When it comes to discrimination, EU cares more about the access to a monastery than about the access to bank credit

If I had the right to vote I would have voted for Britain to stay in EU. But I would have hoped for that this option had won by just one vote, so that there was huge pressure on EU to clean up its act. It sorely needs it.

For instance, the European Commissioner for Internal Market and Services is in charge of promoting free movement of capital and therefore has a lot do to with the extremely important area of regulating the financial services. 

It is a topic of much interest for me since, for more than a decade, I have argued that the Basel Committee’s risk weighted capital requirements for banks, is impeding the free movement of capital with disastrous consequences for the real economy.

But in 2012, during a conference in Washington by the then Commissioner Michel Barnier, I was handed a brochure that presented, as a success story of his office, the following: 

“A French citizen complained about discriminatory entry fees for tourists to Romanian monasteries. The ticket price for non-Romanians was twice as high as that for Romanian citizens. As this policy was contrary to EU principles, the Romanian SOLVIT centre persuaded the church authorities to establish non-discriminatory entry fees for the monasteries. Solved within 9 weeks."

And then I knew for sure something smelled very rotten in the EU, with its full of hubris besserwisser not accountable to anyone technocrats.

How can they waste time on such small time discrimination when those borrowers ex ante perceived as risky, and who therefore already got less bank credit and at higher interest rates, now suffer additional discrimination caused by regulators requiring banks sot hold more capital when lending to them that when lending to those ex ante perceived as safe? And on top of it all, for absolutely no reason, since dangerous excessive bank exposures, are always built up with assets perceived as safe.

Barnier, as Frenchman should know Voltaire’s “May God defend me from my friends: I can defend myself from my enemies.” But now bank regulators tell banks “trust much more your friends”, the AAA rated, and to which in Basel II they assigned a risk weight of 20%; and “beware even more of your enemies”, the below BB- rated, and which were given a risk weight of 150%.

As a result banks can leverage more their equity with “safe” assets than with “risky” assets, and so they now earn higher risk adjusted returns on equity when lending to sovereigns, members of the AAArisktocracy or financing houses, than when lending to SMEs and entrepreneurs.

And as a direct consequence of this regulatory risk aversion, banks do not any longer finance the riskier future, they only refinance the for the short time being safer past.

So there is no wonder EU is not doing well. And if Brexit helps to push for the reform that are needed, then Britain should be given an open invitation to return to it at its leisure.

PS. During the Washington conference I just could not refrain from asking what the French citizen did for 9 weeks while waiting for SOLVIT to come to his rescue.

PS. Lubomir Zaoralek the minister of foreign affairs of the Czech Republic in FT “Europe’s institutions must share the blame forBrexit” July 1. Hear hear!

Why does IMF never mention that credit-risk-weighted capital requirements for banks, is a potent inequality driver?

I refer to an IMF Staff-Discussion-Note titled “Causes and Consequences of Income Inequality: A Global Perspective”. It includes among other “Factors Driving Higher Income Inequality” the following:

“Financial globalization. Financial globalization can facilitate efficient international allocation of capital and promote international risk sharing. At the same time, increased financial flows, particularly foreign direct investment (FDI) and portfolio flows have been shown to increase income inequality in both advanced and emerging market economies… Financial deregulation and globalization have also been cited as factors underlying the increase in financial wealth, relative skill intensity, and wages in the finance industry, one of the fastest growing sectors in advanced.

Financial deepening. Financial deepening can provide households and firms with greater access to resources to meet their financial needs, such as saving for retirement, investing in education, capitalizing on business opportunities, and confronting shocks. Financial deepening accompanied by more inclusive financial systems can thus lower income inequality, while improving the allocation of resources… Theory, however, suggests that … inequality can increase as those with higher incomes and assets have a disproportionately larger share of access to finance, serving to further increase the skill premium, and potentially the return to capital.”

And again I must ask: Why does IMF insist on keeping mum on that huge financial inequality driver that is the risk-weighted capital requirements for banks?

Society lends bank much support, not only directly, by entrusting it with its deposits, but also indirectly, by offering deposit guarantees that if called upon will be paid by taxpayers.

And the Basel Committee thought it could make banks safer by making the capital requirements for banks to be dependent on perceptions of credit risk… while entirely ignoring that those perceptions of risk were already cleared for, by means of risk premiums and size of exposure.

And so, for instance with Basel II, regulators decided that banks were allowed to leverage the societal support over 60 times to 1 when lending to the AAArisktocracy, namely those rated AAA to AA, but only about 12 times to 1, when lending to unrated SMEs and entrepreneurs. That, which allows banks to earn much higher risk-adjusted returns on equity when lending to “The Safe”, blocks the opportunities of “the risky” to obtain fair access to bank credit. It therefore constitutes a huge driver of inequality.

And since the document refers to “Financial deregulation” I must also ask, for the umpteenth time…what financial deregulation? That where a small number of regulators redirect the allocation of bank credit all over the world… de facto imposing global capital controls? You’ve got to be kidding!

No! The Basel Committee is just a nest of irresponsible populist technocrats, who frankly have no idea of what they are doing. For instance they derive those capital requirements, that they themselves declare should be there to cover for unexpected losses, from the perceptions of expected losses. How loony is not that? Clearly the safer something is perceived, the bigger its potential to deliver truly disastrous unexpected losses.

I have often complained about these regulations on the IMF blog… you can Google it on “blog-imfdirect.imf.org Kurowski”. But I have never received an answer from IMF, seemingly the automatic solidarity among technocrats is very strong.

PS.That regulatory protectionism can both keep our banks safe and allocate credit well, is pure and unabridged technocratic populism

PS. My 2019 letter to the Financial Stability Board (FSB)

Greece was taken down by loony statist technocrats or by hard line communists, acting as bank regulators.

More than six years ago, in jest, but also in all seriousness, I set up a blog named AAA-bomb. In it I recounted the actions of “Carlos Molotov Pavlov, a central planner who to avenge his loss of a cushy job in the Soviet entered the bank regulatory system in Basel and managed to create, seed and detonate an AAA-bomb in the heart of the capitalist Empire”

Already in 1999 in a Op-Ed I had written: “The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause the collapse of our banks”.

The AAA-Bomb, which had been invented in 1988 with the Basel Accord, Basel I, and that had been further refined in 2004, Basel II, was the credit-risk-weighted capital requirements for banks.

While these required banks to hold 8 percent in capital when lending to any unrated SME in Europe, these allowed banks, in accordance to how Greece was then rated, to lend to the government of Greece against only 1.6 percent in capital. So banks could leverage their equity, and the support they received from taxpayers, over 60 times lending to Greece, compared to only about 12 times to 1 when lending to, for instance, a German or a Greek SME.

Implicitly those capital requirements meant that regulators believed government bureaucrats were capable of using bank credit more efficiently than the private sector.

And of course that had to mean sovereigns were going to become over-indebted… and Greece was just one of the AAA-bomb's first casualties.

PS. Citizens beware of the Basel Committee's bureaucrats/technocrats bearing gifts to government bureaucrats/technocrats.

PS. Reality was even worse since European Commission felt that the Greece sovereign, even though it could not print euros on its own and independent of credit ratings, should also be 0% risk weighted, which meant European banks could lend to Greece holding no capital (equity) at all. And then they left Greece to pay for all of that mistake.