Tombstones

Here rests a bank regulator who all his life believed that what bankers perceived as risky was more dangerous to our bank systems than what bankers perceived as safe. 

May his soul rest in peace.

Here rests a bank regulator who based the risk weighted bank capital requirements on bankers perceiving risk correctly, and not on that they could be wrong.

May his soul rest in peace.

Here rests a regulator who missed his lectures on conditional probabilities, and therefore did not set the risk weighted capital requirements conditioned on how bankers respond to perceived credit risks.

May his soul rest in peace.

Here rests a regulator who even though bankers respond to perceived credit risks, with size of exposures and risk adjusted interest rates, also wanted bank capital to double up on that same perceived risk

May his soul rest in peace.

Here rests a bank regulator who never understood the systemic risks he introduced into banking, by for instance assigning so much power to credit rating agencies, or his stress-tests of the stresses a la mode.

May his soul rest in peace.

Here rests a bank regulator who for the risk weighted bank capital requirements agreed with risk weights of 20% for dangerous AAA rated and 150% for innocous below BB- rated

May his soul rest in peace.

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

Here rests a bank regulator who caused banks to dangerously overpopulate safe harbors, and sent other investors and small time savers out on the risky oceans. 

May his soul rest in peace.

Here rests a bank regulator who by favoring banks to finance the "safer" present and to stay away from the "riskier" future, blocked millions of entrepreneurs' access to bank credit and with it risk-taking… the oxygen of all development

May his soul rest in peace.

Here rests a statist bank regulator who believed a government bureaucrat knows better (Risk Weight 0%) what to do with credit he’s not personally responsible for, than an entrepreneur or SME (RW 100%)

May his soul rest in peace.

Here rests a bank regulator who for risk weighted bank capital requirements agreed with a low 35% risk weight to residential mortgages, which caused houses to morph from affordable homes to risky investment assets.

May his soul rest in peace.

Here rests a bank regulator with a Ph.D. who proved right Daniel Patrick Moynihan, who supposedly held “There are some mistakes only Ph.Ds. can make.

May his soul rest in peace.

Here lies a central banker who injected huge amounts of liquidity without understanding how risk weighted bank capital requirements distorted the allocation of credit

May his soul rest in peace.

Here lies a financial journalist who scared stiff he would never be invited to important conferences, never questioned the risk weighted bank capital requirements. 

May his soul rest in peace.

Here lies an ordinary citizen who wanting so much to believe it true, swallowed lock stock and barrel the regulatory technocrats' populism imbedded in the risk weighted bank capital requirements

May his soul rest in peace.

Here rests a regulator who helped guarantee especially large bank crises, caused by especially large exposures to what’s perceived especially safe and might not be, and is held against especially little capital

May his soul rest...

PS. A summary of The Basel Committee for Banking Supervision's mistakes

My letter to the Financial Stability Board was received.

http://www.fsb.org/wp-content/uploads/Per-Kurowski.pdf

From: Per Kurowski

Sent: 18 March 2019 19:16

To: Financial Stability Board (FSB)

Subject: SME financing evaluation

I have not found sufficient strength to sit down and formally write up my comments, because I feel I would just be like a heliocentric Galileo writing to a geocentric Inquisition.

The Basel Committee’s standardized risk weights are based on the presumption that what is ex ante perceived as risky is more dangerous to our bank system.

And I hold a totally contrarian opinion. I believe that what is perceived a safe when placed on banks balance sheets to be much more dangerous to our bank system ex post than what is perceived ex ante as risky; and this especially so if those “safe” assets go hand in hand with lower capital requirements, meaning higher leverages, meaning higher risk adjusted returns on equity for what is perceived safe than for what is perceived as risky.

The following Basel II risk weights are signs of total lunacy or an absolute lack of understanding of the concept of conditional probabilities.

AAA to AA rated = 20%; allowed leverage 62.5 times to 1. Below BB- rated = 150%; allowed leverage 8.3 times to 1

The distortion the risk weighting creates in the allocation of credit to the real economy is mindboggling. Just consider the following tail risks.

The best, that which perceived as very risky turning out to be very safe. The worst, that which perceived as very safe turning out to be very risky.

And so the risk weighted capital requirements kills the best and puts the worst on steroids... dooming us to suffer an weakened economy as well as an especially severe bank crisis, resulting from especially large exposures, to what was especially perceived as safe, against especially little capital.

In relative terms all that results in much more and less (see note) expensive credit to for instance sovereigns and the purchase of houses, and less and more expensive credit to SMEs

I am neither a banker nor a regulator but I do believe that the following post helps to give some credibility to my opinions on the issue. And, as a grandfather, I am certainly a stakeholder.

http://subprimeregulations.blogspot.com/2004/11/some-of-my-early-public-opinions- on.html

And here is a more detailed list of my objections to the risk weighting

http://perkurowski.blogspot.com/2016/04/here-are-17-reasons-for-why-i-believe.html

Now if by any chance you would dare open your eyes to the mistakes of your risk weighted bank capital requirements and want more details from me, you know where to find me.

Sincerely

Per Kurowski

A former Executive Director of the World Bank (2002-2004) 

@PerKurowski

Note: In the original letter I erroneously wrote "more and more expensive credit to sovereigns" and not "less expensive", but this should be easily understood as a mistake.

PS. FSB keeps avoiding the issue: June 7, 2019 FSB published a Consultative Document: “Evaluation of the effects of financial regulatory reforms on small and medium-sized enterprise (SME) financing” I quote two parts of it.

1. “For the reforms that are within the scope of this evaluation, post-crisis financial regulatory reforms, the analysis, does not identify negative effects on SME financing in general.” 

Comment: The scope of the analysis does explicitly not include pre-crisis financial regulatory reform, like Basel II. When compared to what was introduced in Basel II, the changes in Basel III produced not really that much “more stringent risk-based capital requirements”. Therefore to limit the analysis to the impact of Basel III changes to risk-based capital requirements, is basically to avoid the issue of how these have, especially since Basel II, profoundly distorted the allocation of credit, and negatively affected the financing of SMEs.

2. “There is some evidence that the more stringent risk-based capital requirements under Basel III slowed the pace and in some jurisdictions tightened the conditions of SME lending at those banks that were least capitalised ex ante relative to other banks.”

Comment: That the Basel III risk-based changes, which in my opinion are minor relative to their importance, “tightened the conditions of SME lending at those banks that were least capitalised ex ante relative to other banks” is something to be expected. There, close to the roof, on the margin, is where the risk weighting most affects; think of “The drowning pool”

PS. A letter to the IMF: "The risk weights in the risk weighted bank capital requirements are to access to credit, what tariffs are to trade, only more pernicious.

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

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

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

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

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

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

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

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

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

Nothing could be so dangerous as big data wrongly interpreted and manipulated

Regulators gathered data on credit risks and developed their risk weighted capital requirements for banks… more risk, more capital – less risk less capital.

But the data they were looking at was the ex-ante perceived credit risks, and not the ex-post possible risks after the ex-ante risks had been cleared for.

And therefore they never realized that what is most dangerous for the banking system is what is perceived very safe and could therefore create large exposures; while what is perceived as very risky is by that fact alone, made innocuous for the banking system

And as a consequence we have already suffered a big crisis because of excessive exposures to AAA rated securities backed with mortgages to the subprime sector; and millions of those risky young dreaming of an opportunity of a bank credit to prosper, have had to give up their dreams or pay higher interest rates that made them even riskier. 

So friends, always prefer well interpreted and well manipulated small data over mishandled big data.

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.

The curious border between what finance professors can understand, and what they cannot understand

If with regulations you allow banks to leverage much more their equity, and all the support these receives from society, with assets type A than with asset type B, then banks will be able to obtain higher expected risk adjusted returns on equity with assets A than with assets B. 

That finance professors can understand.

And the above will cause the banks to exclusively hold assets A, unless assets B offers these a much higher risk adjusted return than what would have been the case in the absence of such regulations.

That finance professors can understand.

And that clearly signifies a distortion in the allocation of bank credit. 

And that finance professors can understand.

But if you just substitute “safe assets” for assets “type A”, and “risky assets”, like loans to SMEs and entrepreneurs, for assets “type B”, then suddenly finance professors no longer understand.

And that I know because no one of them is protesting the distortions in the allocation of credit produced by the risk weighted capital requirements for banks. 

Strange eh?

What behavioral theory explains that?

What would have happened if Basel capital requirements for banks were lower for what’s “risky” than for what’s “safe”?

Many things! Among other:

First, since banks would then not be able to leverage their equity as much as they could with assets perceived as “absolutely safe”, then the risk of traditional bank crises those which result from excessive exposures to what is erroneously perceived as absolutely safe, would of course be lower. And, to top it up, if these were to occur, they would at least find banks covered with much more equity…not standing there bare-naked as now.

Second, the whole procedure of how to game the regulations would change 180 degrees. Instead of having a vested interest in dressing up assets as “absolutely safe”, they would want to dress up assets as “more risky” than they are… and that process would certainly faced more objections, since borrowers and lenders would definitely not share the same objective.

Third, small businesses and entrepreneurs would find it much easier to break that curse described by Mark Twain, of bankers being those who lend you the umbrella when the sun shines and wanting it back as soon as it looks like it is going to rain.

Fourth, it would be harder for too big to fail banks to grow, since low capital requirements hormones are not as effective where it is risky than where it is safe.

Fifth, there would be more “safe” investments available, for you, for me, and for the widows and orphans.

Sadly bank regulators went for an automatic decision: “safe is safe and risky is risky”; and did not take time to deliberate sufficiently on the fact that there where too many empirical evidences that, at least in banking, “risky” was usually safe but that “absolutely safe” could turn into horribly risky.

And here we are… and bank regulators have still not learned that lesson :-(

PS. This is not a proposal... just doing some speculative thinking :-)

Real banking risks do not revolve around what is perceived “risky”, as experts think, but around the “absolutely safe”

What happened with the experts swearing by geocentrism, or the Ptolemaic system, that with the cosmos having Earth stationary at the center of the universe, when Galileo Galilei, Nicolaus Copernicus, Tycho Brahe and Johannes Kepler, convinced the world of the heliocentric model, that with the Sun at the center of the Solar System?

I ask it curious to know of what will happen with all those experts in the Basel Committee, the Financial Stability Board the IMF and places like the academia and the press; like for instance Mario Draghi, Stefan Ingves, Jaime Caruana, Mark Carney, Olivier Blanchard, José Viñals, Martin Wolf and so many other; when it is finally realized that the real serious risks in banking do not revolve around assets perceived as “risky”, as they all think, but around assets perceived as “absolutely safe”.

These regulators’ silly portfolio invariant credit risk based capital (meaning equity) requirements for banks, by impeding the fair access to bank credit of “the risky”, like small businesses and entrepreneurs, not only distorts and hurts the real economy; but they also guarantee major system crisis, since banks are then doomed to, sooner or later, to get caught with their pants down (meaning little equity), with huge exposures to something which was perceived as “infallible” but which has turned into something very risky… often precisely because of too much credit at too low interest rates.

Should it be "More risk more equity – less risk less equity" as these regulators argue?

No! I prefer no distortion, but, if anything, then just the opposite.

These current regulators they all confuse the world of ex-ante perceived risks with the world of ex-post realized dangers.

These regulators have never heard or understood Mark Twain’s “A banker is he who lend you the umbrella when the sun is out, and wants it back as soon as it looks like it is going to rain”

Anything you distort I can distort better, I can distort anything better than you. Yes I can, yes I can, yes I can!

So sings the Basel Committee for Banking Supervision and the Financial Stability Board, while proceeding to distort all common sense out of how banks allocate credit in our real economy.

For this they concocted capital requirements based on the same ex ante perceived risks which were already being cleared for by the market.

And with this they made banks earn much much higher expected risk adjusted returns on equity on assets perceived as “absolutely safe” than on assets perceived as “risky”.

And with that they caused banks not to finance the risky future but only refinance the safer past.

And all for nothing, because that only doom banks to end up gasping for oxygen in dangerously overcrowded “absolutely safe havens”.

If they young would just look up from their iPads for a second, and understand what is being done to them, I would not like to be in the Great Distorters' shoes.

But she knew how to aim!

A regulator´s risk is totally different from a banker´s risk... and current bank regulators do not know this. God save us!

A banker has to believe he has appreciated the risks of assets and borrowers correctly, and covered for these adequately, in order to do his banking business. 

A bank regulator´s risk on the other hand, has nothing to do with the intrinsic risks of bank assets or borrowers, and all to do with whether the banker has been correct or not, in his appreciations of the risks, and if he has adjusted adequately his exposures to it.

And that is why it is so extremely silly of bank regulators to risk-weigh the capital requirements for banks based on the ex ante perceived risk of assets and borrowers, instead of setting a sufficient capital requirement to cover reasonably for the bankers committing mistakes.

And, if trying to do so, the regulator would very soon be able to understand that the assets or borrowers that really signify major dangers for the banks, are those assets that, when booked, were considered “absolutely safe”.

In other words, if risk-weighting, not for the bankers´ risks but for the regulators' risk, the capital requirements for what is perceived as “absolutely safe” should be higher than for what is perceived as “risky”.

And so currently bank regulators are with their risk weights not only distorting the allocation of bank credit to the real economy but, on top of it all, they are doing it in the totally wrong direction. God save us!

Worse than truck being allowed high speeds, is that different speeds are allowed.

Anat Admati in “The Compelling Case for Stronger and More Effective Leverage Regulation in Banking” October 14, 2013, refers to “The speeding analogy” which appeared in hers and Martin Hellwig’s splendid book "The Bankers' new clothes"

“Imagine that trucks were allowed to drive faster than all other cars on the road even though they are the most dangerous. Further suppose that the trucking companies and the drivers are rewarded the faster they are able to make a delivery, benefit from subsidized insurance, and have a special safety system that protects the driver in case of accidents and explosions. The companies might produce narratives suggesting that their deliveries are essential and that the fast delivery is important for economic growth. They and others might produce models suggesting possible “tradeoffs” associated with a lower speed limit for the trucks. Whereas there probably are tradeoffs associated with trucks driving too slowly, it is clear that they are irrelevant, and there are no tradeoffs, when choosing between 90 miles per hour and 50 miles per hour for a truck carrying dangerous cargo in a residential neighborhood”

Yes, Admati is right in her analogy.

What guarantees mayhem more than a generally allowed high speed is, as I have argued for years, to allow different vehicles, based on safety ratings, to drive at different speeds (risk-weights) on the same streets. Sooner or later those safety ratings, will either be captured by interested speeders, or simply be wrong; and besides these loony traffic regulations will make it more difficult for doctors, fire trucks and other vital essentials to arrive in time.

But no, Admati is very wrong in her analogy when she mentions: “Imagine that trucks were allowed to drive faster than all other cars on the road even though they are the most dangerous.”

That is because what's perceived as “most dangerous”, the risky, the trucks, is what currently in banking must transit at the slowest speeds, the lowest allowed bank leverages; while those perceived as the safest, like sovereigns, residential mortgages and AAA rated securities, are those allowed to go through our residential neighborhoods at the highest speeds, the highest allowed leverages.

I do understand, it is hard to internalize that, at least when it comes to banking, that which is perceived as safe is so much more dangerous to the system than that which is perceived as risky. Sadly way too many missed their lectures on conditional probabilities. 

I've used a very similar though quite distinct analogy on my blog.

All this is of course why I give much more importance to eliminating the risk-weighting of the capital requirements for banks, than just increasing the basic capital required. In fact the more capital banks are asked to increase the capital means that, while that is being taken cared off, the worse will be the effective discrimination against those who, even though they in fact pose the least de facto risks for the banks, are been castigated with the highest risk weights. Remember "The drowning pool"

Should not bank regulations meet some minimal ethical standards?

Without any type of bank regulations those perceived as “risky” would pay higher interest rates, have access to smaller loans, and need to accept harsher terms than those perceived as “not-risky”. And that is how it should be, anything else would not make any sense. 

But with the current capital requirements based on ex-ante perceived risk, those officially perceived ex-ante as “risky”, like small businesses and entrepreneurs, need to pay even higher interests, have their access to bank credit even more curtailed, and need to accept even harsher terms, than would be the case without any bank regulations… and that my friend, does not seem ethical to me. 

Nor does it make any sense... since never ever have major bank crisis resulted from excessive bank exposure to what was perceived ex ante as “not- risky”, these have all resulted, no exclusions, from excessive exposure to what was ex-ante perceived as “absolutely not-risky”.

And, of course, these dumb regulations can only help to increase the cliff between the “not-risky-haves” and the “risky-not-haves”

And, of course, these dumb regulations, can only curtail the job creation powers of small businesses and entrepreneurs.

Widows and orphans have been locked out from safe investments

It used to be that the safest investments, the absolutely not-risky, that paid low interests, were reserved for what was known as widows and orphans, those unable to shoulder risk. And banks and other investors took care of the “risky”

Not any longer! With capital requirements for banks that are much lower when banks hold assets deemed as “absolutely not-risky” than when they hold assets deemed as risky, the banks have been induced to earn their return on equity among those perceived as “absolutely not risky”.

You tell me, what return could there be left for a widow and orphan from holding an AAA rated security when banks can hold those same securities against basically no equity of their own at all?

Capice? If not…. perkurowski@gmail.com

The bank regulators are to blame for outlandish bankers' bonuses

Time ago, when banks were banks, a banker needed to be able to carefully analyze the credit risk of his client, and then offer a competitive rate so as not to lose the business. That lead to tight profit margins which needed also to be shared with shareholders, and so there was never really much room for big banker bonuses. 

But then came the regulators and decided that banker did not really have to lend to the “risky” any longer in order to make profits, because since they would be required to hold much less capital when lending to those officially perceived as “not-risky”, the return on equity when doing so, would shoot up, and, to top it up, with less capital, there was of course also less shareholders to have to share those higher margins with. 

And banker bonuses shoot up into the sky, especially for those banker-traders who had not the slightest idea of how to analyze credit risk. 

Do you find that hard to understand?... then let me phrase it as a question. 

Where do you think there is more room for huge banker bonuses, in the lending to the “risky” where banks need to hold 8 percent in capital, or in lending to the “absolutely not-risky” where banks are allowed to hold only 1.6 percent, or less, in capital?

Educating Martin Wolf (and others in dire need of it): Stupid Bank Regulations 101

When banks are allowed to hold less capital against assets perceived ex-ante as “not risky” the regulators are effectively discriminating against banks holding assets ex-ante perceived as “risky”, like loans to small businesses or entrepreneurs. 

And that amounts to a distortion of the market. The direct effects of that distortion is that those perceived as not risky will have an ampler and cheaper access to bank credit than what would have been the case without these regulations, and those perceived as “risky”, will have a scarcer and more expensive access to bank credit that would have been the case without these regulations.

In other words, it signifies a regulatory subsidy to those already benefitted by the market and banks from being perceived as “not risky”, and a regulatory tax on those already being taxed by the market and banks because they are perceived as "risky".

In other words we´ve got ourselves a much ignored class-war carried out under the cover of bank regulations by the "not risky" against the "risky".

And that discrimination against what is perceived as risky, must of course negatively impact the economy and the creation of jobs, which both thrive precisely based on the risk-taking. 

And all for no good purpose at all, because never ever has a major bank crisis resulted from excessive exposures to what was ex ante perceived as risky. 

And all that regulatory nonsense, or even worse than nonsense, is a direct result of not specifying clearly what the purpose of our banks is. Surely it cannot be to survive in an economy where everything else fails.

And, if regulators absolutely must interfere, because it is in their nature, then why don´t they do it with a purpose, and for instance set the capital requirements for banks based on potential-for-jobs-for-youth ratings?

And, if regulators absolutely must interfere, and must to do so based on perceived risks then why not do so based on how bankers react to perceived risk. Although in that case it would seem that the capital requirements for banks should be higher for any asset perceived as “absolutely not-risky” and lower for any asset perceived as “risky”.

Also as is, no one has any idea of what the real market interest rates are. For instance what would be the UK Treasury rate if banks needed to hold as much capital when lending to the UK Treasury, than when lending to a UK citizen? 

Research assignment (choose one of the two) 

1. Make a regression between the major problem assets during the crisis and the low capital requirements for holding those assets, and then explain what inferences can be drawn from the results. 

2. Investigate who could have authorized bank regulators to award subsidies on access to bank credit to the “not-risky” or tax the access to bank credit of the “risky”. Alternatively you could investigate who could have authorized bank regulators to earn more, by means on higher leverage, when lending to the “not-risky” than when lending to the “risky”.

PS. There will be a quiz on this soon 

An unconstitutional odious discrimination!

When a bank lends to the government it is required to hold zero percent in equity; when it lends to a corporation rated AAA by one of three credit rating agencies then they need 1.6 percent; but, when lending to an entrepreneur or a small business that has not been rated, then the bank is required to hold 8 percent in equity. As bank equity is scarce and expensive this amount to an arbitrary discrimination against unrated entrepreneurs and small businesses.

If I was an entrepreneur or a small business in the US I would go to a judge and denounce that I am being discriminated against by the financial regulators, in an unconstitutional way.

I would also take the opportunity to explain to the judge how perfectly stupid this discrimination is considering that it is precisely the entrepreneurs and small businesses those who can create the real fiscally sustainable jobs, as well as the AAAs of tomorrow; and also remind the judge that entrepreneurs and small businesses had nothing to do in creating this crisis.

PS. What would the US Supreme court opine if asked: “Is a regulatory discrimination against The Risky and in favor of The Infallible, not an odious and unconstitutional negative action?”