IMF, your main role in supporting social spending, is helping to make sure the resources needed to be spent, are there.

I refer to IMF Policy Paper “A Strategy for IMF Engagement on Social Spending” dated June 2019.

The best strategy for IMF to engage on Social Spending is making sure the real economy, in a sustainable way, provides the most resources to it. That must at this moment begin by loudly protesting the risk weighted capital requirements for banks, something on which the IMF, sadly, has kept silence on for soon three decades.

Since 1988, with the Basel Accord, bank regulations have included, as its pillar, risk weighted capital requirements for banks. The higher the perceived credit risk is, the higher the capital banks need to hold and vice versa, the lower the perceived credit risk is, the lower the capital banks need to hold.

In Basel II of 2004 these risk weights ranged from 0% assigned to AAA to AA rated sovereigns, to 150% assigned to corporates rated below BB-. With a basic capital requirement of 8% that allowed banks to leverage their capital from, an infinite number of times till about 8.3 times.

By doing so that piece of regulation has seriously distorted the allocation of credit, putting both our bank systems at great risk and weakening the possibilities of our real economy to grow in a sustainable balanced way.

We already heard a canary clearly sing in the mine when a crisis exploded because of excessive demand for the securities backed by mortgages to the subprime sector. That demand resulted from that US investment banks and European banks, were allowed to leverage their capital with these securities a mind-boggling 62.5 times, if only a human fallible rating company had assigned it an AAA to AA rating. 

And all that “safe” financing of houses, have only caused these to morph from being homes into being investment assets, at great risk of causing future financial instability. 

And all those “risky” SMEs and entrepreneurs, who used to have their credit needs primarily serviced by banks, are now forced to fish in other less adequate waters. 

And what to say about the 0% risk weighting of all eurozone sovereigns that assume debt denominated in a currency that de facto is not their domestic printable one?

A lower risk weight assigned to the sovereign than to an entrepreneur implies the opinion that a bureaucrat knows better what to do with bank credit, than the entrepreneur who puts his own name to it. If that’s not statism what is? 

In summary: To favor the financing of the ‘safer present’ over the ‘riskier future’ only guarantees the weakening of the economy; and especially large bank crises, because of especially large exposures to what is especially perceived as safe, against especially little capital.

And sadly IMF has kept notorious silence on this.

Regulatory risk aversion distorts credit and causes dangerous bank exposures to what is perceived, decreed or concocted as safe.

Mark Carney, Governor of the Bank of England, and the Chair of the Financial Stability Board, on April 7, 2017 gave a speech titled: “The high road to a responsible, open financial system”. 

Carney said: “The pillars of responsible financial globalisation eroded prior to the global financial crisis. Regulation became light touch and ineffective…. few participants were exposed to the full consequences of their actions as governance and compensation arrangements focused on the short term.”

But to call regulations that as a pillar has risk weighted capital requirements for banks, which allow banks to leverage assets differently because of perceived or decreed risk, “light touch”, is pure nonsense. And if there is anything as focused on the short term, that must be regulations that give banks incentives not to lend to the “riskier” future, but to take refuge in refinancing the “safer” past and present.

Carney bragged: “The system is safer because banks are now much more resilient, with capital requirements for the largest global banks that are ten times higher than before the crisis and a new leverage ratio that guards against risks that may seem low but prove not.” 

Since that “ten times higher” refers to capital in relation to risk weighted assets, and he has no way to ascertain the ex ante risk perceptions will coincide with the ex post realities, that number may or may not be true. The improvement might come from banks shedding a lot of safe “risky” assets and taking on more exposures to potentially risky “safe” assets. Finally, mentioning “a new leverage ratio that guards against risks that may seem low but prove not”, amounts to admitting they had no idea what they were doing before.

Carney opined: “The financial system is simpler. As banks have become less complex and more focused, they are lending more to households and businesses and less to each other. A series of measures are eliminating toxic and fragile forms of shadow banking while reinforcing the best of resilient market-based finance. And more durable market infrastructure is simplifying the previously complex – and dangerous – web of exposures in derivative markets.”

He wishes!

But when I object the strongest is when Carney states “The financial system is fairer because of reforms that are ending the era of “too big to fail” banks and addressing the root causes of a torrent of misconduct.”

Fairer? With regulators favoring those who perceived as safe were already favored with easier access to bank credit, and increasing the obstacles for those who perceived as risky already found it harder to access bank credit, has nothing to do with fairness. It is just odious regulatory discrimination.

Bank regulators, de facto, decreed more inequality.

François Villeroy de Galhau, I don’t think you have earned the right to quote Ortega y Gasset

François Villeroy de Galhau, Governor of the Banque de France, when addressing The Asociación de Mercados Financieros Annual Financial Convention in Madrid on November 21, 2016 ends his “Europe facing a new political economy” by quoting José Ortega y Gasset, the famous Madrid-born philosopher:

“Life is a series of collisions with the future; it is not the sum of what we have been, but what we yearn to be”. 

Absolutely Mr Villeroy de Galhau. But what are we to say of bank regulators like you who with their risk weighted capital requirements, give banks great incentives to earn the highest risk adjusted returns on equity when refinancing the "safer" past and present, so as to make them stay away from any collision resulting from financing a "riskier" future.

Regulators make banks finance “safe” basements where young can live with their parents, not the risky jobs they need.

Ever since regulators introduced credit risk weighted capital requirements for banks, these are not financing sufficiently the "riskier" future, only refinancing excessively the "safer" past and present.

For instance, the risk weight of 35% when financing “safe” houses, and of 100% when financing “risky” SMEs, results only in the building of basements where the young can live with their parents, and not in the creation of the new generation of jobs the young need.

Here's an aide memoire on the monstrous mistakes of such capital requirements.

The Basel Committee, Financial Stability Board and other frightened risk adverse bank nannies, they mandated stagnation.

When you allow banks to hold less capital when financing what’s perceived as safe than when financing the risky; banks earn higher expected risk adjusted returns on equity when financing the safe than when financing the risky; and so you are de facto instructing the banks to stop financing the riskier future and keep to refinancing the safer past… something which guarantees stagnation… a failure to develop, progress or advance… something which guarantees lack of employment for the young and retirement hardships for the old. 

I would prefer not to distort the allocation of bank credit but, if I had to, then I would try to ascertain that bank credit goes to where it could do the society the most good; in which case I would consider basing these on job creation ratings and environmental sustainability ratings, and not on some useless credit ratings already cleared for by banks with the size of their exposures and interest rates.

PS. If you want more explanations on the statist and idiotic bank regulations that are taking our Western society down, here is a brief aide memoire.

PS. If you want to know whether I have any idea of what I am talking about, here is a short summary of my early opinions on this issue since 1997.

If a banker, I would ask: Is our bank being fooled by Basel regulators to dangerously overcrowd safe havens?

Gentlemen,

We are allowed to hold less capital against what is ex ante perceived (decreed or concocted to be safe than against what I perceived to be risky.

That, when compared to if we had to hold the same capital against any asset now permit us to expect higher risk adjusted returns on equity for what is perceived as safe than on what is perceived as risky.

To be able to earn more ROE on the safe than on the risky sounds wonderful, but it has its costs: 

First we might be willing to accept risk adjusted rates from “the safe” than might be lower than what would be the case in an undistorted market.

Second, to compensate for the above, we might be requiring “the risky”, like SMEs and entrepreneurs to pay us higher risk adjusted rates than what they would have to pay us in the case of an undistorted market, and that means we might lose out on some interesting business or otherwise make “the risky” riskier. 

If it was only our bank that had access to this regulatory distortion, then we might benefit without rocking the boat, but the fact is that the whole banking system is doing the same, and so the distortions in the allocation of bank credit to the real economy are huge.

So friends, it is clear that if we go on following the directives of our bank regulators, and basically only keep to refinancing the safer past, we are doomed to end up, sooner or later, gasping for oxygen in an overpopulated safe haven. 

And by abandoning the financing of the riskier future, we are also neglecting our duties to the real economy, and our children and grandchildren might, should, hold us accountable for that.

So what are we to do? What can we do? 

May I suggest we look into the possibility of ignoring the different capital requirements and, based of course on a sound bank diversification and portfolio management, begin, without discrimination, to look at the risk premiums offered by all, risky and safe, on an equal dollar to dollar basis.

Or, as our famous colleague Mr. George Banks once suggested, we could all go and fly a kite!

When will bank regulators stop making bankers’ wet dreams come true and do more for the beautiful dreams of our young?

What is a banker’s wet dream? Presumably to earn a lot of return on equity while not having to take risks. And the regulators granted that dream by allowing banks to have especially little capital against assets perceived as safe. Little capital means high leverage, and which means high-expected risk adjusted returns on equity. So banks just refinance the "safer" past.

What could our young ones dream of? To find decent jobs that allows them to form families and earn sufficiently to maintain these well. And that we know requires a lot of SMEs and entrepreneurs to open up new roads and ways to jobs in the real economy. But these dreams are denied by the regulators when requiring banks to hold more capital when lending to the “risky” than when lending to the safe. More capital means lower leverage, and which means lower expected risk adjusted returns on equity. So banks do not finance the "riskier" future.

And the current nightmare is that regulators are not even aware of what their credit risk aversion is doing. “A ship in harbor is safe, but that is not what ships are for.” John A Shedd

And the current nightmare is that regulators are not even aware that for the banking system, what’s perceived as safe, is the only that can generate those dangerous excessive exposures that bring on crises.  “May God defend me from my friends [what’s safe]: I can defend myself from my enemies [what’s risky]” Voltaire

Here is an aide-mémoire that explains some incredible mistakes in the risk weighted capital requirements for banks, the pillar of current regulations.

Mr Hiroshi Nakaso, you are wrong! You and your colleagues, so irresponsibly, changed the nature of our banks.

Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan gave on March 21, 2016 a speech titled “Challenges toward financial stability and the policy frontier – unconventional monetary policy, macro-prudence, and financial institutions’ low profitability” 

In it he said: “Joseph Alois Schumpeter, in his seminal “The Theory of Economic Development” stresses the important role played by the “banker”, as well as that of the “entrepreneur”. The banker profits from her ability to identify those entrepreneurs who develop truly innovative undertakings that are high-quality startups, and from generating information that leads to improved corporate performance. Schumpeter expects that such profit motives of the banker backed up by her exceptional ability to pick winners would bring about a more efficient reallocation of risks in the macro economy and lead to an endogenous rise in the economic growth rate.

This role of the banker- promoting the creative destruction through financial intermediation – has not changed since the time of Schumpeter.”

You are so wrong Mr Nakaso! You and your colleagues have changed the role of the banker.

With your risk weighted capital requirements for banks, which allow banks to leverage more their equity with what is perceived safe than with what is perceived risky; and thereby be able to obtain higher expected risk-adjusted returns on equity when financing what’s “safe” than when financing what’s “risky”, have certainly changed the role of the banker.

Nowadays his role, as you and you colleagues have seen it fit, is simply to avoid taking credit risks.

If you do not believe me look at the following authorized bank equity leverages in Basel II. (The risk weights in Basel III remains the same)

When lending to prime sovereigns, the sky is the limit. 

When lending to the AAArisktocracy 62.5 times to 1.

When financing residential housing 35.7 times to 1

And when lending to risky unrated SMEs and entreprenuers, only 12.5 times to 1

And that Mr Nakaso, is why banks do not any longer finance the riskier future, they just refinance the, for the very short time being, safer past.

The next generations will hold you and your colleagues accountable for this regulatory atrocity.