

“The assets assigned the lowest risk, for which capital requirements were therefore low or nonexistent, were those that had the most political support: sovereign credits and home mortgages. Ironically, losses on those two types of assets would fuel the global crisis in 2008 and a subsequent European crisis in 2011. The American “overall leverage” approach had a disadvantage as well in the eyes of shareholders and executives focused on return on capital; it seemed to discourage holdings of the safest assets, in particular low-return US government securities."

Thanks!

So, now let me ask America’s economists two questions:

If since its Founding Fathers’ days America’s banks had been regulated so as to finance much more the government and residential mortgages than loans to its small businesses and entrepreneurs, would America be where it is now? 

Knowing that all those excessive bank exposures that have set on major bank crises were always built-up with what was ex ante perceived as very safe, what true precautionary purpose do these regulations serve?

And one question to America’s lawyers:

The risk weighted bank capital requirements with decreed weights of 0% Federal Government 100% - We the People, do they really conform with what 's wanted in the U.S. Constitution?

Where do I come from? 

At the World Bank “Let us not forget that the other side of the Basel [Committee’s regulatory risk weighted capital requirements] coin might be many, many developing opportunities in credit foregone”

As one of the Christian Western World? God make us daring!

As one having a strong opinion? My letter to the Financial Stability Board.

25 years on the issue. My first Op-Ed ever, began with what this post does.

My brevissimus criticism lecture on the Basel Committee’s bank regulations

Students. 

Let’s refer to two types of bank assets, those perceived as safe, e.g., government debt and residential mortgages; and those perceived as risky, e.g., loans to small businesses and entrepreneurs.

Let’s also assume all these assets, whether the Safe or the Risky, are offering perfect risk adjusted interest rates.

Before the Basel Committee regulations, the banks, with a general look to the safety of their whole portfolio, would have given all of these assets, whether safe or risky, a quite similar consideration.

But, when the Basel Committee imposed risk weighted bank capital requirements, more capital/equity for what’s perceived as risky than for what’s perceived (or decreed) as safe, that all changed.

Because banks can now leverage their capital/equity much more with what’s “safe”, the risk adjusted interest rates offered by the Safe, produce them higher risk adjusted returns on their equity, than the risk adjusted interest rates offered by the Risky.

That dramatically distorted the allocation of bank credit. 

The Safe now get too much credit, often at rates lower than what their correct risk adjusted interest rate would demand. As a consequence, excessive bank exposures are construed, turning the Safe effectively into risky and very dangerous to the stability of bank systems. (Have you ever heard of a dangerous asset bubble built-up with assets perceived as risky?)

The Risky now get too little credit and, whatever they get, is at interest rates higher than what their correct risk adjusted interest rates would merit. As a consequence, the Risky become riskier, and too little risk-taking, the oxygen of all development, takes place, something which, of course, weakens the economy.

Why would regulators do this? As Paul Volcker (valiantly) confessed “The assets assigned the lowest risk, for which bank capital requirements were therefore low or nonexistent, were those that had the most political support: sovereign credits and home mortgages”

Students, one big problem is that the Academia seem not to care one iota about it, so this might have been your only chance to hear this explanation. 

Why should you care? Having banks give much priority to refinancing the safer present than financing the riskier future, cannot be in your best interests.

Where would the Home of the Brave be, if all its immigrants had been met by risk-adverse bank regulations?

In his Washington Post May 27 op-ed, “Subsidizing America’s most important product," George F. Will referred to “Joseph Schumpeter an immigrant from Austria” whose theory was that “the principal drivers of social dynamism are… innovators — inventors of new things and companies” and added that “The common denominator [of it] is the restless, risk-taking spirit of a talented few.”The de facto spirit of the risk weighted bank capital requirements in the United States can currently be summarized in the following way: 

“We regulators allow you banks to leverage your capital a lot, and therefore earn high risk adjusted returns on equity, with what’s safe, e.g., Treasuries and residential mortgages. But, as a quid pro quo, you need to stay away from what’s risky, e.g., small businesses and entrepreneurs”

So, let me ask: Where would the Home of the Brave be if all its immigrants had been met by such regulatory risk adverseness?

PS. Not the first time I have asked myself that question.

PS. John Kenneth Galbraith wrote: “For the new parts of the country [USA’s West] … there was the right to create banks at will and therewith the notes and deposits that resulted from their loans…[if] the bank failed…someone was left holding the worthless notes… but some borrowers from this bank were now in business... [jobs created]. “Money: Whence it came where it went” 1975

PS. And at the World Bank I argued time and time again: “There’s a clear need for an adequate equilibrium between risk-avoidance and the risk-taking needed to sustain growth.”

PS. God make us daring!

PS. And, to top it up, in The Land of the Free, that risk aversion came hand in hand with outright statism

Risk weights are to access to credit what protectionist tariffs are to trade, only more pernicious.

A letter to the Executive Directors and Staff of the International Monetary Fund.

For decades now IMF has helped to spread around all developing countries the pillar of the Basel Committee’s bank regulations; the risk weighted capital requirements for banks.

Since risk taking is in essence the oxygen of any development, that piece of regulation is fundamentally flawed, especially for developing countries.

How do risk weighted capital requirements alter the incentives for banks? 

If banks hold the same capital against their whole portfolio, as they used do until some three decades ago, then with an eye on their overall portfolio and funding structure, banks lend in accordance to what produces them the highest risk adjusted interest rate; which would also provide them with the highest risk adjusted return on equity.

But, when different assets have different capital requirements, obtaining the highest risk adjusted return on equity will depend on how many times the risk adjusted interest rate for any specific loan or asset will depend on how many times it can be leveraged. The higher the allowed leverage is, the easier it is to obtain a high ROE; which means that “safe” highly leveregable loans could be competitive at lower risk adjusted interest rates than before, while “risky” lower leveregable loans would require paying higher risk adjusted interest rates. 

In essence the introduction of that regulation has caused banks to substitute savvy loan officers with equity minimizing engineers.

How do risk weighted capital requirements distort the allocation of bank credit?

The regulators based their decision on how much banks were allowed to leverage their capital with for the different assets, solely on the perceptions of credit risk. It never explicitly had one iota to do with banks fulfilling their obligation of allocating credit efficiently to the real economy.

So the introduction of that regulation simply distorts the allocation of bank credit; in favor of “the safer present” and against “the riskier future”. 

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

Specifically, a credit that is perceived as risky but that is directly related to helping reach a Sustainable Development Goal is much less favored by bankers, and now by bank regulators too, than a credit, perceived as safe, but which purpose could in fact be harmful to any SDG.

Specifically, safe credits for the purchase of houses are much more favored over credits to risky entrepreneurs, those who could create the jobs that would allow the income needed to service the mortgages and pay the utilities. 

Specifically, assigning lower risk weights to the sovereign than to citizens de implies de facto a statist belief that bureaucrats know better what to do with bank credit, than entrepreneurs who put their name on the line.

In other words these risk weight are to access to credit what tariffs are to trade, only much more pernicious. 

Do risk weighted capital requirements make our banks system safer?

If that regulation made the financial system safer there would at least be a favorable tradeoff. But it doesn’t, much the contrary. Too much easy credit can turn what is safe into something risky, like for instance morphing houses from being affordable homes into investment assets. 

The 2007/2008-bank crisis would never have happened or, if so, remotely had been of the same scale had regulators, for their risk weights, instead of perceived credit risk risks, used the probabilities of banks investing conditioned on how credit risks were perceived.

Many Eurozone sovereigns would not face current high levels of indebtedness had not EU authorities decreed a Sovereign Debt Privilege and assigned it a 0% risk weight, this even though they take on debt denominated in a currency that de facto is not their domestic printable one.

And so, at the end of the day, this regulation only guarantees especially large bank crisis, caused by especially large exposures to what was perceived (or decreed) as especially safe, which end up being especially risky, and are held against especially little capital.

Risk weighted capital requirements and inequality.

John Kenneth Galbraith wrote: “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… the poor risk… is another name for the poor man.” “Money: Whence it came where it went” 1975.

So I ask, how many millions of SMEs and entrepreneurs have not been given the opportunity to advance with credits over the last 25 years as a direct result of it?

IMF, please, wake up!

Should banks not be regulated? 

Of course these need to be regulated! I am only reminding everyone of the fact that the damage dumb bank regulators can cause when meddling without taking enough care, by far surpasses anything the free market can do. A free market would never have knowingly allowed banks to leverage 62.5 times their equity like regulators did, only because some very few human fallible credit rating agencies had assigned an AAA to AA rating to some securities backed with mortgages to the US subprime sector. 

A simple leverage ratio between 10 to 15% for all banks assets would be a much mote effective regulation than all those thousands of pages that currently exist.

And please, please, please, stop talking about "deregulation" in the presence of such an awful and intrusive mis-regulation. The regulators imposed the worst kind of capital controls.

Of course, just in case, all problems here referred to, are clearly applicable to developed economies too.

Sincerely,

Per Kurowski

@PerKurowski

PS. Basel Committee’s distortion of credit allocation explained to dummies, in just four tweets.

PS. “The assets assigned the lowest risk, for which capital requirements were therefore low or nonexistent, were those that had the most political support: sovereign credits and home mortgages. Ironically, losses on those two types of assets would fuel the global crisis in 2008 and a subsequent European crisis in 2011”, “Keeping at it” 2018, Paul Volcker

PS. My 2019 letter to the Financial Stability Board

PS. An ever growing aide memoire on Basel Committee’s many mistakes.

PS. The risk weighted bank capital requirements utterly distorted central banks’ monetary policy by directing way too much credit to what’s decreed or perceived as “safe”, sovereign/ residential mortgages/ AAA rated; and way too little to “risky” SMEs and entrepreneurs.

PS. Because it would also create distortions I am not proposing it, but would not risk weighted bank capital requirements based on SDGs ratings at least show more purpose for our banks? And, in the case of sovereigns, besides credit ratings, do we citizens not also need ethic ratings?

PS. “Are Basel bank regulations good for development?” a document presented at the High-level Dialogue on Financing for Developing at the United Nations, New York, October 2007.

PS. GDP growth based on too much carbs and too little proteins? Muscular or obese?

PS. Being creditworthy and being worthy of credit, c'est pas la même chose :-(

PS. And I am no newcomer to this issue

PS. Here AI - ChatGPT opining on risk weights and tariffs

What I as a former Executive Director of the World Bank pray that any new President of it understands

I was an Executive Director at the World Bank from November 2002 until October 2004. During that time the Basel Committee's Basel II bank regulations were being discussed. It was approved in June 2004. 

I was against the basic principles of those regulations that had begun with the Basel Accord of 1988, Basel I. That should be clear from Op-Eds I had published earlier, transcripts of my statements at the WB Board, and in the letters that I wrote and FT published during that time. Here is a brief summary of all that 

Since then I haven't changed my mind... the risk weighted capital requirements for banks, which are a pillar of those bank regulations, is almost unimaginable bad.

I pray the next president of the world’s premier development bank, whoever he is, and wherever he comes from, at least, as a minimum minimorum, understands:

First, that risk-taking is the oxygen of any development, and therefore the regulators’ risk adverse risk weighted capital requirements, will distort against banks taking the risks that help to push our economies forward. “A ship in harbor is safe, but that is not what ships are for.”, John A Shedd.

Second, that what’s perceived as risky is much less dangerous to our bank systems than what’s perceived as safe, and so that these regulations doom us to especially large bank crises, because of especially large exposures to what is especially perceived (or decreed) as safe, against especially little capital.

Do you not agree that mine is a quite reasonable wish?

PS. Here is a current summary of why I know the risk weighted capital requirements for banks are utter and dangerous nonsense.

@PerKurowski

Should our nannie state tax all risk-taking at higher rates, as current bank regulators do?

Motorcycles, in terms of deaths per miles driven, are much riskier than cars. Should society therefore levy a special risk tax to compensate it for the unnecessary early death of its members? (Even though we know more people die in car than motorcycle accidents) 

Since sport injuries have a cost for the society should we tax sports based on their injury rates? For instance, applying a ten percent risk tax on cricket and only one percent on croquet (to cover for the pesky squirrels).

If one assumes that the risks involved with any activity are not adequately perceived or considered, one could of course construe a case for those taxes. But, should we dare to assume risks are not already perceived and cleared for if we therefore could end up with a very risky too risk adverse society?

And I ask all this because taxing risk-taking is exactly what current regulators do with their risk weighted capital requirements for banks.

They now require banks to hold more capital against what is already perceived as riskier (motorcycles) than against what is perceived as safe (cars). This translates into banks having much higher possibility of maximizing their returns on equity with what is “safe” than with what is “risky”; which de facto is a tax on “the risky”.

Consequences? Banks build up dangerously large exposures to what is perceived, decreed, or concocted as safe, like sovereigns, AAArisktocracy and mortgages; and to small exposures, or even no exposure at all to what is perceived as risky, like SMEs and entrepreneurs.

Clearly if the risks are already perceived and considered by bankers, in the size of the exposure and the interest rates charged, to then also have the capital reflect the perceived risks, cause these risks to be excessively considered; resulting in an excessively risk-adverse banking system.

Just consider that already, partly because of the higher risk perceptions, many more people die in car than in motorcycle accidents. 

Think of a society where no one drives motorcycles or plays cricket because the risk-taxes are too high, and all keep to cars and crocket. Is that the kind of society that will be strong enough to survive? Is that what we want?

I am sorry but there is no more figurative way to express it. The Basel Committee for Banking Regulations and their affiliated regulators have effectively castrated our banking system. Will that make us safer? Of course not! 

Our banks will dangerously overpopulate safe-havens; in which they will die from lack of oxygen.

Our economies are going to dwindle into nothing, when denied the oxygen of risk-taking necessary for all development.

Friends, we must urgently get rid of these dangerously inept bank nannies.

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've 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

Why are excessive bank exposures to what’s perceived safe considered as excessive risk-taking when disaster strikes?

In terms of risk perceptions there are four basic possible outcomes:

1. What was perceived as safe and that turned out safe.

2. What was perceived as safe but that turned out risky. 

3. What was perceived as risky and that turned out risky.

4. What was perceived as risky but that turned out safe.

Of these outcomes only number 2 is truly dangerous for the bank systems, as it is only with assets perceived as safe that banks in general build up those large exposures that could spell disaster if they turn out to be risky.

So any sensible bank regulator should care more about what the banks ex ante perceive as safe than with what they perceive as risky.

That they did not! With their risk weighted capital requirements, more perceived risk more capital – less risk less capital, the regulators guaranteed that when crisis broke out bank would be standing there especially naked in terms of capital. 

One problem is that when exposures to something considered as safe turn out risky, which indicates a mistake has been made, too many have incentives to erase from everyones memory that fact of it having been perceived as safe.

Just look at the last 2007/08 crisis. Even though it was 100% the result of excessive exposures to something perceived as very safe (AAA rated MBS), or to something decreed by regulators as very safe (sovereigns, Greece) 99.99% of all explanations for that crisis put it down to excessive risk-taking.

For Europe that miss-definition of the origin of the crisis, impedes it to find the way out of it. That only opens up ample room for northern and southern Europe to blame each other instead.

The truth is that Europe could disintegrate because of bank regulators doing all they can to avoid being blamed for their mistakes.

It is prudent for our banks to take risks on the not so creditworthy, especially if these are up to something worthy

In a recent article in the Financial Times a bank was mentioned to be “an exemplar of prudence…[because] The target loan loss ratio is zero; [and] low loan losses, in turn, allow the bank to offer competitively priced loans and personalized service to creditworthy customers.”

To me that points clearly to what’s wrong with banks nowadays. “A target loan loss ratio of zero”… might allow “to offer competitively priced to creditworthy customers” but it will clearly not offer sufficient opportunities of credit to the not so creditworthy, those which includes too many risky SMEs and entrepreneurs, but also that could help provide the proteins the economy needs to move forward, in order not to stall and fall.

And the real truth is that, in the medium and long term, the creditworthy could benefit much more by banks taking much more risks on the not creditworthy, especially if these seem to be up to something worthy, than by they just getting low priced loans.

And if to the “zero loss loan target” you then add the distortion in the allocation of bank credit caused by the risk weighted capital requirements for banks, you might get a feel for why our economies seem to stagnate. 

Those regulations require the banks to hold more equity when lending to someone perceived risky, than when lending to someone perceived safe. And so that results in banks earning higher expected risk adjusted returns on equity when lending to someone perceived, decreed or concocted as safe, than when lending to someone perceived as risky. And that signifies that, around the world, millions of “risky” SMEs and entrepreneurs are not given the opportunity they might deserve and we might need for them to get.

As is, the banking system no longer finances the “riskier” future but only refinances the “safer” past, and that is as imprudent as can be, at least for our grandchildren.

Those bankers who with reasoned audacity take chances on the future are good servants of the society. Those who only maximize return on equity by diminishing the required capital and avoiding risks are, in the best of cases, absolutely boring.

And don’t get me wrong; I do not want to endanger our banking system, it is just the opposite. The forgotten truth is that major bank crises never ever result from banks building up excessive exposures to what ex ante is perceived as risky, it is not in the nature of bankers, as Mark Twain explained in terms of sun, rain and umbrellas.

The big crises always result from unexpected event of because of excessive exposures to something erroneously considered as safe.

PS. With their risk weighted capital requirements the regulators decreed inequality.

Dare answer this question, and then dare reflect on current bank regulations, and then dare do something about it.

An AAA rating signifies a “prime” asset and assets rated below BB- signify, at their best as “highly speculative”

So here is the question: 

What might be more dangerous to the banking system, too much exposure to AAA rated assets, or too much exposure to below BB- rated assets?

Which is your answer? Here's a hint: “May God defend me from my friends, I can defend myself from my enemies” Voltaire

If you reply as I do, that of course banks would never-ever build up excessive and dangerous to something rated below BB-, and that this is much more likely to happen with AAA rated assets, then I dare you to reflect on the following:

Your regulators, for the purpose of deciding the capital requirements for banks, assigned a risk-weight of 150% for assets rated below BB-, and a risk-weight of only 20% to AAA rated assets.

Does that sound like the regulators know what they are doing?

If you answer “Yes!” go back to sleep, but if by any chance you answer “No!, then you must know you have a very important assignment in front of you, that is, if you care about the future economic perspectives of your children and grandchildren.

And this is just an appetizer on all the Basel Committee for Banking Supervision’s idiotic mistakes.

PS. What legal consequences should a bank regulator face if, informed of a serious mistake, he does nothing to correct it?