How dumb can we allow our bank regulators to be?

The Financial Stability Board in its meeting on June 24, 2013 in Basel declared:

“Despite important progress in strengthening the resilience of the global financial system, some parts of the system remain in a state of incomplete repair. Some jurisdictions need to continue to improve the capitalisation of their banking systems.”

But, of course, not a word that it was them, and their chums at the Basel Committee who, with that mother of all bad inventions, namely the capital requirements for banks based on perceived risk, allowed the banks to explode their balance sheets on what was perceived as “absolutely safe” holding almost no capital; and completely ignoring the fact that all major bank crisis, no exclusions, have detonated because of excessive exposures to what was perceived as “absolutely safe”, but turned out not to be.

1.6 percent in capital, a 62.5 to 1 leverage when lending to Greece but 8 percent capital, five times less, a 12.5 to 1 leverage when lending to a German unrated entrepreneur. How dumb is one allowed to be?

These regulators should all be sent home… disgraced... and paraded with a dunce cap, a cone of shame, on their heads.

PS. This was written before I knew that EU authorities had assigned all eurozone sovereigns, including Greece, a 0% risk weight, which meant allowing infinite leverage.

PS. My letter to the Financial Stability Board

But when will Europe debate “Regulatory Abuse of Market Regulation”?

In Europe the European Parliament, and others related, are debating a “Market Abuse Regulation”. That is OK, though I must wonder about when they will begin debating “Regulatory Abuse of Market Regulation”?

Allowing banks to hold much less capital when lending to “The Infallible” than when lending to “The Risky”, as Basel II and III regulations do, allow banks to earn much higher expected risk-adjusted return on their equity when lending to the AAAristocracy than when lending for instance to small- and medium-sized enterprises… and that, as anyone should be able to understand, is as abusive to the market as can be!

Ask the regulators!

You tell me, is Mario Draghi being shameless, or is he just ignorant?

In a speech before the French National Assembly in Paris, 26 of June 2013, Mario Draghi, the President of the ECB, said:

“The ECB has been very active in responding to the crisis. We have robustly defended the stability of our monetary union and therefore of our money. And we stand ready to act again when needed.

However, it is important to acknowledge that there are limits to what monetary policy can achieve. This is not a question of the scope of our mandate. It is fundamentally about what different institutions are empowered to do.

One pertinent example is the current shortage of credit for many households and small- and medium-sized enterprises. Credit provision requires funding, capital and a positive risk assessment. The central bank can help ensure funding and address macroeconomic risk. But it cannot provide capital, nor can it affect banks’ assessment of the creditworthiness of individual borrowers.

Similarly, monetary policy cannot create real economic growth. If growth is stalling because the economy is not producing enough or because firms have lost competitiveness, this is beyond the power of the central bank to fix.”

And I repeat: “the current shortage of credit for many households and small- and medium-sized enterprises… The central bank … cannot provide capital, nor can it affect banks’ assessment of the creditworthiness of individual borrowers”

And this is the same Mario Draghi who for many years chaired the Financial Stability Board, that which fully endorsed the Basel bank regulations.

The central bank, though more precisely the regulators, do “not affect banks’ assessment of the creditworthiness of individual borrowers”, but, since they decide how much bank equity goes with each one of those assessments, they decide how much risk-adjusted return on equity banks should expect from each individual borrower. 

And since Basel regulations, allow banks to hold much less capital when lending to “The Infallible” than when lending to “The Risky”, the banks earn much higher expected risk-adjusted return on equity when lending to the AAAristocracy, than when lending to the “many households and small- and medium-sized enterprises”

And that constitutes precisely the fundamental cause for “the current shortage of bank credit to many households and small- and medium-sized enterprises”.

And that is so especially now, given the immense bank capital shortage that has resulted from for instance having allowed banks to lend to ("almost infallible") Greece holding only 1.6 percent in capital, something which implies a mindboggling allowed leverage of equity of 62.5 times to 1.

And so, you tell me, is Mario Draghi being shameless, or is he just ignorant?

Why, why, why? What is this Basel Committee bank regulation lunacy?

What if the Department of Education ordered that all teachers who were teaching those perceived as brighter should receive a substantial bonus, not payable to those teaching those perceived as less intelligent?

And I ask that because something like that it is precisely what the bank regulators of the Basel Committee do when they allow banks, doing normal banking business, to earn a much higher risk adjusted return on their equity when lending to “The Infallible”, like to the AAAristocracy, than when lending to “The Risky”, like to small businesses and entrepreneurs. Tell me what lunacy is this?

And I ask that because those regulations translates into “The Infallible” having even more access to bank credit at even lower interest rates, and “The Risky”, having even less access to bank credit at even higher rates.

And I ask that because no major bank crises ever has resulted from excessive exposures to “The Risky” they have all, no exceptions, resulted from excessive exposures to what was erroneously thought as belonging to “The Infallible”.

And I ask that, because our real economy did not get prosperous, nor did we get our jobs when young, by the banks lending solely to “The Infallible”. We need our banks to lend to “The Risky”, with reasoned audacity.

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?

G8, for the unemployed young ones sake, please wake up! We do not pray “God make us daring” for nothing.

G8, the world has not reached this far by avoiding taking risks. Current bank regulations which by allowing banks to hold much less equity against assets perceived as “absolutely safe” than against assets perceived as “risky”, allow banks to earn much higher expected risk-adjusted returns on equity when lending to The Infallible than when lending to The Risky. 

That has castrated our banks which makes it impossible for these to allocate economic resources efficiently in the real economy. That dooms our youth to unemployment. Never forget The Infallible of today were The Risky of yesterday.

That does not make our banks safer either, as it only guarantees that any absolutely safe-haven will, sooner or later, become dangerously overpopulated, and then catch our banks with their pants down, meaning with no capital. Just consider how Basel II did Europe in.

G8, please wake up and throw away current bank regulations issued by the Basel Committee. We do not pray “God make us daring” for nothing.

If only Basel Committees’ bank regulations applied to the World Bank.

Then perhaps it would have been easier for the World Bank to understand how flawed these bank regulations, which are basically being imposed on the whole world, really are. 

Can you imagine the Executive Directors having to discuss that one way of reaching capital sufficiency for the bank, so as to satisfy regulators, is to lend more to those countries perceived as ‘infallible” and lend less to those countries perceived as “risky”, because the latter requires the bank to hold much more capital as a percentage… and this even though the “risky”, precisely because they are perceived as “risky”, already receive much smaller loans under much more demanding terms? 

Risk-taking is the oxygen of all development, and the “risky” are usually the actors in the real economy who, living on its margins, most need access to bank credit. In fact no country has been able to develop by means of regulations which would favor “The Infallible, those already favored by banks and markets, and thereby odiously discriminating against “The Risky” those already discriminated by banks and markets. 

And not only that, since no major bank crisis has ever resulted from excessive exposures to "The Risky" but always from excessive exposures to who were wrongly thought as being “The Infallible, the whole regulatory exercise is completely useless. 

That the world’s premier development bank, and which I as a former executive director have learned to admire in so many ways, has not been able to stand up to regulators and speak out in the name of risk-taking and in the name of “The Risky”, is a terrible disappointment to me. 

Much as a result of its silence, regulators around the world are now castrating the banks, making these completely useless in terms of performing their vital social function of allocating financial resources efficiently. 

Also much as a result of its silence, banks around the world are dangerously overpopulating whatever is perceived as a “safe-haven” 

And much as a result of its silence, youth all around the world are suffering from the lack of jobs which have resulted from banks not lending to small, mediums and large businesses and entrepreneurs who do not possess top credit ratings in equitable terms. 

Perhaps the World Bank would benefit from the recommendation Katie Couric says she once received, namely that "A boat is always safe in the harbor, but that's not what boats are built for."

PS. Some in the World Bank are perfectly aware of how much, during my two brief years as an ED, I warned about the crisis that was doomed to happen. And yet, these meek do not dare to officially invite me to the World Bank to expose to a wider audience the fundaments of my criticisms against the pillar, the pride and the joy of the Basel Committee, the risk-weighted capital requirements. 

Davis Polk quite faulty analysis of the Brown-Vitter Bill

Davis Polk when analyzing the Brown-Vitter Bill evidences that they, like most discussants of the issue, have not yet understood the very dangerous implications for the banking system which results from risk-weighing bank assets so as to determine their specific capital requirements for banks. With respect to this they write the following: 

“The Brown-Vitter leverage ratio is too blunt an instrument for prudential financial regulation because it is not capable of distinguishing between risky and non-risky assets, and could result in two banks with vastly different risk profiles holding exactly the same amount of capital. 

By making a leverage ratio the centerpiece of its capital framework, the Brown-Vitter bill represents a deliberate departure from the risk-based capital framework, notwithstanding the fact that the risk-based approach has been endorsed and adopted by all major economies around the world."

Let me explain a couple of real street life facts to these lawyers who have so clearly been captured by some desk illusions. If they then need more they can always go to my blog or call me. 

The perceived risks which are considered for setting the risk-weights are already cleared for by the banks on the assets side of the balance sheet, by means of interest rates (risk-premiums) amount of exposure and other terms. So therefore, forcing the banks to clear for the same perceived risks on the other side of the balance sheet, in their equity, only guarantees banks will overdose on perceived risks. 

When banks are able to hold less equity for “safe” asset than for the “risky” that translates directly into the expected risk adjusted return on bank equity on assets perceived as safe will be much higher than the same expected risk adjusted return on equity on assets perceived as “risky”, something which obviously introduces huge distortions and which make it impossible for the banks to perform their vital social function of allocating resources as efficiently as possible in the economy. 

The following question could also help to shed some light on this issue: “Do you approve that those who by being perceived as “The Infallible” are already much favored, should be additionally favored by the banks, and that those who by being perceived as “The Risky” are already discriminated against, should be additionally discriminated against by the banks?” Davis Polk, how do you think US Congressmen, in “the land of the brave” would respond to that? 

Davis Polk writes: 

“The inherent disadvantage of a leverage ratio such as the one in the Brown-Vitter bill is its inability to distinguish between risky and non-risky assets. Imagine two banks with exactly the same amount of tangible common equity and exactly the same amount of total assets. Bank A’s assets primarily consist of U.S. Treasury bonds backed by the full faith and credit of the U.S. government. Bank B’s assets primarily consist of the junior tranches of commercial real estate securitizations and equity exposures. 

The two banks would have exactly the same leverage ratio under the Brown-Vitter bill, notwithstanding their entirely different risk profiles. In contrast, under a risk-based capital framework, Bank B’s risk-based capital ratio would be lower than Bank A’s risk-based capital ratio, reflecting Bank B’s riskier balance sheet” 

And my question to Davis Polk would be: How do you know for sure Bank B is riskier than Bank A? What if Bank A held some long term U.S Treasury bonds and interest rates increased? Is not the US Government's strength a direct result of the audacity of its risk-taking citizens? 

Davis Polk also writes: 

“The Brown-Vitter rose-colored glasses view of U.S. banking history in the 19th century is contradicted by the facts” 

Well, Davis Polk, if you were to go to history then you would see that all major bank crisis have always been detonated by excessive exposures to what was ex-ante perceived as belonging to “The Infallible”, but turned out ex-post not to be, and never ever by excessive bank exposures to what ex-ante was perceived as part of “The Risky”. And just look at the current crisis… all bank assets that have created problems were those for which regulators allowed low capital requirements. And not a single of all bank exposure to “The Risky” has caused a capital insufficiency to appear. 

No, you in Davis Polk, instead of admiring so much what the Basel Committee has been up to, should really start to question their lack of wisdom. 

In November 1999, in an Op-Ed I wrote “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 its collapse” 

And that is precisely what the Basel Committee did when it concocted the risk-weighted capital requirements, and no one questioned it sufficiently on it. Davis Polk, after the 2007-08 shock are you going to help the regulators to set us up for the next one? If we let them it seems it can only get worse, since now with Basel III they also want to add liquidity requirements based fundamentally on the same perceived risks. 

Davis Polk. I know you are lawyers… but do you really believe the US became what it is by having the banks avoiding risks? If the banks do not help society to take the risk it needs for the real economy to move forward, and to create the next generation of jobs our kids and grandchildren will need... who is going to do that? You and me? 

PS. Does this mean that I agree with the entire Brown-Vitter bill and with nothing of what Davis Polk states? Of course not! For instance I believe that capital requirements between 8 and 10 would suffice if we got rid of all of risk weighting? And I also think much thought should be given to how to help banks raise equity fast, so as to get over that problem and not allowing it to be a drag on the economy for years.

PS. Oh I forgot to mention the fact that minuscule capital requirements, resulting from minuscule risk-weights, are the best growth hormones ever for the too-big-to-fail banks.

The Basel Committee violates democracy

Imagine that in the parliament of any European country (or in the US Congress) supposedly to make banks safer, someone proposes the following: 

To allow banks to hold far less capital when lending to "The Infallible" than when lending to “The Risky”; so that they earn a return on equity far higher when they lend to "The Infallible" that when they lend to "The Risky"; so that they lend to "The Infallible" and refrain from lending to "The Risky". 

And then, in the discussion of such a proposal, it is concluded that this would mean that those being perceived as "The Infallible" and who already pay less interest, and who already have more access to credit when compared with that of "The Risky", shall have even more generous access to bank credit. 

And so therefore this would also mean that those being perceived as "The Risky" and who already pay much higher interest, and who already have a much more restricted access to credit when compared with that of "The Infallible", will suffer even more adversities accessing bank credit. 

And in the debate, when asked about who "The Infallible", those favored are, and who "The Risky", those to be so obnoxiously discriminates are, the response is: "The Infallible" are primarily good governments and private borrowers who have a triple-A credit rating, and "The Risky" are primarily all those small, medium and large businesses and entrepreneurs who do not have a credit rating issued by one of the three major rating agencies. 

What possibilities do you believe the previous proposal has to be approved? 

None! They would throw it out faster than fast, and surely its proponent would have to wave goodbye to his political career, as he would be the laughing-stock of the year. 

And especially so when in the discussions it appears that no banking crisis in history has resulted from excessive lending to "The Risky", as these have all resulted from excessive lending to who were considered members of “The Infallible", but were not. 

And especially so when you hear the question: "If banks will not finance " The Risky", those who perhaps most can generate the new sources of employments our youth craves for and needs ... who the hell will finance then? You and me?” 

And especially so when you hear the opinion: "The signaling of some bureaucrats intervening the signals of the market, sounds to me a recipe for making banking much more insecure than it currently is". 

But the sad fact is that these banking regulations exist and are called Basel II and are already applied throughout Europe. 

According to Basel II, a Spanish bank, for example, must maintain 8 percent in capital when lending to a "risky" Spanish businessman, but was required to hold only 1.6 percent in capital when lending to Greece, or even zero capital when lending to its own government, or for example to the government of Germany. 

And therefore citizens, I suggest you find out where on earth did the Basel Committee get the authority to impose something of such fundamental importance, something which all your respective parliaments would never have approved of. It seems to me that it completely violates the procedures of a democracy.

El Universal

The Shadow Financial Regulatory Committee seems composed by besserwissers who do not know what they are talking about

The Shadow Financial Regulatory Committee, a group of academic critics of federal financial regulatory policies met on December 10, 2012, and elaborated on its critique of Dodd-Frank as “not accounting properly for the risks and costs of the programs and for reinforcing incentives to engage in risky activity that increases the risk of future bailouts”.

These besserwissers have no idea of what they are talking about. The current incentives, much lower capital requirements for banks when lending to "The Infallible" than when lending to "The Risky" are all aligned towards making the banks engage in what is perceived as absolutely safe activities… and which of course, by handing out incentives that will sooner or later lead to a dangerous overpopulation of the safe-havens, increases dramatically the risk of future bailouts. 

Now they have a meeting on May 13, 2013, and I sure hope and pray, they have learnt something in the interim.

Professor Alan S Blinder. If you listen carefully enough, you will notice the music hasn´t stopped.

Professor Alan S. Blinder in his book “After the music stopped” 2013, discusses the origins of the recent bank crisis. In it he lists as “the malevolent seven” the following factors as the villains that conspired to create the recent financial crisis. (Page 28)

1. inflated asset prices, especially of houses but also of certain securities; 

2. excessive leverage throughout the financial system and the economy; 

3. lax financial regulation both in terms of what was left unregulated and how poorly the various regulators performed their duties; 

4. disgraceful banking practices in subprime and other mortgage lending; 

5. the crazy-quilt of unregulated securities and derivatives that were built on these bad mortgages; 

6. The abysmal performance of the statistical rating agencies, which helped the crazy-quilt get stitch together; and 

7. the perverse compensation system in many financial institutions that created powerful incentives to go for broke. 

These are no doubt malevolent villains, but Professor Blinder misses what really helped to insufflate so much life into these: 

In chapter 10 Professor Blinder writes: “A bank that earns1 percent profit on assets will earn a 15 percent return in capital, if it is leveraged 15 to 1. But if its leverage drops to 10 to 1, that same 1 percent return on asset will translate to only a 10 percent return on capital. If a bank is forced to hold larger volumes of highly liquid assets like Treasury bills, its average return on assets will decline. This is just arithmetic.” 

That is indeed correct arithmetic, but, unfortunately, as currently regulated, it does not apply to banking. This is so because regulators have imposed a system of different capital requirements based on “perceived risk”, and mostly as perceived by the credit rating agencies. 

These capital requirements allow banks to hold much lower capital against exposures to what is perceived as “absolutely safe” than for exposures perceived as “risky”. Just as an example, a German bank, to which after June 2004 Basel II applied, needed, and needs, to hold 8 percent in capital when lending to for instance a small German business, signifying a leverage of 12.5 to 1, but if buying a triple A rated security, like those collateralized by lousy awarded mortgages to the subprime sector, then it only needed, and needs, to hold 1.6 percent in capital, signifying a mindboggling authorized leverage of 62.5 to 1. Fifty times more! 

In fact the advantages that these capital requirements gave anything officially perceived as “safe” suddenly signified that the expected risk-adjusted returns on equity when lending to The Infallible became much larger than when lending to The Risky. 

That the US had not yet fully implemented Basel II is somewhat irrelevant. The US had committed to do so, and in fact SEC in April of 2004 had already approved that these capital requirements were going to apply for the investment banks they supervised. 

As Professor Blinder should be able to understand this senseless regulations introduced huge distortions into the banking system. Since those distortions are far from over, and could in fact become even worse with the introduction of liquidity requirements which are also much based on perceived risk, he might also understand that in reality, the very bad music, hasn’t stopped. 

“Did Bear Sterns, Lehman Brothers and AIG founder over insolvency or illiquidity?” asks Professor Blinder. He advances that is “Not easy to answer”. I have no doubt though. It was an insolvency which resulted from bad incentives and which led banks to dangerously overpopulate safe-havens. 

AIG, as an example, would not have been able to sell a fraction of the credit default swaps they sold had it not been for the fact that since AIG was rated AAA, the purchase of such a CDS immediately allowed the banks to reduce the capital they needed to hold against the exposure being insured.

Are bank regulators violating the human rights of the next generations?

The current capital requirements for banks in Basel II, which are based on perceived risks already previously cleared for, are immensely lower for exposures to “The Infallible”, like to some favored sovereigns and the AAA rated, than for exposures to “The Risky”, like to small and medium businesses and entrepreneurs. And therefore, banks earn immensely more expected risk-adjusted returns on equity when lending to “The Infallible”, than when lending to “The Risky”. 

And that in essence means that banks are following lending and investment objectives much more suitable to retiring baby-boomers, those who adore safety and cash liquid values, than those of the many young, who need much more daring long-term risk-taking... in order to stand a chance to find a job...during their lifetime. 

And nobody even wants to discuss that distortion, not even the World Bank, the world´s premier development bank. 

And as a result, the gap between the haves, the old, the history, the developed, “The Infallible” and the have-nots, the young, the future, the not developed, “The Risky”, is also increasing. 

Damn those aprės nous le déluge regulators. They castrated our banks and made these abandon our young ones. With what authority do they think they can do a thing like that? 

And, forgive me for asking, but is not a discrimination against the needs of the next generations, in all essence some sort of violation of human rights? And of course one thing is for the regulators to do so unwittingly... but persisting in it even after someone has explained it to them?

Should we not haul the Basel Committee and Financial Stability Board in front of the International Criminal Court in Hague, so as to at least demand the immediate suspension of this odious regulatory policy?

An American approach to banking

Regarding your April 29 Washington Post editorial “A diet for the big banks”:

It suffices to remember the saying about “a banker being that chap who lends you the umbrella when the sun shines but wants it back as soon as it looks like it is going to rain” to know that those assets perceived as safe are already much favored over those perceived as risky. The risk weights applied by the Basel III regulations and based on exactly those same perceived risks only increase the gap between “The Infallible” and “The Risky.”

And that is why I very much salute the bill by Sens. Sherrod Brown (D-Ohio) and David Vitter (R-La.) that looks to “require more capital and better capital but also limit the ‘risk-weighting’ of assets.” More capital is a perfectly legitimate requirement, but the imposition of risk weights is fundamentally incompatible with “a land of the brave.” The United States did not become what it is by avoiding risks.

That the bill puts the United States at odds with Basel III regulations does not matter, as those regulations have been proven harmful enough. On the contrary, Europe would also do better with a Brown-Vitter proposal.

Per Kurowski, Rockville

The writer was an executive director of the World Bank from 2002 to 2004.

Ps. A recent comment to the Financial Stability Board

Here other of my letters in the Washington Post on this issue:
June 20, 2008: An Aspect of the Bubble
December 27, 2009: Another 'worst': Faulty bank regulation

January 6, 2012: Handcuffed by a triple-A rating
December 23, 2014: Let the market rule on risky trades
November 11, 2015: Reverse-mortgaging the future
August 9, 2016: Banks, regulators and risk
April 16, 2017: When banks play it too safe 

July 11, 2018: There is another tariff war that is being dangerously ignored. 

December 30, 2018: Affordable homes or investment assets?

REVISED “The Bankers´ New Clothes”, by Anat Admati and Martin Hellwig, is a very good, and therefore [not] a dangerous book

Anat Admati and Martin Hellwig in their “The Bankers´ New Clothes” write the following about risk-weighted assets: 

“The risk-weighting approach gives the impression of being scientific”. 

“The risk-weighting approach is extremely complex and has many unintended consequences that harm the financial system. It allows banks to reduce their equity by concentrating on investments that the regulations treats as safe.” 

“The official approach to the regulation of bank equity, enshrined in the different Basel agreements is unsatisfactory… the complex attempts in this regulation to fine tune-equity requirements – for example, by relying on risk measurements and weights- are deeply flawed and create many distortions, among them a bias against traditional business lending.” 

And yet the authors when then writing “Whatever the merits of stating equity requirements relative risk-weighted assets may be in theory”, evidence they cannot or dare not free themselves entirely from believing there is something valuable in risk-weighting.

But no! There are no merits to risk-weighting, even in theory. It is just a big dumb regulatory mistake! Clearing in the capital requirements for perceived risks already cleared for on the assets side with risk premiums, amounts of exposure and other terms, just dooms banks to overdose on perceived risks, like those expressed in credit ratings, and at the same time effectively hinders the banks from performing an effective resource allocation which is so important for the society. 

The authors write “The idea behind risk-weighting is that if the assets banks hold are less risky, less equity may be needed for a bank to absorb potential losses”. What regulatory lunacy is that? If banks believe they hold less risky assets they will hold these at much lower risk-premiums, for much larger amounts, and on much more generous terms. Come on, does that sound like something which could merit banks holding less capital?

And because of their lingering doubts, what Anat Admati and Martin Hellwig propose in their book, is not so much the need of eliminating the distortion of the risk-weights, but the need for more capital. And that is why, especially as I considered it a very good book, and it includes so much of what I have argued over the last decade, I must also call it a very dangerous book.

Let me explain: If the capital requirements for a bank were zero, then risk-weights would not discriminate nor distort. It is the higher the capital requirements are, than the larger will the discrimination and the distortion the risk-weights produce. 

The authors argue: “Requiring that bank’s equity be at least on the order of 20-30 percent of their total assets would make the financial system substantially safer and healthier” Can you imagine what distortions that would cause if something like the current risk-weights are kept? 

No! and especially since I look at the banks not as separate entities in Mars, but a part of the real economy on Earth, I bet that a Basel II, 8 percent capital requirement that came with absolutely no risk-weighting, would make the financial system and the real economy substantially safer and healthier, and sturdier, than a 20-30 percent capital where regulators remain thinking of themselves as risk-managers of the world. 

And here is a previous comment on the same book

DISCLAIMER: I have just exchanged opinions with Anat Admati and she holds that contrary to what I interpreted the book makes clear that they completely oppose the pillar of Basel bank regulations, namely risk-weighted capital requirements based on perceived risk. Great! I wonder where this now leaves the Basel Committee and the Financial Stability Board, as risk-weighting is their Pillar, pride and joy.

Clearly this is a big support for the bank bill being introduced by Senators Sherrod Brown, Democrat of Ohio, and David Vitter, Republican of Louisiana. Go Brown-Vitter! Screw Basel! Enough is enough!

Its what’s safe that’s risky!

Matt Taibbi and other Libor-Scandal exploiters, distracts us from correcting a much worse interest rate manipulation.

The regulators, for absolutely no reason at all, allowed banks to hold immensely less capital when lending to the “infallible”, among these some sovereigns and the AAA rated, than when lending to the “risky”, among these the small and medium businesses and entrepreneurs. 

That completely distorted the access of the real economy to bank credit, as well as the most important reference rate, the borrowing rates of the most solid sovereigns, usually the proxy for the risk-free rates. 

And that has signified an enormous tax, paid directly by all those bank borrowers perceived as “risky”, and indirectly by the society, by means of the many lost economic growth and job creation opportunities. 

For me the real cost of the society of that regulatory manipulation of bank capital, could be about a million times higher than all the costs for the society produced by the Libor rate manipulation 

I explain: one day the quoted Libor could be somewhat higher than its true rate, and on that day, Libor based borrowers would pay somewhat more, and investors earn somewhat more; other days the quoted Libor could be somewhat lower than its true value and the opposite would hold. But, in the long run, not much distortion was created and very few were really harmed. 

I certainly do not condone any Libor rate manipulation and those guilty of it should be punished with prison sentences which requires them having to pay for their own prison costs, but I do object to Matt Taibbi and other’s so scandalous agenda driven attacks on "Gangster Bankers", because that only distracts us from correcting a much worse interest rate manipulation.

PS. Matt Taibbi quotes MIT professor Andrew Lo saying that the Libor Scandal “dwarfs by orders of magnitude any financial scam in the history of markets.” If it is true he said that, then this professor has no idea of what he is talking about. If Professor Andrew Lo were to accept to debate the issue, he might do himself a favor by looking at the following material for a small quiz.

PS. Below two comments on Matt Taibbi’s article which I posted on the RollingStone web. 

1. Anyone capable of explaining the payoff in “The Biggest Price-Fixing Scandal Ever” being some “sushi rolls from yesterday”? 

2. The Libor Manipulation Scandal started because of the reporting of Libor rates which were lower than what they should have been... not higher... and so all borrowers who were on a Libor plus spread basis had to pay banks less interests. Can someone explain the irony of that?

Two facts on Basel I, II and III

The first fact is that since banks are allowed to hold less capital, and therefore to leverage the risk-adjusted margins more on their capital, and therefore to obtain much higher expected returns on equity when lending to what is perceived as “safe” than when lending to what is perceived as “risky”, current regulations are completely distorting our financial system. 

That has caused banks to create excessive exposures to what was erroneously perceived as risky, like in AAA rated securities, Greece, real estate, and to refrain from lending to those in the real economy perceived as “risky”, like small businesses and entrepreneurs. 

The second fact is that the first fact is not even mentioned, much less discussed. 

CFA, revoke any certification given to anyone in the Basel Committee or the Financial Stability Board.

If a certified financial advisor was offering the same advice to a wealthy retiree and to a poor young professional, he would have his CFA certification immediately revoked. 

Yet that is exactly what all in the Basel Committee and the Financial Stability Board are doing when regulating our banks and primarily serving the interest of soon retiring baby-boomers’ Après moi le déluge philosophy.

They require all our banks to act in the same way, concentrating on lending to what is perceived or decreed as “absolutely safe”, like lending to its sovereign or financing residential mortgages, while avoiding all of what is perceived as “risky”, like the lending to small and medium businesses and entrepreneurs.

If bank regulators cannot refrain themselves from meddling, why do they not at least meddle in a more useful way?

Current capital requirements of the banks are based on the information provided in credit ratings, something that makes no sense because bankers and markets have already seen that information and considered it when they set their interest rates, decide how much to lend or invest, and under what terms. 

Therefore I often ask: “Bank regulators why do you use credit ratings in your capital requirements and not something like job creation potential ratings, or environmentally friendly ratings?” 

I am sure that if banks were allowed to hold a bit less capital... and therefore be allowed to leverage their equity more... and therefore be able to obtain a higher risk-adjusted return on equity… whenever lending or investing in something especially good from a job creation or sustainability point of view, then the banks would be performing better for the whole society. 

As is, the banks are only performing better for those who possess good credit ratings, for “The Infallible” leaving all “The Risky” out in the cold.

Other unanswered questions

Questions on bank regulations which experts are not answering... or even discussing

If all bank crisis in history have resulted from excessive exposures to what was perceived as “absolutely safe”, or at least very safe, and none ever, from excessive exposures to what was perceived as "risky"… what is the rationale behind the pillar of current Basel regulations, namely capital requirements for banks which are much lower for what is perceived as "absolutely safe", or at least very safe, than those for what is perceived as “risky”? Does not all empirical evidence suggest instead that the capital requirements should be slightly higher for what is perceived as "absolutely safe" than for what is perceived as "risky"? 

Since perceived risk is already cleared for by banks on the asset side of the balance sheet, by means of interest rates, amount of exposure and other terms, why did the Basel Committee for banking supervision decided banks needed to clear for the same perceived risk, in the liabilities and equity side of their balance sheet, by means of risk-weighted capital requirements? Does this not doom banks to overdose on perceived risk?

Current capital requirements, allow banks to earn a much higher risk-adjusted return on equity when lending to what is “absolutely safe”, “The “Infallible”, and so banks avoid lending to “The Risky”. But since “The Risky” includes for example small businesses and entrepreneurs, and whose access to credit is absolutely indispensable for the real economy to move forward, who is then supposed to finance what is “risky”? Bureaucrats or citizens? Is not taking smart risks on behalf of the society exactly what bankers are supposed to do?

Bank regulations that so much favor “The Infallible”, those already favored by bankers and markets, and so much discriminates against “The Risky”, those already sufficiently disfavored by bankers and markets, can only lead to increase the gap between the haves, the rich, the history, the old, the developed, and the have-nots, the poor, the future, the young, the undeveloped. Is that what you want?

Please, if you are able to extract an answer from the experts that is reasonable, send me a copy of it to

perkurowski@gmail.com

PS. If bank regulators must meddle, why do they not meddle in a more useful way?

IMF’s “Rethinking Macro Policy II was a great conference, though My Question, again, went unanswered.

Very thankful for the invitation I attended IMF’s “Rethinking Macro Policy II” conference, April 16 and 17, and in which there was a special session on financial regulations. 

There were many good presentations and discussions and if I absolutely must pick one as the best that must be the one on financial cycles presented by Claudio Borio who currently is the Research Director and Deputy Head of the Monetary and Economic Department at the Bank for International Settlements (BIS). 

And as I usually have done over the last six years when attending conferences like these, I asked as many experts as possible:

My Question: 

If all bank crisis in history have resulted from excessive exposures to what was perceived as “absolutely safe”, or at least very safe, and none ever from excessive exposures to what was perceived as "risky"… what is the rationale behind the pillar of current Basel regulations, namely capital requirements for banks which are much lower for what is perceived as "absolutely safe", or at least very safe, than those for what is perceived as “risky”? Does not all empirical evidence suggest instead that the capital requirements should be slightly higher for what is perceived as "absolutely safe" than for what is perceived as "risky"?

As to the answers, as usual, some were intrigued, others stuttered, and many replied “Oh I know there is a clear explanation for the current capital requirements, I just can't remember right now what it was”.

And though I try to avoid asking those I know I have asked before, like Martin Wolf and Lord Turner, I found one participant who answered: “Yes, you asked me that 3 years ago and I have not been able to figure it out yet either”. 

By the way, have a look at a letter which asks a related question, and that I am trying to deliver to as many Ministers as possible during these World Bank and IMF Spring Meetings in Washington, April 19-20 

Please, anyone reading this post and possessing an answer to my Question, I would much appreciate sending it to me at perkurowski@gmail.com

PS. In the conference I met someone who like me knows there is no rational answer.

PS. Here is a more extensive list of the horrendous mistakes of the risk weighted capital requirements