US, it is not easy to remain “the land of the brave”, with castrated banks singing in falsetto

I came late to DAVID A. STOCKMAN´s Sundown in America, in the New York Times, “State-Wrecked: The Corruption of Capitalism in America” March 30, comments were closed. 

But this is what I would have commented, again, for the umpteenth time. 

America, be careful you do not turn into “the land of the pusillanimous”…since that is where you are heading with current bank regulations.

The day when bank regulators came up with, or accepted, the idea that banks could hold less capital against what was perceived as “absolutely not risky”, than against what was perceived as “risky”, even though those perceptions were already being cleared for by means of interest rates, size of exposures and other contractual terms, that day they castrated the banks. 

And friends, it is not easy to remain “the land of the brave” with your banks singing in falsetto.

http://subprimeregulations.blogspot.com/2013/03/there-is-plentiful-of-vested-interest.html

Basel Committee, Financial Stability Board, please do not make fun of us, or bullshit yourselves

Here is a document, which in 2005 explains why bank regulators like Mario Draghi, Lord Turner, Alan Greenspan, Mark Carney, Stefan Ingves, Michel Barnier and many other, and commentators like Martin Wolf, decided to give their full backing, in 2004, to Basel II capital requirements based on perceived risk.

It says: “This paper purely focuses on explaining the Basel II risk weight formulas in a non-technical way by describing the economic foundations as well as the underlying mathematical model and its input parameters”… and so unfortunately “By its very nature this means that this document cannot describe the full depth of the Basel Committee’s thinking as it developed the IRB framework”… but luckily for us “For further, more technical reading, references to background papers are provided.” 

Is someone trying to make fun of us? 

The document details: 

“The model should be portfolio invariant, i.e. the capital required for any given loan should only depend on the risk of that loan and must not depend on the portfolio it is added to. This characteristic has been deemed vital in order to make the new IRB framework applicable to a wider range of countries and institutions. 

Taking into account the actual portfolio composition when determining capital for each loan - as is done in more advanced credit portfolio models - would have been a too complex task for most banks and supervisors alike. The desire for portfolio invariance, however, makes recognition of institution-specific diversification effects within the framework difficult: diversification effects would depend on how well a new loan fits into an existing portfolio. 

As a result the Revised Framework was calibrated to well diversified banks. Where a bank deviates from this ideal it is expected to address this under Pillar 2 of the framework. If a bank failed at this, supervisors would have to take action under the supervisory review process (pillar 2).” 

And so that means to tell us our and all other bank supervisors around the globe who have adopted Basel II are up to this? 

Bullshit!

PS. Who wrote it?

PS. Please help me ask the question that debunks all this Basel II nonsense.

There is plentiful of vested interest in hiding a major bank regulatory stupidity.

In my country Venezuela, during many decades, the interest rate charged by banks was fixed by the government, and was the same for all borrowers, independently of the risk that each one of them was perceived to represent. Under such circumstances, a system of capital requirements for banks based on perceived risks, more-risk-more-capital less-risk-less-capital, makes sense. 

But, when banks already clear for perceived risks, by means of interest rates, amounts of exposure and other contractual terms, then re-clearing for the same perception in the capital requirements, makes absolutely no sense. 

And yet capital requirements based on perceived risks, is the pillar of the Basel Committee’s bank regulations. How on earth could this have happened? Why was, and is, this never questioned? 

The unhappy Barings’ Bank trader Nick Leeson writes in his memoirs: “And they never dared ask me any basic questions, since they were afraid of looking stupid about not understanding futures and options.” And if we add that most or perhaps all of the discussion on bank regulations take place in a mutual admiration club, where one does not harshly question colleagues, do I need to explain more? 

The current capital requirements for banks allow banks to earn immensely higher expected risk adjusted returns on equity when lending to “The Infallible” than when lending to “The Risky” and this creates a distortion that makes it impossible for banks to allocate economic resources efficiently. 

It dooms the banks to end up, sooner or later, with extremely high exposures to something wrongly perceived as safe and little capital to back it up with. Like in AAA rated securities backed with lousily awarded mortgages or in loans to Greece. 

It also dooms those actors within the real economy who are perceived as “risky”, like small businesses and entrepreneurs, to have less and more expensive access to bank credit. 

On the web site of Nick Leeson we find the question: “How could one trader bring down the Barings banking empire that had funded the Napoleonic Wars?”

And we could just the same ask: How could an idea so stupid it will bring down all the economies of the Western World find approval among experts? 

Well think about all banks regulators, all academicians, all ministry of finance bureaucrats, all central bankers, all finance journalists, all “financial crisis 2007-08 experts” and so many more who have not said a word questioning these loony capital requirements, and you will understand that there is huge amount of vested interest in banding together to silence this most embarrassing truth. 

But, the truth needs to come out, and the responsible need to be held accountable, so as to help us out of the current crisis, and so to make it less possible that a small group of expert global regulators will again be allowed to mess it all up this much. 

How can we help? Easy, ask any potential silencer to explain to you the rationale behind capital requirements, beyond what that fuzzy “more-risk-more-capital less-risk-less-capital, it sounds logical” provides. 

If he can’t, then tell him “So I should assume you do not understand it? ... And send me his name. 

If you would ever get an answer that makes sense, please send it to me, and if correct, I would as they say, have to eat my hat and much humble pie.

Basel Committee, stop giving our banks your capital requirements suppositories.

Banks, before the Basel era, cleared for perceived risk, that which for instance is to be found in credit ratings, by taking caplets containing the interest rate (risk-premiums), the size of the exposure and other contractual terms. 

But Basel II, and now Basel III, ordered the banks to also clear for exactly the same perceived risk, credit ratings, by means of a suppositories containing capital requirements, more risk more capital, less risk less capital. 

That double dosage against “perceived risk” allow banks to leverage many times more their equity when lending to what is perceived as “safe” than when lending to what is perceived as “risky”, and that allows the banks a much higher expected risk-adjusted return on equity when lending to “The Infallible” than when lending to “The Risky”. 

And that distorts and makes it impossible for banks to allocate economic resources efficiently. 

Mr. Irving Fisher, could you please explain the rationale behind Basel's capital requirements for banks, to us “The Risky”?

Mr Irving Fisher.

On March 13 you gave a speech titled “Ending too-big-to-fail”. 

In it you said “I am here today to speak of the plight of hardworking Main Street bankers who simply want to be given a level playing field and fair treatment in competing with megabanks”. And you then frequently and correctly mention all the subsidies of TBTF banks paid through the implicit government guarantees. 

It is a great speech, nothing wrong with it, BUT, when is someone of your caliber to stand up and equally ask for a level playing field and fair treatment of all those bank borrowers perceived as “risky”. 

“The Risky” they know and accept they have to pay higher interest rates, get smaller loans, and be subject to harsher contractual terms, “that’s life”. But why on earth should they have to pay even higher interest rates, and get even smaller loans just because some regulators decide to impose on banks, capital requirements which are also based on the same perceived risk. 

That allows the banks to hold much less capital when lending to “The Infallible” than when lending to “The Risky”. 

And that allows the banks to leverage the risk-adjusted-margins many times more when lending to “The Infallible” than when lending to “The Risky”. 

And that allows the banks to earn much higher expected risk adjusted returns on their equity when lending to “The Infallible” than when lending to “The Risky”. 

And that forces “The Risky” to compensate the banks additionally. And that is not a level playing field or a fair treatment 

And these very low capital requirements associated with anything dressed up as “safe” also constitute one really potent growth hormone for the TBTF banks. 

Mr. Fisher you said “Regulators cannot enforce rules that are not easily understood” 

Recently Floyd Norris, in “Masked by Gibberish, the Risks Run Amok” March 21, quoted the following from the unhappy Barings trader Nick Leeson´s memoirs: “And they never dared ask me any basic questions, since they were afraid of looking stupid about not understanding futures and options.” 

And that is precisely what I think happened with the capital requirements for banks, once these had been accidentally concocted, all regulators were afraid of looking stupid about not understanding these, and kept silence… and, this really unforgivable, they are still silent about it

And so Mr. Irving Fisher, on behalf of all those medium and small businesses and entrepreneurs, discriminated against twice by the fact they are perceived as "risky", if you have understood it, please explain to us the rationale behind those capital requirements for banks. 

I mean since “The Risky” have never ever caused a major bank crisis, only “The Infallible” who turn out risky do that, one could even make a case for higher bank capital requirement for banks when lending to “The Infallible” than when lending to us “The Risky”. 

And by the way Mr. Fisher, I also believe that giving “The Risky“ a level playing field and fair treatment, is the best way, by helping their clients, to help those hardworking Main Street bankers.

Sincerely,

Per Kurowski

Dear finance professors of the world, can you please help me?

Before the Basel Committee regulations’ era, banks cleared for (ex-ante) perceived risk, that information which for instance is to be found in credit ratings, by means of interest rate (risk-premiums), the size of the exposure, and other contractual terms; let us call that “in the numerator”. 

But Basel II, and now Basel III, instruct the banks to also clear, I would call it re-clear, for exactly the same (ex-ante risk) perceived risk, credit ratings, “in the denominator”, by means of different capital requirements, more risk more capital, less risk less capital. 

That is just plain crazy. Allowing banks to leverage many times more when lending to what is perceived as “safe” than when lending to what is perceived as “risky”, allows the banks a much higher expected risk-adjusted return on equity when lending to “The Infallible” than when lending to “The Risky”. That distorts and makes it impossible for banks to allocate resources efficiently.

Recently Anat Admati and Martin Hellwig published an excellent “The Bankers’ New Clothes” 2013, though I think “The Regulators’ New Clothes” would have been a better title. But, in one passage they write “Whatever merits of stating equity requirements relative to risk-weighted assets may be in theory, in practice…” 

And, dear finance professors, my problem is that I have not been able to find anything yet that I would include within the “Whatever merits”. 

Besides the so fuzzy “more risk more capital, less risk less capital, it sounds logical”, do you have any idea why the regulators did that? If not, can you help me asking around? 

I mean, it is no minor thing that our whole banking system seems to be driven by a loony double consideration of perceived risks.

I mean it is no minor thing that our bank regulators have decided to favor “The Infallible” those already favored by the market and bankers and thereby discriminate against “The Risky”, like all our small businesses and entrepreneurs.

Mario Draghi, as a regulator, what have have you done to our banks in Cyprus?

I quote from an interview with Mr Athanasios Orphanides, ex Governor of the Central Bank of Cyprus, conducted on 19 April 2011by Michele Kambas and Sakari Suonimen of Reuters, and which appears on the web of Bank of International Settlements. 

“Q. Cypriot banks hold a sizeable quantity of Greek debt. How damaging or potentially damaging could that exposure be? Could the Central Bank have taken any steps to limit banks exposure to a single borrower? 

A. With respect to the exposure of Cypriot banks to Greek debt, we have examined the situation and we have come to the conclusion that even though there is exposure in our banking system, that exposure is manageable because our banks are very well capitalized. 

So even in the highly unlikely situation, if you wanted to run the counter factual, for example, of imposing losses on the holdings of Greek debt, our banks would manage to weather that. To understand how well capitalised our banking system is, a comparison may be useful. Our banks already meet the stricter capital requirements that are being phased in under Basel III. By contrast, in some other member states in the euro area there have been explicit calculations about how much additional capital would need to be infused into banking systems in order to meet those requirements. This is testament to the very strong capital position of our banking system. 

Regarding steps to limit exposure by any of our banks to any sovereign holdings in the euro area, as part of the supervisory process of the Central Bank of Cyprus we demand that all of our banks have good risk management systems in place. Of course, we do not control the specific decisions on portfolio holdings of banks. Whenever we determine that there is undue concentration of risks then we demand that additional capital be held in order to account for these risks. This way we manage risks to the system.” 

Which all leads me to questions that, if a Cypriot, I would make to bank regulators, for instance to Mario Draghi who for many years was the Chairman of the Financial Stability Board. 

Sir, what on earth were you thinking of when, with Basel II, you allowed our banks from little Cyprus, to lend to Greece against holding only 1.6 percent in capital, meaning authorizing them to leverage 62.5 to 1? 

Sir, and why the current problems, when we read that in April 2011, our banks “already meet the stricter capital requirements that are being phased in under Basel III?”

Come on...What have you done to our banks Mario?

For Basel IV, what do I propose?

Ex ante perceived risks are already cleared for in the numerator, by means of interest rate (risk-premiums) size of exposure and other terms, and so it is just plain stupid to clear for the same risks in the denominator, with different capital requirements based on risk-weights. That only guarantees a distortion that makes nothing safer, and just causes banks to overdose on perceived risks. 

Therefore risk-weighted capital requirements are to be eliminated completely.

But, if bank regulators absolutely must meddle, in order to satisfy their egos, or show off their expertise, and there are going to be some higher capital requirements for some assets, those should be applied to what is ex ante perceived as “absolutely safe”, since all major bank crises ever, have originated in excessive bank exposures to this category of assets.

And, if bank regulators absolutely must meddle, in order to satisfy their egos, or show off their expertise, and there are going to be some lower capital requirements, to induce some higher returns on bank equity, those should be only accepted in as much as these stimulate the banks to better fulfill a social purpose, like basing it on potential for job creation ratings, or sustainability ratings.

And, in no way shall there be any discrimination that favors any short term financial instrument over a long term one.

And in this respect, the initial Basel IV proposition contains just one line, the following:

“Banks shall hold 8 percent in capital, as defined in Basel III, against all assets.”

The Basel IV capitalization can be reached by allowing each bank to apply its current capital to total assets ratio (including sovereigns), and then let it build up that ratio over a period of some years, with about 0.5 percent per year until reaching said 8 percent level. 

But, since the faster banks reach their final Basel IV capitalization, the better for the real economy, the regulators, accepting their full responsibility for the current extreme low capitalization of banks, should beg for some temporary important tax incentives on all bank capital increases taking place within one year of the Basel IV approval.

What is the Basel Committee’s Stefan Ingves now saying, “risk-adjusted (regulatory) returns”?

Stefan Ingves, the Chairman of the Basel Committee in “Where to next? Priorities and themes for the Basel”, a speech delivered on March 12, in page 5 of transcripts, says: 

“The major reforms…that have been developed by the Committee…intended to generate a more resilient financial system, in which higher levels of capital and liquidity are held, and in which risk is appropriately managed and priced. This will obviously have consequences for the costs of financial intermediation, although studies undertaken suggest that this cost is both relatively small, and considerably outweighed by the benefits of increased financial stability. 

Nevertheless ... The Committee is mindful of two potential consequences from the programme of reforms. 

While a degree of deleveraging and increased risk premia are intended consequences of the reforms, there is always a danger that some unintended consequences may arise… 

A second potential consequence relates to the incentives that may arise as the banking sector adapts to the reforms by moving into those businesses where risk-adjusted (regulatory) returns are greatest. This reshaping of banking (either within bank balance sheets or outside the regulated banking system) needs to be monitored on an ongoing basis…” 

What Mr Ingves? “risk-adjusted (regulatory) returns”? This is the first time I read the Basel Committee admitting it is (hopefully unwittingly) distorting the markets, and thereby making it impossible for the banks to efficiently allocate economic resources.

It is not about banks arbitraging opportunities between bank balance sheets or outside the regulated banking system, something quite frequently discussed, but about arbitrating “within bank balances”. 

And so it is not about risk-adjusted bank returns, appropriately managed and priced, something perfectly natural, but about “risk-adjusted (regulatory) returns”. 

In other words, it is about the Basel Committee deciding about where banks can obtain higher or lower returns. 

In other words, as I have argued for a decade, it is not about the credits our banks give out being guided by the markets invisible hand, but by the Basel Committees invisible (and unaccountable) hand. 

Who the hell authorized you Basel Committee bureaucrats to do that? 

And then, “... studies undertaken suggest that this cost is both relatively small”. 

Basel Committee, I dare you to show those studies… If you think, like in Basel II, that authorizing banks to leverage 62.5 times to 1 when lending to a AAA rated client but only 12.5 to 1 when it is an unrated “risky” borrower, has only “relative small” effects on the interest rate that the unrated “risky” borrower has to pay in order to make up for the discrimination, you simply have no idea what you are talking about. 

And then “…this cost [is] considerably outweighed by the benefits of increased financial stability” 

Basel Committee, please, don’t mock us, what stability?

Basel Committee, Financial Stability Board, Hugo Chavez… the same shit!

For more than a decade now I have tried to ask Venezuelan politicians or government petrocrats and oiligarchs, such as Hugo Chavez, where they get that crazy idea that they are able to sow trillion dollars of oil seeds better than what each Venezuelan citizens can do sowing a couple of hundred dollars of that seed per month. And they never answer. 

http://theoilcurse.blogspot.com/

http://www.petropolitan.blogspot.com/

For more than a decade now I have tied to ask the Basel Committee and the Financial Stability Board where they get that crazy idea that if banks only lend to “The Infallible” and avoid like the pest lending to “The [dirty] Risky”, everything is going to be fine and dandy. And they never answer. 

http://subprimeregulations.blogspot.com/

http://bombaaaa.blogspot.com/

I guess the Basel Committee and the Financial Stability Board and Hugo Chavez are genetically from the same stock... in other words, the same not accepting to be held accountable to no one shit.

You bank regulators... get your priorities right, urgently, or we depict you on some shame poles.

Very few of us like having banks "too big to fail" or bankers receiving exaggerated bonuses. 

But, if banks are “too big to fail” and bonuses to bankers seem immorally large, but our banks still do a good job allocating economic resources efficiently, that is hard, but still quite livable. 

But if banks do not allocate economic resources efficiently, then even if all our banks are small, and easy to liquidate, and all our bankers do not receive more compensation than anyone else, that is still, something completely unacceptable. 

So please, European Parliament, European Commission, Basel Committee, Financial Stability Board, Michel Barnier, Stefan Ingves, Mario Draghi, Mark Carney, Lord Turner, Ben Bernanke… get your priorities right! 

The way YOU allow banks to hold lower capital against exposures considered as risky, than for exposures considered as safe, and which allows banks to earn higher expected risk-adjusted returns on what is perceived as safe than on what is perceived as risky, is bloody murdering the economies of the Western World, those economies which became prosperous thanks to a lot of risk-taking. 

When I think of all those opportunities missed, forever, to generate good jobs for our youth, only because of your regulations, I tell you I would have no qualms whatsoever depicting you on some shame poles, and placing these totems all around the most public places in Europe and America.

The regulators force “risky” borrowers to pay the banks a kicker for them lending to the “safe”

I can perhaps understand paying widows and orphans a kicker when they invest in something “absolutely safe” and which earns them a very low return, but, to pay that kicker to a bank, that really sounds outrageous. 

And this what regulators actually do when they allow banks to leverage much more their equity for exposures to assets deemed “absolutely safe”, like the AAAristocracy or solvent sovereigns, than what they can leverage “risky assets”, like medium and small businesses and entrepreneurs. 

And the worst is that the kicker is not paid by the government. No! It is paid by those perceived as “The Risky”, by means of interest rates higher than ordinary and by getting bank loans smaller than ordinary. 

Really, that banks are regulated to earn much higher risk-adjusted returns on equity for “safe” than for “risky” is just plain crazy distortion.

And that this is not even an issue, never ceases to surprise me.

Is America, the land of the brave living within the land of the sissy, or vice-versa?

I just finished seeing Zero Dark Thirty, which refers to all that US risk-taking needed in order to kill Osama Bin Laden, something quite compatible with the “land of the brave”. 

But then I compare that to all that sissy and dumb risk-aversion implicit in bank regulations which pay banks extra returns on equity, for lending to “The Infallible”, no matter how useless, and not when lending to “The Risky”, no matter how important, and I wonder how all that can coexist within one same country. There just has to be some immense disconnect. 

Is America, USA, the land of the brave living within the land of the sissy, or vice-versa?

Children and grandchildren, the truth about your fathers and grandfathers who are bank regulators

Your fathers, or grandfathers who are bank regulators, actually thought that if banks were allowed to leverage more their equity with exposures to those perceived as absolutely safe, than for those perceived as risky, we would not have any more bank crises. 

And this they believed even though all bank crises in the world have resulted from excessive exposures to those perceived as “The Infallible” and never ever because of excessive exposures to “The Risky”. 

Sorry kids, I wish I had not to say this, but they were really stupid. For your sake, I hope it is not something genetically.

PS. If you think that I am being too severe with your fathers and grandfathers who are bank regulators, then think of all the fathers and grandfathers who are not bank regulators, and who will suffer seeing their children and grandchildren not finding a job, only because of senselessly risk-adverse regulations.

My objection to “An Explanatory Note on the Basel II IRB Risk Weight Functions”, July 2005, Bank of International Settlements

The document referred to in the title describes how the Basel II risk-weights came about. I have two major concerns with what it states and one immense with what it ignores: 

First, it describe one important simplification needed in order to allow a practical implementation of a rating based capital allocation, namely that “The model should be portfolio invariant, i.e. the capital required for any given loan should only depend on the risk of that loan and must not depend on the portfolio it is added to…. . 

The simplification is justified with “A Risk-Factor Model Foundation for Ratings-Based Bank Capital Rules” by Michael B. Gordy a senior economist at the Board of Governors of the Federal Reserve System, October 22, 2002. 

And so it states “As a result the Revised Framework was calibrated to well diversified banks… If a bank failed at this, supervisors would have to take action under the supervisory review process” 

And that places an immense supervision burden on a body often not sufficiently equipped for it, and worse still, a body that had been sold a feeling that, with the rating based risk-weights, it had already solved the problem forever. 

Second it states: “Losses above expected levels are usually referred to as Unexpected Losses (UL) - institutions know they will occur now and then, but they cannot know in advance their timing or severity. Interest rates, including risk premia, charged on credit exposures may absorb some components of unexpected losses, but the market will not support prices sufficient to cover all unexpected losses. Capital is needed to cover the risks of such peak losses, and therefore it has a loss-absorbing function.” 

That is indeed correct, but that does not mean one can go ahead assuming that these risk premiums are covering zero of the unexpected losses, or that the market will “not support prices sufficient” the same over the whole range of perceived risks. In fact given basic bankers risk-aversion, I would make a case that where the markets do not support the prices correctly, is mostly for whatever is perceived as “absolutely safe”, and that, for the “risky”, it might overprice it instead.

Also if one must use credit rating information which is already available for the bankers to see, then instead of basing it on what the ratings indicate, one should base it on how bankers usually act when observing those ratings. Then they would have seen that bank crises never ever occur because of excessive exposures to "The Risky" but always from excessive exposures to "The Infallible".

Sincerely to use the expected as a proxy of the unexpected is as nutty as can be. The more safe an asset might seem the more room there is for bad unexpected events. The riskier an asset might seem the less the room for bad unexpected events.

And then finally, what the document completely ignores, is that the setting of differential risk-weights, by allowing banks to leverage risk and transaction cost adjusted margins immensely more for what is perceived as “absolutely safe”, introduces a very dangerous bias and distortion against what is considered as “risky”. 

And I just do not understand how that came to happen. Though banks do use risk-models to estimate appropriate capital levels, when looking for capital, they do not make separate share issues based on perceived risks, indeed, as all capital has usually to cover for all risks. 

In fact by allowing banks to hold much less capital against what is perceived as “safe” than against what is perceived as “risky”, regulators are in fact allowing for speculative profits, not on what is “risky” but on what is safe… and that turning the world upside down cannot be healthy. What about the efficient resource allocation function of our banks? With their risk weights the regulators are de facto telling us that those perceived as safe use bank credit more efficiently than those perceived as risky... and that we all know is not so.

And I must ask again: If banks are induced to make more profit on what is perceived as safe than on what is perceived as risky… then what is left for us… and for our orphans and widows?

Boston Consulting Group, a consultant who does not dare to speak a truth that might hurt, is no real consultant.

Boston Consulting Group wrote a reasonably good paper about the need to finance the Next-Generation Companies, and which it presented at the World Economic Forum in Davos in 2013 

Unfortunately, the paper fails to identify that, courtesy of excessively sissy bank regulators, we now have capital requirements for banks which favor “The Infallible” and thereby discriminate “The Risky”, and which of course means favoring the past, those who have already made it, and therefore discriminating against the Next-Generation Companies. 

How come the Boston Consulting Company does not raise that issue? Would it be because doing so would reveal bank regulators for the fools they are? 

As I see it a consultant who does not dare to speak a truth that might hurt, is no real consultant.

A good consultant should always try to block group-think, not nurture it.

For those in blissful ignorance, this is what the Basel Committee’s Basel II decreed for our banks

We the members of the Basel Committee, as self-appointed guardians of your interests, knowing that banks want to maximize the returns on their equity, and wanting the banks to play it safer and not take risks, hereby ordain: 

Banks will still be allowed to lend to those perceived as “risky”, usually those not rated or those with not so good credit ratings, usually the small and medium sized businesses or entrepreneurs, against 8 percent in capital; meaning that banks are able to leverage their capital with the risk and cost of transaction margins of those exposures, 12.5 times to 1. 

But now, when lending to the safe or the absolutely-safe, the latter including AAA rated securities and so and so sovereigns like Greece, they will only need to hold 4 or 1.6 percent in capital respectively; meaning that banks will now be able to leverage their risk and cost of transaction margins of those exposures, 25 or 62.5 times to 1. (A jolly profitable proposition for playing it safe we would say) 

And finally, in the case of lending to sovereigns considered to be infallible, most often our bosses, at least in a formal sense, then banks need to hold no capital at all, and so there, as far as leverage concerns, the sky is the limit. 

Happy safe and huge bank equity returns!!! 

PS. Of course Basel II led the banks to create the excessive and dangerous large exposures to what was ex-ante considered as absolutely safe but that ex-post turns duo to be Potemkin ratings, and which caused the current crisis. Of course Basel II, and perhaps even more upcoming Basel III, stops the banks from lending to “The Risky”, those we most need to help us to get out of the crisis, and get our youngsters their jobs.

If bank regulators head east, when they should head west, is that a minor mistake?

All bank crises in the world has resulted from something perceived as safer that it really was, and no bank crisis ever from excessive exposures to what was perceived as risky when booked. 

And so therefore when the Basel Committee and the Financial Stability Board set up bank regulations known as Basel II and that as its pillar has capital requirements which are much lower for bank exposures to what is perceived as to “The Infallible” than for what is perceived as “The Risky”, then it would seem they are heading in the totally wrong direction. 

And so of course we got ourselves a traditional bank crisis because of excessive exposures to assets perceived as safe like AAA rated securities, sovereigns like Greece and Spanish real estate. 

And those regulations also cause that “The Risky”, those already discriminated against on account of that perception, end up paying even higher risk-premiums, getting even smaller loans and having to accept even harsher contract terms. 

And so of course making it more difficult for "The Risky", like small and medium businesses and entrepreneurs, we can not get our real economy going, so as to create the jobs we need, especially for our young. 

I have not been able to extract an answer on this from the regulators for many years now, and now they are threatening to make it even worse when, in Basel III, they are concocting some liquidity requirements also based on perceived risks. Can you please help me with that?

The absurd front and back door security of our banking system

Suppose you live in a house which has often been burglarized. It has two doors. One, your back door, faces a dark alley and has therefore many bolts and security latches. The other one, your front door, faces a well lit walkway in a friendly community, and so that even though it has a lock, it is often kept open. And absolutely all illegal entrances by the burglars have been through your front door, never ever through the back door. 

Now what would you say about a security consultant who then recommends you adding two pit bulls at your back door and placing a welcome doormat at your front door? Would you contract his services? I guess not. 

I say this because that is precisely what our bank regulators did with Basel II, by lowering the capital requirements for the banks when lending to “The Infallible”, those who enter by the front door, those truly dangerous when not really infallible; and thereby scaring away even more “The Risky”, those who enter through the back door, those who never pose a real danger, and those who are so useful for the  real economy.

The pillar of the Basel Committee and the Financial Stability Board regulations, capital requirements for banks based on perceived risk of assets already cleared for by means on interest rates, amounts of exposure and other terms, is therefore completely absurd. And now, with Basel III, with liquidity requirements also based on perceived risk, they want to close the back door and open the front door even more.

Even so the world still respects these utterly failed regulators so much that even an FT, which proudly declares a “Without fear and without favour” motto, dares not question their capabilities.

Could it really be that the silliness of these regulations exceed our society´s limits of imagination and so it has become trapped in the quagmire of a: “They can´t be so dumb, so what is it we do not understand?”

Bank regulators fixed the game, bribed the players, and got us the crisis they paid for.

Before the current set of bank regulations, all borrowers could be treated equally good or bad by the bankers, though Mark Twain held there was a natural risk-adverseness among bankers that played out in a strong bias against those perceived as “risky”. 

But the Basel Committee for Banking Supervision, thinking it was doing its duty as a nanny, paid the bankers to treat those perceived as “safe” borrowers so much better than those perceived as “risky”. And this they did by allowing the bank to hold much less capital against the first, and thereby obtaining a much higher risk adjusted return on equity when lending to “The Infallible” than when lending to “The Risky”. 

And of course, the banks accumulated excessive exposures to what was ex-ante perceived as safe but that ex-post turned out to be very risky, against very little capital, and the crisis exploded. 

And of course, since these dumb regulations remain in place, banks do not finance those borrowers that find themselves on the margin of the real economy, like small businesses and entrepreneurs, and who are extremely important if we want to get out of the crisis. 

Poor us! How do we get rid of these crazy nannies?