About banks, black donkeys and plain donkeys

There was a little town with a road on which some farmers in horse drawn carriages speeding along at 12.5 mph. sometimes suffered severe injuries when crashing into some of the black donkeys who roamed around the area. And the little town now wanted to prepare for the coming of speedy automobiles. 

But, before a town hall meeting could be held on the issue, Franz Basil, a local bully, presented regulations which stated: If a black donkey is seen, then the maximum speed allowed is 12.5 mph, but if there is no black donkey to be seen, 62.5 mph will be allowed. And to be absolutely sure about it, we are going to set up black donkey outlook outposts so as to rate the possibility there is one.

And since the proposal was immediately hailed as brilliant by some of Franz Basil´s comrade bullies, and some did not want to show they did not understand a iota about what he was talking about, and everyone was happy about a plan that offered the possibility of never ever more a black donkey incident, it was acclaimed, and some even discussed asking their king to knight Franz Basil.

For a while it looked as if all was going well, except for the fact that those who were allowed to drive at only 12.5 mph, were slowly driven off the road, “move over you slow stupid farmer”. 

But then, some weeks later, suddenly a real bloodbath resulted when a couple of vehicles driving at 62.5 mph smashed into some black donkeys.

One could hear the small weak voice of an old local farmer saying: “It had to happen, it was too silly to begin with, the crashing into black donkeys never ever occur when you see these, but only when you do not, for whatever reason, blinded by the sun, to dark to see, or just distracted thinking about coming home fast to your sweet wife. And who could think that those looking out for the black donkeys would not suffer of the same”.

But Franz Basil and his accolades, being the bullies they are, shut him up, offering the solution of allowing authorized speed differences to remain but now making certain that, at no point in time, the average speed of those driving on the road could be higher than 33.3 mph. And, again, understanding even less than before, no others said anything, but “Ah!” in awe.

And there the little town lays licking its wounds, just waiting for the next accident to occur and its farmers not being able to drive around.

But you may ask, “what about the plain donkeys?” Well I leave you to figure out who they are.

Data: The Basel Committee´s authorized speeds

Basel II risk weight for when there is perceived risk, “The Risky” is 100%, which on 8% basic capital requirement produces an authorized leverage of 12.5 to 1. 

Basel II risk weight for when there is no perceived risk, the AAAristocracy, is 20%, which on 8% basic capital requirement produces an authorized leverage of 62.5 to 1.

Basel III 3 percent leverage ratio is equivalent to a 33.3 to 1 average

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

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

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

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

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

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

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

Now I am extremely worried

Holy Moly!

Is it that regulators, economists, even Nobel Prize winners, do not understand that… lower capital requirements for banks on some assets than others, means that banks will earn higher expected risk adjusted returns on some assets than others?

Have not anyone of these studied finance?

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

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

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

Yes, Admati is right in her analogy.

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

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

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

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

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

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

In the hands of self righteous, arrogant, dumb and unsupervised bank regulators, Europe is doomed.

Let there be no doubt. Basel II did the eurozone in, but, Basel III, is fundamentally still a perceived risk-based bank regulatory regime. All its new concoctions, like Leverage Ratio, Liquidity Coverage Ratio and Net Stable Funding Ratio are, admittedly, only backstops, supplements or complements.

And this means that banks will still be allowed to hold much less capital against loans to “The Infallible”, like to sovereigns, the housing sector and the AAAristocracy, than against loans to “The Risky”, like to medium and small businesses, entrepreneurs and start-ups.

And that means, of course, banks will be making much higher expected risk-adjusted returns on equity when lending to The Infallible than when lending to The Risky.

And that means, of course, banks will not lend to the future, only refinance the past.

And that means, of course, Europe will not risk exploring sufficiently the new adventurous bays it needs in order to sustain a movement forward, and to create sturdy jobs for its youth, and will therefore die, gasping for oxygen, in dangerously overpopulated safe havens.

Europe, I cry for you. You have no idea of what you have gotten yourself into. Your banking system has been overtaken by what must be the stupidest risk-averse mentality, incapable of understanding the simple fact that what is perceived, ex ante, as “risky”, has never ever caused a major bank crisis, only what has been erroneously perceived as absolutely safe do that.

Europe, for your own sake, rid yourself of the false Pharisees in the Basel Committee for Banking Supervision and in the Financial Stability Board, as fast as you can!

God make us daring!

The Basel Committee´s and the Financial Stability Board's loony concept of our risks with banks. God help us!

Basel II assigns a 150% risk weight to loans rated below BB- which, since the basic capital requirement in Basel II is 8 percent, means that a bank is required to hold 12 percent in capital (equity) against those loans… an authorized leverage of 8 to 1.

And Basel II assigns a risk weight of only 20% to loans rated AAA to AA which, with the same basic capital requirement of 8 percent, means that a bank is required to hold 1.6 percent in capital (equity) against those loans… an authorized leverage of 62.5 to 1.

Q: If you were a regulator, what would you think poses the greatest dangers for us with the banks, the possibility of their excessive exposure to something rated AAA to AA which turns out to be risky, or their “excessive” exposure to something rated BB- which turns out to be even more risky than that?

A: The first of course. There would be very few or no "excessive" exposures to anything rated below BB-. And, if so, the banks would have collected a lot of risk premiums too... which is also capital (equity).

You see, the Basel Committee’s risk weights measure the risks of the assets and the borrowers for the banks, but not the bank risks for us. You see, our and the bank regulators’ problems with banks, have absolutely nothing to do with banks and bankers getting it right, and absolutely all to do with banks and bankers, getting it wrong!

You understand it... but the members of the Basel Committee and the Financial Stability Board don't.

And that kind of unwise risk-weighting is still part of Basel III. In fact, more than five years after a crisis erupted, as a consequence of many assets perceived as safe turning very risky, and banks then having almost no capital against these assets, the basic principle of their faulty method of risk-weighting is not even discussed.

And much much less do the current regulators understand that capital requirements adjusted for "perceived" risk-weights, completely distorts the allocation of bank credit in the real economy.

And we have placed our banks in the hands of this kind of regulators. God help us!

Who are the rent extractors and who the rent payers of current bank regulations?

The pillar of current bank regulations is capital requirements for banks based on perceived risk, a.k.a. risk-weights. The more risk the more capital the much less “risk” the much less capital. 

That means that the rent extractors are:

1. The bankers, whose dream of making high equity return on what is perceived as “absolutely safe” has come through… that is of course until they discover the ex ante perceptions were, ex post, wrong.

2. "The Infallible": the "sovereigns, the housing sector and the AAAristocracy; namely those who will have much more access, in much better terms, to bank credit.

And that means that the rent squeezed payers are:

1. "The Risky”: medium and small businesses, entrepreneurs and star ups, namely those who will have much less access and in much worse terms, to bank credit.

2. And of course all the unemployed youth who will find their possibilities in life to gain access to decent and sturdy jobs much reduced by this senseless regulatory risk aversion.

Our slowing hybrid real economy is running out of gas... and is in a shutdown mode!

Our economy is like a hybrid car. It accelerates using a motor fueled by risk taking, and then, playing it safe, breaking, it draws energy which it stores in a battery that can be used to further move forward, for a while.

Unfortunately, with current perceived risk-weighted capital requirements for banks, banks are not financing the future, only refinancing the past… and so we are running only on batteries, risking running out of all risk-taking!

In other words, our real economy has been placed, by dumb regulators, in a real shutdown mode.

The Financial Stability Board is still without a clue of how banks best serve the needs of the real economy

I strongly object the statement of Mark Carney Chairman of the Financial Stability Board to the International Monetary and Financial Committee Washington,DC, 12 October 2013 

It opens with:

“In Washington in 2008, the G20 committed to fundamental reform of the global financial system. The objectives were to correct the fault lines that led to the global financial crisis and to build a safer, more resilient source of finance to serve better the needs of the real economy.”

And it concludes with:

The completion and full, timely and consistent implementation of reforms will not only build more resilient national systems but also, by building confidence in each other’s commitments, support a more effective and open system. The result will be a resilient global financial system that serves an increasingly global real economy throughout the economic cycle, including the inevitable economic shocks. That system will best support the ultimate objective of strong, sustainable and balanced economic growth and job creation.

And the whole statements does not mention even once, much less recognizes it, the number one fault line which not only led directly to the financial crisis, but also impedes banks from serving the needs of the real economy and the creation of jobs.

And I refer, of course, to the so rotten pillar of the Basel Committee’s regulations, namely the risk-weighted bank capital requirements, those which lead banks to solely refinance the past and not finance the future.

These regulators, they just care about the banks, they do not care about the real economy.

God help us!

With Basel II-III risk-weighted capital requirements, banks are not financing the future, only refinancing the past

The pillar of Basel II and Basel III bank regulations is capital requirements based on perceived risk. More-risk-more-capital and less-risk-less-capital.

That results in that banks can obtain much much higher risk-adjusted returns when lending to “The Infallible”, like some sovereigns, the housing sector and the AAAristocracy, than when lending to “The Risky”, like to medium and small businesses, entrepreneurs and start-ups.

And that results in banks lending much more to the “safer” developed past, than to the “riskier” developing future.

And anyone who does not understand that, or fully understands that risk-taking is the oxygen of development, should, frankly, not be working at the World Bank, the world’s premier development bank.

On the risk of risk aversion, I spoke over and over again, as an Executive Director of the World Bank, 2002-2004. But no one wanted to listen, all were just too much in love with the illusion of the ‘never ever a bank crisis again’. And I can understand that, I come from a country, Venezuela, where citizens do believe, over and over again, crazy messianic promises.

And I protested during the High-level Dialogue on Financing for Developing at the United Nations too. But what weight could my small unknown voice carry, when drowned by all those Monday morning quarterbacks, like the Nobel Prize winner Stiglitz, complaining, ex post, about the excessive risk taking of banks.

And it is now more than five years since the bank crisis broke out, precisely because being caught with little capital and excessive exposures to some of “The Infallible”, like AAA rated securities, Icelandic banks, Greece, and real estate in Spain; and our real economy is suffering from the lack of access to bank credit of “The Risky”.

And yet, we still have to read important documents of the World Bank, like Chapter 6 in the World Development Report 2014, “The role of the financial system in managing risks”; and “Financing for Development Post-2015”, which do not even mention the criminal distortions produced by the risk-weighted capital requirements for banks. It makes you want to cry for all the unemployed young.. 

But perhaps there is a glimmer of hope. Professor Stiglitz in "The Changing of the Monetary Guard" in the “Annual Meetings Daily”, October 12, writes about regulations that "affects the supply and allocation of credit - a crucial determinant of macroeconomic activity", and that "Any serious candidate for Fed Chairman should understand the importance of good regulation and the need to return the US banking system to the business of providing credit, especially to ordinary Americans and small and medium sized businesses (that is, those who cannot raise money on the capital markets)”. And that “return”, might mean he, and perhaps some other, have finally understood what happened.

Let us pray that at least Janet Yellen does understand it, especially since those in the Basel Committee and the Financial Stability Board evidence they are still clueless.

What would I do? First we absolutely need to hold the regulators accountable. Fire them, Hollywood would never allow a Basel III to be directed by the same who produced a box-office flop like Basel II… and parade them down some avenues wearing dunce caps.

Then accept that the banking systems is so seriously under-capitalized, and distorted, that extraordinary measures need to be taken, carefully but urgently, Basel IV, if we are not to doom our young unemployed to become a lost generation.

PS. All risk management must begin by clearly identifying those risks we cannot afford not to take… and, in banking, we cannot afford the banks not to take the risks the real economy needs.

Are there intended “unintended consequences” of the Basel Committee’s bank regulations?

There I was as a civil society participant (don’t ask me what that means) during the World Bank and IMF meetings. Suddenly, on a screen, I saw announced a “Forum on the effects of Financial Regulatory Reforms on Emerging Markets and Developing Economies (EMDEs). 

Since development and bank regulations is perhaps what I have most dedicated myself to over the last decade, completely pro-bono, I immediately went there. 

I announced that I was not registered, but the person attending said that did not matter, that I should write my name on a list, and I was given a folder. One hour later, because I had another scheduled appointment, I left, utterly depressed. What I regard as a monstrous mistake of Basel bank regulations, both for developed and the developing countries, was still not even on their radar screen.

You see, I have no respect for those who, with capital requirements for banks based on perceived risks, keep banks from financing the future my constituency needs, only in order to refinance the past.

But later, to my surprise, in the folder, I found a list with the emails of all the participants. And below is what I immediately wrote to them. Pardon some of the language, but I was truly upset. And I do hold them much responsible for the current sufferings of, for instance, the unemployed youth.

Are there intended “unintended consequences” of the Basel Committee’s bank regulations?

If you piss against the wind, and get wet, you might, theoretically, call that an unintended consequence, but, a sailor, even a drunk one, would just call that a dumb consequence of doing something stupid.

And if you allow banks to hold much less capital against what is ex ante perceived as “absolutely safe”, than what they need to hold against what is perceived as “risky”; banks will therefore make much more risk adjusted returns on their equity lending to the former than when lending to the latter. And the result HAS TO BE that you will get too much bank lending to “The Infallible”, like to sovereigns, housing sector and the AAAristocracy, and too little to “The Risky”, like to medium and small businesses, entrepreneurs and start-ups.

And that, even though, theoretically, you might call it an unintended consequence, even a sailor, though perhaps not a very drunk one, would also call it a dumb consequence of doing something really stupid. 

Dumb, because major bank crises never result from too much lending to The Risky, these are always the consequence of too much lending to some of “The Infallible” which, ex post, turned out to be very risky.

Dumb, because it completely ignores the risk-taking the real economy needs, in order to grow and remain sturdy. The growth of an economy which is almost exclusively based on “safe assets” only leads to its obesity.

Dumb, because it increases the inequality gap between “The Infallible”, which usually includes more of the past, the old, the developed and the haves; and “The Risky”, mostly the future, the young, the not developed, the have-nots.

And so when the Basel Committee and the Financial Stability Board, more than five years after this crisis of “absolutely safes” blew up in its faces, do not even recognize that their regulations are dramatically distorting the allocation of bank credit in the real economy, you really must have to wonder whether some truly dark intended “unintended consequences” might lay behind all this.

PS. I am not a regulator but once, way back, I was a sailor… though not a drunk one… at least not too much… and so I do know something of what I am talking about.

Per Kurowski

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

One who screamed and warned like no one about Basel II… to no avail

The two documents I saw referred to in the meeting are:

http://www.financialstabilityboard.org/publications/r_120619e.htm

http://www.financialstabilityboard.org/publications/r_130912.htm

Ms Bolivia...where I learned not to piss against the wind... 1966... 16 years old.

My question, for the umpteenth time, to the World Bank and IMF, at the Civil Society roundtable

And so the Civil Society Round Table took place, and I had the luck of being able to ask my question… again.

Mme Lagarde, Professor Jim Yong Kim minute 49:05 – 50:10

Never ever, have bank crises resulted from excessive exposures to "The Risky", these have always resulted, no exceptions, from excessive exposures to what was, ex ante, perceived as belonging to "The Infallible", but that, ex post, turned out to be very risky?

Nonetheless current regulations, allow banks to earn much much higher risk-adjusted returns on equity, on exposures to infallible sovereigns, to the housing sector and to the AAAristocracy, than on exposures to "The Risky".

And that means that the access to bank credit of medium and small companies, entreprenuers and start-ups, those who most need it, becomes severely impaired.

Why does the World Bank, and IMF, never speak out against this brutal distortion of the allocation of bank credit to the real economy... and which stops job creation.

Thanks

And I got answers, from both 

Mme Christine Lagarde minute 52:55 - 57:25

Not a bad answer at all, but, unfortunately, she expresses more concern about the risk weights not being correct than about the risk weighing creating distortions, even if the risk weights are absolutely correct.

Jim Yong Kim minute 57:25 - on a less direct answer.

The answers are probably the result of them having reached a point in their life, and their careers, where, subconsciously, they care immensely more about the health of banks than they do about the health of the real economy. Also, of course, they suffer from that Monday Morning Quarterback’s syndrome, which results from confusing ex ante perceptions, with ex post results.

I wish they would invite me to sit down and with just a pencil and one sheet of paper and 10 minutes, explain to them at what crossroad they and the bank regulators got lost.

And, as what could be seen among others from my formal written statements as an Executive Director of the World Bank, 2002-2004, while Basel II was being discussed, few, if any, can evidence so well being deserved listened too. Will this happen? I do not know. I just know there are many  too interested in that not happening.

“The World Development Report 2014 - Risk and Opportunity”, seems to completely ignore what is dumb and dangerous with Basel Committee´s risk adverse bank regulations

In its introduction, Jim Yong Kim, the president of the World Bank, expresses his “hope that the WDR-2014 will lead to risk management policies that allow us to minimize the danger of future crisis and to seize every opportunity for development.”

Sir, though WDR 2014 will surely contribute importantly in many ways and in many areas, unfortunately, with respect to the "Financial Sector", it does little, or even nothing, to help to achieve those goals. This is so because it seems to completely ignore the absolutely mistaken principles of current bank regulations being disseminated around the world. With their dumb and dangerous risk-aversion, these regulations attempt directly against development and stability. More than manage risks, those regulations have generated enormous risks.

More than 10 years ago, April 2003, when commenting on The World Bank’s Strategic Framework 2004-06, in a written statement which I delivered as an Executive Director of the World Bank, I opined the following: 

"The Basel Committee dictates norms for the banking industry that might be of extreme importance for the world’s economic development. In its drive to impose more supervision and reduce vulnerabilities, there is a clear need for an external observer of stature to assure that there is an adequate equilibrium between risk-avoidance and the risk-taking needed to sustain growth. The World Bank seems to be the only suitable existing organization to assume such a role."

Unfortunately, the World Bank, or any other institution, did not assume such a role, and as a consequence we have landed ourselves with the most dumb and dangerous bank regulations possible.

Before explaining it, let me, just as a reference for why I deserve being listened to, point to a similar statement at the Board on October 19, 2004, and in which I so correctly and timely warned: 

“We believe that much of the world’s financial markets are currently being dangerously overstretched though an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions.”

The pillar of the Basel Committee’s bank regulations, is capital requirements for banks based on ex ante perceived risks of borrowers. These allow banks to hold much much less capital against assets perceived as “absolutely safe”, “The Infallible”, than against assets perceived as belonging to “The Risky”. A more capable regulator, would be much more concerned about what bankers do with the risks they perceive, and with what happens when those ex ante perceptions, turn out, ex post, to have been wrong.

And those risk-weighted capital requirements result directly in that banks are able to earn much much higher risk adjusted returns on equity, when lending to some sovereigns, housing or the AAArisktocracy, than when lending to the medium and small businesses, entrepreneurs and start-ups. Something like rewarding children with chocolate cake when they eat ice cream, and punishing them with spinach when they eat broccoli... and declaring being surprised when kids turn out obese. And it is all like drastically changing the payouts on roulette bets, and believing the game of roulette will remain the same. 

And since the assessments of safeness and riskiness were to be done by very few human fallible credit rating agencies, on January 2003, in a letter published in the Financial Times, I also warned:

"Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds. Friends, as it is, the world is tough enough." 

And so those regulations doomed of course the banks to, sooner or later, create excessive and dangerous bank exposures to something that would have erroneously been considered as “absolutely safe”; like AAA rated securities backed with lousily awarded mortgages to the subprime sector, banks in Ireland, real estate in Spain, and sovereigns, like Greece. And doomed the banks to have especially little capital when the biggest disasters struck. It even did the eurozone in. Just a little empirical research on what causes bank crises, would have concluded that... never ever, those ex ante perceived as risky.

And, of course, that also doomed those who though “risky”, are the true dynamos of the real economy, and the best possible creators of the next generation of sturdy jobs, and who are those most in need of bank credit, to have their competitive access to bank credit severely curtailed. And that has effectively placed the economy in a shutdown mode… and whatever movement we might detect in it, might have to do with the sad fact that it is heading down down, on a very slippery slope.

And this truly odious regulatory discrimination is only helping to increase the gap between the past, the developed, the haves, and the future, the developing, the have nots. In other words it excludes more than it includes. WDR-2014 writes: “All too often risk management strategies prove ineffective (or introduce other risks) because they are not coordinated among all relevant policy stake holders”. Indeed! And I ask… who consulted bank regulations with “The Risky” borrowers?

But not one word about all that in WDR-2014!

The WDR-2014 does state though: “Stability. The Achilles’ heel of the financial system is its propensity for crisis”. And that is wrong! Its Achilles’ heel is the propensity to try to delay the crises. May 2003, at the World Bank in a workshop on bank regulations, I told those present: 

“A regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, could be a much more effective regulation. The avoidance of a crisis, by any means, might strangely lead us to the one and only bank, therefore setting us up for the mother of all moral hazards—just to proceed later to the mother of all bank crises.” 

And the WDR-2014 does propose creating a "National Risk Board", "an integrated, permanent risk management agency that deals with multiple risks." That might have some advantages, but it also reminds me of why, in November 1999, I had to write in an Op Ed:

"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 total collapse"

Jim Yong Kim also writes: “This year’s WDR cautions that the greatest risk may be taking no risk at all”. And he is absolutely correct. But, unfortunately, the great institution he presides, the world’s premier development bank, seems not to fully understand that risk-taking is in fact the oxygen of development.

And, therefore, the World Bank has done nothing to stop the members of the Basel Committee, and of the Financial Stability Board, those who with so much hubris believe themselves capable of being the financial risk-managers of the world, from applying their so truly risky risk-adverse bank regulations.

Let me end by reminding you that these regulators, those who after the Basel II flop are still allowed to work on Basel III (neither Hollywood nor Bollywood would be so dumb), were the real enablers of our current bank crisis. If in doubt, just ask yourselves whether the market, in the absence of any bank regulations, would have allowed banks to leverage 50 to 1?

God make us daring! We need bankers capable of reasoned audacity! World Bank, step up to your duties!

Per Kurowski

PS. IMF is also completely disoriented by current bank regulations. They have for instance no idea of what would be the real market interest rates on public debt, for instance in the US, if banks needed to hold the same amount of capital against it, as they are required to hold against a loan to a citizen.

PS. I hear you. "Per, how can this be?" Well, Patrick Moynihan said “there are mistakes only PhDs can make; and George Orwell that “one has to belong to the intelligentsia to believe things like that: no ordinary man could be such a fool.” But I personally think, this is the typical thing to happen, when the wish of not criticizing colleagues in ones networks, crosses the path of those not wanting to admit they do not understand one thing of the mumbo jumbo that is being said.

PS. Here is a current summary of why I know the risk weighted capital requirements for banks are utter and dangerous nonsense.

You, the bank regulating scientists, would you please explain something to a layman?

Below what I saw while walking around in the Washington Zoo with my constituency (my grandchild) and which inspired me to ask our bank regulation scientists friends a question.

Smithsonian scientists learn a lot by observing animals. 

Now its your turn to WATCH AND LEARN

So now it is with you bank regulator. You are the scientist. Scientist learns a lot, by observing banks and bankers. So please explain.

Observe what type of bank exposures have caused all major bank crises:

1. One or many of those ex ante considered risky, and that ex-post turned out to be risky?

2. One or many of those ex ante considered risky, and that ex-post turned out to be safe?

3. One or many of those ex ante considered absolutely safe risky, and that ex-post turned out to be safe?

4. One or many of those ex ante considered absolutely safe risky and that ex-post turned out to be very risky?

And now, you bank scientists answer us non bank scientists. 

For what type of exposures would the empirical evidence suggest the capital requirements for banks should be higher?

Aha! 

And so then explain to us, in easy terms, why you, the Basel Committee for Banking Supervision, the Supreme Global Bank Supervisor, set rules which allowed the banks to have much much less capital for what was ex ante perceived as "absolutely safe", than for what ex ante is perceived as risky?

Please?

PS. My own humble opinion is that our bank regulation scientist friends have got themselves trapped in quite a bit of confusion. They keep on analyzing the possible failure of bank borrowers and not, as they should, the reasons for why banks fail, as entities or in allocating credit to the real economy. And that is of course not the same thing, or, as they say in French, c’est pas la même chose… For instance instead of looking at the ex ante credit ratings of bank borrowers they should look at what bankers do when they see those same credit ratings.

In other words, the regulators instead of analyzing so much the ex ante creditworthiness of bank borrowers, to determine their risk weights, should have analyzed, at least a little, the ex-post explanations for why banks fail and for why bank crises occur. Holy moly!

PS. As I see it: The world (with its banks) is much better off thinking that the risky are less risky than we think them to be, than that the "safe" are as safe as we think.

What should the punishment be for those who risk Europe´s (and America's) unemployed youth to become a lost generation?

There are of course many who share the responsibility for risking that Europe´s (and America's) unemployed youth becomes a lost generation. But, in my opinion, the guiltiest party is regulators who came up with the absolutely lunatic criteria of making capital requirements for banks a function of the ex ante perceived risk which was already being cleared for by the banks, by means of interest rates (risk premiums), size of exposures and other contractual terms.

That distorted all common sense out of bank credit allocation in the real economy, and also caused that when something ex ante perceived “absolutely safe” turns out ex post to be “very risky”, the usual cause of all bank crises, that the banks ended up totally undercapitalized and at least temporarily unable to help out in any recovery.

These regulators have not been shamed sufficiently much less punished. In fact they were reauthorized to proceed to make a new set of regulations Basel III, conserving the same rotten apple of Basel II.

When I think about the pain and suffering these dumb regulators have and will be inflicting on millions of our young ones, then, parading them down avenues wearing dunce caps, seem to be sort of an absolute minimal social sanction.

We absolutely must hold these regulators accountable, but, until now, for around six years, they have been able to avoid taking any responsibility using a lot of distractive maneuvers. 

Many years ago, at a seminar, the facilitator asked the group to look at a video and try to keep count of how many times a group of persons passed a white ball among themselves. After one minute he asked around, getting answers like 13, 14, and 15. He then asked whether someone had noticed something strange. I, who had as it seems been distracted from looking at the ball (through luck or genes), had noticed the presence of a gorilla coming into the scene, pounding his chest and then leaving. 

So please, J'accuse...!, lookout for the Basel Committee's capital requirements for banks gorilla, who is pounding on our economies, and on the job prospects of our young

We need “The Risky” to access bank credit, competitively, especially in bad times, as “The Infallible” alone cannot pull us out of anything

If a bank charges a 3 percent risk premium to set of small and medium businesses, entrepreneurs and start-ups borrowers, then it is reserving for sustaining losses of about 30 percent on 10 percent of these borrowers, something which, as bankers do not give loans were they think they are going to lose, is a hell of a great reserve.

But, the higher risk premiums paid by “The Risky” was something completely disregarded by the regulators when setting those capital requirements for banks based on perceived risk and that so much favor bank lending to “The Infallible”, in essence sovereigns, housing and the AAAristocracy.

You see, our current set of bank regulators, they do not care one iota about the fact that their capital requirements utterly distorts the allocation of bank credit in the real economy, and in which, it is really the access to bank credit of “The Risky”, in competitive terms, what most needs to be assured.

You see our current bank regulators care only about the banks, and that is why they are so damn bad bank regulators.

You see our current bank regulators are so scared shit about all ex ante “risk”, they fail to understand that, ex post, only “The Infallible” cause major bank disasters.

There is nothing as risky for the banks, and for us, as not taking a risk on “The Risky” of the real economy.

God make us daring!

Why is the President of the World Bank not informed about consequences of risk-weighted capital requirements for banks?

In Russia, September 6, 2013, Jim Yong Kim, the President of the World Bank Group, said the following in his statement issued at the end of the G20 summit.

“The G20 has pledged to achieve strong, sustainable, balanced and inclusive growth, and creating more and higher-quality jobs.”

Mr. Jim Yong Kim. As long as bank regulators allow banks to hold much much less capital when lending to "The Infallible", like some sovereigns, housing or the AAAristocracy; than what they are required to hold when lending to “The Risky”, like medium and small businesses, entrepreneurs and start-ups; and which means the banks will earn much much higher risk-adjusted returns on their equity when lending to the former than when lending to the latter... "strong, sustainable, balanced and inclusive growth" able to create more and higher-quality jobs” will just not happen. 

The odious and dangerous discrimination of "The Risky" does only increase, not reduce, the gap between those perceived as safe, the past, the developed, the haves, and those perceived as “risky”, the future, the developing, the have nots.

And the truly sad thing is that no one in the world’s premier development bank wants to inform its president about it.

Mr. Jim Yong Kim. I assure you, risk-taking is the oxygen of development. God make us daring!

Per Kurowski

A former Executive Director of the World Bank, 2002-2004

The Financial Stability Board, Mark Carney, is not telling the truth to the leaders of G20

Mark Carney, in the name of The Financial Stability Board (FSB), on September 5, 2013, reports to the G20 Leaders the following:

"In Washington in 2008, the G20 committed to fundamental reform of the global financial system. The objectives were to correct the fault lines that led to the global financial crisis and to build a safer, more resilient source of finance to serve better the needs of the real economy... FSB members have made major progress correcting the fault lines that caused the crisis.”

And that is just not true.

The major fault line that lead to the global financial crisis, were capital requirements for banks which allowed banks to earn much much higher risk-adjusted returns on equity on exposures that were perceived as “absolutely safe”, than on exposures perceived as” risky”. 

That consequentially stimulated the banks to build up excessive exposures to The Infallible, The AAAristocracy, and which later, in much as a result of it, when some of these exposures turned sour, it found the banks standing there naked with little capital to cover themselves up with.

And that problem, of how the capital requirements distort and makes it impossible for the banks to allocated bank credit efficiently to the real economy, has not even yet begun to be discussed, at least not in public.

The ridicule small capital requirements for some “ultra-safe” exposures also served as the most important growth-hormone for the “too big to fail” banks.

FSB also states in the document that “the risk models that banks use to calculate their capital needs show worryingly large differences” . And I ask,  what’s their problem? Do they want the whole world to use the same risk models, so that when these turn out wrong, as they will do sooner or later, everyone goes down the tube in a virtuous kumbayah like solidarity? 

When will these regulators understand their duty is not to assure the existence of the right risk-models, but to prepare for when the risk-models of bankers turn out to be wrong?

In case you wonder what possible credential would I have to dare to call out the bluff of the Financial Stability Board, let me just put forward, as one of many, that as an Executive Director of the World Bank, in a written statement delivered in October 2004, I warned that “We believe that much of the world’s financial markets are currently being dangerously overstretched though an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions.”

Leaders of the G20. It is your duty to stop the nonsensical and extremely risky risk-aversion of the Basel Committee for Banking Supervision and the Financial Stability Board. Our children and grandchildren deserve it.

Finance ministers of the world. How many of you believe risk-aversion is good for the economy? Raise your hands!

What if Mark Twain knew about the capital requirements for banks in Basel I, II and III, based on ex ante perceived risks?

If Mark Twain resurrected, and read about what our current bank regulator came up with, in terms of capital requirements based on perceived risk, which allow the banks to earn much much higher risk-adjusted returns on equity when lending to “The Infallible”, than when lending to “The Risky”, he would need to expand on his opinion on bankers, to something like what follows:

“A bank regulator is one who likes the banker to lend out the umbrella when the sun shines, even more than what a banker likes to do that, truly amazing; and one who wants the banker to take that umbrella back when there is the slightest indication it could rain, even faster than what the banker would like to do, equally truly amazing.”

David A. Stockman’s “The Great Deformation” did not include what is perhaps the greatest deformation.

David A. Stockman’s The Great Deformation is a truly great book, except for the fact that sadly it misses out on what in my mind constitutes the greatest deformation… namely allowing for much much lower capital (equity) requirements for banks on exposures that are considered as “absolutely safe”, than what they are required to hold for exposures considered as “risky”.

That allows the banks to grow so as to end up as Too Big To Fail, and to earn much higher risk-adjusted returns when lending to “The Infallible”, than when lending to “The Risky”.

And that distorts completely the way credit is allocated within the real economy, so that too much at too low interest rates of it goes to the "The Infallible", like the sovereign and the AAAristocracy (or AAArisktocracy) and too little to at too high interest to "The Risky", like medium and small businesses, entrepreneurs and star-ups.

And that effectively increases the de-facto risk-adverseness of banks, in the home of the brave, and in all other countries were these truly lamentable regulations are applied. And if that is not a deformation, what is?

Stockman does not mention that because of Basel II, approved in June 2004, and what SEC approved for US investment banks, April 2004, the European banks and the US investment banks could hold AAA rated securities, or lend against these securities, holding only 1.6 percent in capital, meaning leveraging their equity a mind-boggling 62.5 times to 1. 

And a result, though Stockman, in Chapter 20, “How the Fed brought the gambling mania to America’s neighborhoods”, explains splendidly the tragedy of how extremely bad mortgages were awarded to the subprime and other sectors in the US, and then packaged into dubious AAA rated securities sold all over the world, he misses out completely on the main reason for why the world demanded these securities and all other “supper-safies” so much, that it completely lost its common sense.

Let me assure everyone that if the banks had needed to hold the 8 percent they have to hold when lending to their “risky” citizen, then the current US subprime, Greek sovereign, Spanish real estate, Cyprus' banks, and similar tragedies, would not have happened. It is as easy as that… which of course does not make it any easier to swallow.

I hope that in the next edition of “The Great Deformation” David Stockman at least rewrites his chapter 20 so as to include these considerations. It would be a shame not to do so in such a good book.

And I need to repeat it again: A nation were banks need to hold 8 percent in capital when lending to the citizens, but are allowed to lend to their government against zero capital, is a deformed nation.

PS. The risk weights of 0% for the Sovereign, 20% for the AAArisktocracy and 100% for We the People, is anathema to America.

God make us daring!