There is, might really be unwittingly, a high treason going on, against the western world, against the Judeo Christian civilization.

I was born a coward. Or at least quite risk adverse. And the many risk I have taken, is mostly because of blissful ignorance, or a glass of wine too much.

But I have always known about the importance of risk-taking, which is why I have always been grateful that my world was able to ride on the coattails of daring risk-takers; and that is why I often complained that Mark Twain was too right when he, supposedly, described bankers as those who lend you the umbrella when the sun is out, and want it back as soon as it seems it is going to rain.

But then came some bank regulators and really messed it up. Even more wimpy than I, they decided banks could hold less capital when lending to what was perceived as safe than when lending to what was perceived as risky, which meant banks would be able to earn much higher risk-adjusted returns on what was perceived as “safe” than on what was perceived as ”risky”. 

And, of course, that meant banks stopped giving credits in competitive risk-adjusted terms to the medium and small businesses, entrepreneurs and start-ups, to those that keep our bicycle moving forward, not stalling, not falling.

And now I fret for my daughters, and I fret even more for my grandchild, soon grandchildren, because I know that if my western world, my Judeo-Christian civilization, stays in the hands of adversaries to risk taking, it will just go down, down, down.

Regulators, if you really must distort, why not do it for a purpose in mind? Why not use, instead of credit ratings, job for our youth ratings?

Mamma Mia!

Inequality production 101

Lecture 2: Set much lower capital requirements for banks when lending to the "Infallible Sovereign" and the AAAristocracy than when lending to "The Risky", so that banks earn much higher risk-adjusted returns on equity when lending to the former than when lending to the latter.

That signifies that those who have made it thanks to risk taking in the past and/or are now perceived as "absolutely safe" will receive too much too cheap bank credit, while those perceived as "risky", and who have to risk it in order to make it in the future, will get too little and too expensive bank credit.

That guarantees the inequality of opportunities, and which as you should remember from Lecture 1, is the prime ingredient in any inequality production.

This is the mumbo jumbo that the Basel Committee bet our whole western world banking system on. Shame on it!

Here is the document which describes the risk-weight functions of Basel II

An Explanatory Note on the Basel II IRB Risk Weight Functions, Bank for International Settlements, July 2005

And these are the 3 papers referenced therein:

A risk-factor model foundation for ratings-based bank capital rules, by Michael B. Gordy, October 2002

Robert C Merton, On the pricing of corporate debt: The risk structure of interest rates. 1974, Journal of Finance 29, 449 - 470. 

Oldrich Vasicek, O. (2002) Loan portfolio value. RISK, December 2002, 160 - 162

All put together, does not make any sense!

And on that the Basel Committee, and the Financial Stability Board bet our whole western world banking system. Shame on it! How could they?

And that same crazy risk-weighing function is still part of Basel III

I wonder who wrote that “Explanatory Note”. “The confidence level is fixed at 99.9%, i.e. an institution is expected to suffer losses that exceed its level of tier 1 and tier 2 capital on average once in a thousand years”. That must indeed be the Bank Regulator’s real New Clothes.

Come on Mario Draghi, Adair Turner, Mark Carney, Stefan Ingves, Michel Barnier, or anyone else involved with bank regulations... have a go at explaining it to us! I bet you do not understand it either... but your egos stop you from recognizing that.

Is being consistent better than being right? Is the quest for consistency not just a cover up for mediocrity?

We read: “The members of the Financial Stability Board´s Regional Consultative Group for Europe were updated by the Basel Committee on Banking Supervision on the findings of the regulatory consistency assessment of risk-weighted assets for market risk and credit risk in banks’ portfolios, and shared national perspectives on regulatory consistency of risk weights.”

Of course we like consistency, but what is more important, that all these European countries are consistent in their assessment of risk-weighted assets for market risk and credit risk in banks’ portfolios, or that some in the group, could get it right, even if this meant acting inconsistently?

Has the biodiversity of opinions no longer any value? Is this quest for consistency not just a cover up for mediocrity?

The Basel Committee´s and the Financial Stability Board's loony concept of our risks with banks. God help us!

Basel II assigns a 150% risk weight to loans rated below BB- which, since the basic capital requirement in Basel II is 8 percent, means that a bank is required to hold 12 percent in capital (equity) against those loans… an authorized leverage of 8 to 1.

And Basel II assigns a risk weight of only 20% to loans rated AAA to AA which, with the same basic capital requirement of 8 percent, means that a bank is required to hold 1.6 percent in capital (equity) against those loans… an authorized leverage of 62.5 to 1.

Q: If you were a regulator, what would you think poses the greatest dangers for us with the banks, the possibility of their excessive exposure to something rated AAA to AA which turns out to be risky, or their “excessive” exposure to something rated BB- which turns out to be even more risky than that?

A: The first of course. There would be very few or no "excessive" exposures to anything rated below BB-. And, if so, the banks would have collected a lot of risk premiums too... which is also capital (equity).

You see, the Basel Committee’s risk weights measure the risks of the assets and the borrowers for the banks, but not the bank risks for us. You see, our and the bank regulators’ problems with banks, have absolutely nothing to do with banks and bankers getting it right, and absolutely all to do with banks and bankers, getting it wrong!

You understand it... but the members of the Basel Committee and the Financial Stability Board don't.

And that kind of unwise risk-weighting is still part of Basel III. In fact, more than five years after a crisis erupted, as a consequence of many assets perceived as safe turning very risky, and banks then having almost no capital against these assets, the basic principle of their faulty method of risk-weighting is not even discussed.

And much much less do the current regulators understand that capital requirements adjusted for "perceived" risk-weights, completely distorts the allocation of bank credit in the real economy.

And we have placed our banks in the hands of this kind of regulators. God help us!

With Basel II-III risk-weighted capital requirements, banks are not financing the future, only refinancing the past

The pillar of Basel II and Basel III bank regulations is capital requirements based on perceived risk. More-risk-more-capital and less-risk-less-capital.

That results in that banks can obtain much much higher risk-adjusted returns when lending to “The Infallible”, like some sovereigns, the housing sector and the AAAristocracy, than when lending to “The Risky”, like to medium and small businesses, entrepreneurs and start-ups.

And that results in banks lending much more to the “safer” developed past, than to the “riskier” developing future.

And anyone who does not understand that, or fully understands that risk-taking is the oxygen of development, should, frankly, not be working at the World Bank, the world’s premier development bank.

On the risk of risk aversion, I spoke over and over again, as an Executive Director of the World Bank, 2002-2004. But no one wanted to listen, all were just too much in love with the illusion of the ‘never ever a bank crisis again’. And I can understand that, I come from a country, Venezuela, where citizens do believe, over and over again, crazy messianic promises.

And I protested during the High-level Dialogue on Financing for Developing at the United Nations too. But what weight could my small unknown voice carry, when drowned by all those Monday morning quarterbacks, like the Nobel Prize winner Stiglitz, complaining, ex post, about the excessive risk taking of banks.

And it is now more than five years since the bank crisis broke out, precisely because being caught with little capital and excessive exposures to some of “The Infallible”, like AAA rated securities, Icelandic banks, Greece, and real estate in Spain; and our real economy is suffering from the lack of access to bank credit of “The Risky”.

And yet, we still have to read important documents of the World Bank, like Chapter 6 in the World Development Report 2014, “The role of the financial system in managing risks”; and “Financing for Development Post-2015”, which do not even mention the criminal distortions produced by the risk-weighted capital requirements for banks. It makes you want to cry for all the unemployed young.. 

But perhaps there is a glimmer of hope. Professor Stiglitz in "The Changing of the Monetary Guard" in the “Annual Meetings Daily”, October 12, writes about regulations that "affects the supply and allocation of credit - a crucial determinant of macroeconomic activity", and that "Any serious candidate for Fed Chairman should understand the importance of good regulation and the need to return the US banking system to the business of providing credit, especially to ordinary Americans and small and medium sized businesses (that is, those who cannot raise money on the capital markets)”. And that “return”, might mean he, and perhaps some other, have finally understood what happened.

Let us pray that at least Janet Yellen does understand it, especially since those in the Basel Committee and the Financial Stability Board evidence they are still clueless.

What would I do? First we absolutely need to hold the regulators accountable. Fire them, Hollywood would never allow a Basel III to be directed by the same who produced a box-office flop like Basel II… and parade them down some avenues wearing dunce caps.

Then accept that the banking systems is so seriously under-capitalized, and distorted, that extraordinary measures need to be taken, carefully but urgently, Basel IV, if we are not to doom our young unemployed to become a lost generation.

PS. All risk management must begin by clearly identifying those risks we cannot afford not to take… and, in banking, we cannot afford the banks not to take the risks the real economy needs.

Why is the President of the World Bank not informed about consequences of risk-weighted capital requirements for banks?

In Russia, September 6, 2013, Jim Yong Kim, the President of the World Bank Group, said the following in his statement issued at the end of the G20 summit.

“The G20 has pledged to achieve strong, sustainable, balanced and inclusive growth, and creating more and higher-quality jobs.”

Mr. Jim Yong Kim. As long as bank regulators allow banks to hold much much less capital when lending to "The Infallible", like some sovereigns, housing or the AAAristocracy; than what they are required to hold when lending to “The Risky”, like medium and small businesses, entrepreneurs and start-ups; and which means the banks will earn much much higher risk-adjusted returns on their equity when lending to the former than when lending to the latter... "strong, sustainable, balanced and inclusive growth" able to create more and higher-quality jobs” will just not happen. 

The odious and dangerous discrimination of "The Risky" does only increase, not reduce, the gap between those perceived as safe, the past, the developed, the haves, and those perceived as “risky”, the future, the developing, the have nots.

And the truly sad thing is that no one in the world’s premier development bank wants to inform its president about it.

Mr. Jim Yong Kim. I assure you, risk-taking is the oxygen of development. God make us daring!

Per Kurowski

A former Executive Director of the World Bank, 2002-2004

The Basel Committee seems to be drowning in in-house surrealism. Put it out of its misery

Risk weighted capital requirements are insane, since the perceived risks they are based on, are already been cleared for in interest rates, amounts of exposure and other terms. 

And not only am I saying it. Anat Admati and Martin Hellwig recently wrote “the studies that support the Basel III proposals are based on flawed models and their quantitative results are meaningless. For example, they assume that the required return on equity is independent of risk”.

And now the Basel III reformers are introducing a simple, transparent, non-risk based leverage ratio of 3 percent to act as a credible supplementary measure to the risk-based capital requirements.

And they argue they do that to “reinforce the risk-based requirements with a simple, non-risk-based "backstop" measure.” “reinforce”? They’ve got to be joking. "Supplementary" as they say,  perhaps somewhat, though the fact remains that capital requirements will still be based on perceived risk and therefore still favor “The Infallible” those already favored by banks and markets, and discriminate against “The Risky” those already discriminated against by banks and markets.

And read this! “Implementation of the leverage ratio requirement has begun with bank-level reporting to supervisors of the leverage ratio and its components from 1 January 2013, and will proceed with public disclosure starting 1 January 2015.” And which means that before January 1st 2013 we the public, will not have the right to know how really leveraged our banks are.

The Basel Committee seems to be drowning in in-house surrealism, and some ministers or central bankers should show some mercy and put it out of its misery

Why can´t a sequestration begin cutting where it could be most productive?

Iceland: Financial System Stability Assessment—an Update completed August 2008

I invite you to read: “The update to the Financial System Stability Assessment on Iceland was prepared by a staff team of the International Monetary Fund and the World Bank as background documentation for the periodic consultation with the member country. It is based on the information available at the time it was completed on August 19, 2008 and provided background information to the staff report on the 2008 Article IV consultation discussions with Iceland, which was discussed by the Executive Board on September 10, 2008, prior to the recent Board discussion on a Stand-By Arrangement for Iceland.”

It makes fascinating reading, especially in these times when the regulators now want to tackle systemic risks while ignoring that their regulations are in fact the prime source of systemic risk.

In it, dated just a month before the crisis exploded at the end of September 2008, we can, among other, read the following:

“The banking system’s reported financial indicators are above minimum regulatory requirements and stress tests suggest that the system is resilient. Bank capital averaged almost 13 percent of risk-weighted assets between 2003 and 2006, dropped to 12 percent in 2007 and to approximately 11 percent in the first half of 2008, but remain above the 8 percent minimum. Liquidity ratios are likewise above minimum levels.

Notwithstanding the positive indicators, vulnerabilities are high and increasing, reflecting the deteriorating financial environment”

To me once again, this just proves that no one had the faintest idea of what the “risk-weighted assets” really meant and, if they did, they had no will to question the significance of risk-weighting.