All dollars (or Pounds, or Euros) should be equal!

The efficient market hypothesis, and the capacity of free markets to allocate efficiently financial resources have, as a consequence of the recent financial crisis, been seriously questioned. There is absolutely no cause for that.

In a free market all dollars pursuing assets are equal, and so the prices reflect the markets appreciations of returns, risks, and other factors… and so in essence, all assets will produce equivalent all included risk-adjusted returns. Like any bet on the roulette.

But then came bank regulators, with their risk-weighted capital requirements, more risk more capital, less risk less capital, and determined that some dollars, those being lent to what was perceived as “absolutely safe” were worth much more because these could be leveraged by banks much much more, than the dollars lent to what was perceived as “risky”. Like doubling the roulette payout when playing it safe, like betting on a color.

And of course that made it impossible for the markets to function. It would be like pricing assets in dollars Euros and Pounds, simultaneously without informing the markets of which currency was used. In fact, since bank capital when in “risk-free” land could sometimes be leveraged about 40 times more than when in “risky” land, the currencies used are perhaps more like dollars, pesos and yen. 

And so a dollar going to someone “risky” is for the banks worth de facto much much less than a dollar going to the AAAristocracy. Talk about financial exclusion! Talk about increasing inequality gaps!

Discriminating against risk-taking, in the "Home of the Brave"... you´ve got to be kidding!

Please regulators, allow a dollar to be a dollar for everyone! So that markets will work again!

PS. By the way who authorized all that?

Do you want your bank regulators have a total lack of confidence in your banks?

Markets, banks, bankers they do all one way or another perceive risk of default of borrowers and adjust to these by means of interest rates, size of exposures and other terms. 

And so when bank regulators order banks to also adjust to the same perceived risk in their capital requirements then they are implicitly considering the banks to be absolutely blind. 

Frankly, is that the type of regulators you want? 

Don´t you think that if a regulator believes in that kind of nonsense, he is a regulator that can be too easily be taken for a ride?

America, more bank capital (equity) required for loans to “The Risky” than to “The Infallible”, is contrary to Liberty & Opportunity

Yesterday, in the good company of friends who value liberty above all, I visited the Statue of Liberty for the first time. As a son of immigrants, though not to America, looking at her my eyes went tearful, thinking about the challenges of leaving all behind, and beginning, from scratch, a new life in a new unknown foreign country.

And sitting there listening to a great audio guide I was reminded all the time of that she, Lady of Liberty, stood there greeting all, to the Land of Freedom and Opportunities.

And it all made me reflect again on the fact that current bank regulations, odiously discriminate against what is perceived as “risky”... And my eyes went tearful again. Let me explain.

Of course, a newly arrived unknown immigrant, with nothing or little to his name, would be perceived as risky by any banker, and therefore be charged higher interests, be lent lesser amounts, and have to accept stricter terms, than what applied to those residents of the Americas who already had the opportunity to made a good name and some assets for themselves.

But, those days, luckily, there was not a bank regulator in America who ordered that, on top of a bankers natural risk-adverseness, banks also needed to hold much much more capital when lending to “The Risky” than when lending to “The Infallible”.

And so those days’ bankers were free to apply their own criteria, and “The Risky” free to access opportunities, without the interference of some dumb and overly concerned nanny.

Now though, since 1988, Basel Accord, bank regulations are based on capital requirements which are much much lower when lending to “The Infallible” than when lending to “The Risky”. And that means that banks make a much much higher risk-adjusted return on assets when lending to The Infallible, than when lending to The Risky.

And that means that a current immigrant, or an American who has not yet made it to the AAAristocracy (or the AAArisktocracy) has much lesser opportunities of obtaining a bank credit to make real the kind of America’s dreams which made America what it is… because please don’t tell me that America was just built upon house ownership credit cards and consumption.

Dear Friends, "The Home of the Brave" should not accept this kind of suicidal regulatory risk-aversion, which stops banks from financing the "riskier" future and only propels these to refinance the "safer" past.

By the way I read the law, though only a layman it seems to me it is even prohibited.

God make us daring!

PS. On any Thanksgiving Day, Americans should be deeply grateful for all those who dared take the risks they all needed, and for those days bank regulators did not stand in their way. 

PS. I am not an American, but since my father was freed from a concentration camp by Americans in 1945… I confess being much biased in its favor… at least of that 1945's America.

PS. I have absolutely no objection to all the security measures taken around the Statue of Liberty but, the way some security officers voiced their authority, unfortunately, made me think of a sacrilege.

PS. Risk weights of 100% for the Sovereign and 0% for “We the People” reads like a slap in the face of USA’s Founding Fathers

PS. Here is an aide memoire on the mistakes in the risk weighted capital requirements for banks.

PS. And here are some of my early opinions on these regulations, some of them while being an Executive Director at the World Bank, 2002-04

PS. And here is a very humble home-made youtube comment on it all, from 2010

In Europe banks no longer finance the future

These just refinance the past... (and so Europe is going down, down, down)

Let me refer again to the tragically misguided banking regulations in the world, designed by some who do not care one iota for the real economy, that which are not the banks.

The main principle of such regulations are capital requirements (equity) based on perceived risks. More risk more capital, less risk less capital.

And that results in the bank can expect to earn much higher expected risk-adjusted returns on equity , when financing the safe (refinancing the past) than when finance the risky (the future).

And that results in that the economies do not take enough risks to produce its absolutely-safes of tomorrow ... but will dedicated itself to milk the cows of yesterday, to extract their last drop of milk.

And all sheer stupidity. Regulators ignored, and still ignore, that perceived risks, such as those reflected in credit ratings, have already been cleared for by banks and markets when setting interest rates, the amounts of the loans, duration and other clauses, And so when the same perceptions of risk, are reused, now to determine the required capital, this only ensures that the banking system overdoses on perceived risk.

They also forgot that their regulatory risk with banks has nothing to do with the perceived risks of the bank's customers ... and everything to do with how the bankers perceive and react to these perceptions.

And that the above causes distortions in the allocation of bank credit in the real economy, still nothing is discussed.

For an older person, retired, with barely sufficient savings, a financial advisor must recommend a super safe conservative investment strategy which provides liquidity, traditionally bonds. But, in the case of a young professional, who is saving for retirement in 30 years, the obligatory advice is to take much more risks, such as buying stocks.

And so you can say that bank regulators follow rules adequate for the old, and not for the young. I assure you that if the European youth, such as that in Spain, Italy, Portugal and Greece, lifted their eyes just a little while from their iPads, or similar devices, and realized what was being done to them, many sites would burn...like Troy.

Worse yet, the regulators require banks to have an 8% capital when lending to an ordinary citizen entrepreneur, but allow these to lend to their governments, holding no capital at all. This has quietly introduced a perverse communism, and disrupted all price-risk equations in capital markets. Of course, all in close association with other beneficiaries like the members of the AAAristocracy.

But, you might say ... "At least we will have safe banks". Do not delude yourself. All banking crisis, whenever not a case of outright fraud, have been unleashed by excessive lending to what ex ante was perceived as absolutely safe, and which, ex post, turned out to be risky, and no banking crisis in history, has resulted because of excessive loans to what was correctly perceived as risky.

As a young man, in Sweden, in the churches where from time to time I went, they sang psalms which implored, "God, make us daring". European regulators, with respect to their banks, are now rewarding cowardice... (and so Europe is going down, down, down)

Translated from El Universal

The Financial Stability Board evidences its utter confusion, again, with their G-SIBs list, a subset of the G-SIFIs.

In reference to “the policy judgment to be informed by various empirical analysis of the systemic risk that the Globally Systemic Important Banks Institutions” pose, in order to set the G-SIBs cutoff score, and determine to which of five “buckets” each one of the monster too big to fail banks belong, the Financial Stability Board published, on November 11, their end-2012 data G-SIB list.

For those who need some translation the G-SIBs are the banks among the Globally Financial Important Financial Institutions, the G-SIFIs.

And we there now find 29 banks, since recently Bank of China was added to the original 28, perhaps because China objected to not having one single bank among that exclusive group of banks.

But, what does all this mean? There are 5 buckets indicating how much additional capital each bank as a percentage of risk-weighted assets a banks needs to hold, for the regulators feeling reasonably sure, the world is secure. These buckets are 1%, 1.5%, 2%, 2.5% and, the horror, the empty 3.5% bucket.

I mention that last one because although “the bucket thresholds will be set initially such that bucket 5 is empty, if this bucket should become populated in the future, a new bucket will be added to maintain incentives for banks to avoid becoming more systemically important… eg if bucket 5 should become populated, bucket 6 would be created with a minimum higher loss absorbency requirement of 4.5% etc)."

If you think the above to sound as a quite infantile regulations, like scaring the children with the boogeyman, I would probably share your appreciation… because what do you think could happen if suddenly regulators got so scared that empty bucket had to be occupied? Would that not cause a crisis by itself?

But let us see how boogeyman the boogeyman really is. The secret is in the “as a percentage of risk-weighted assets”. If the risk weights are low enough that extra capital banks need to hold does not mean much. 

If a G-SIB holds 1/3 each of 0%, 20% and 50% risk-weighted assets, then the currently most G-SIBs, those in the additional 2.5% capital budget, then it is authorized to leverage over 40 to 1. Is this sane?

Why do they not try with an extra 3 percent on all assets, no matter an asset’s risk-weight. That would really put a cracker in the G-SIBs’ pants. Perhaps Bank of China would scream… “Take me out, I don’t belong here”

No friends let me assure you that if I was a Global Systemic Important Bank, and that the price for being The Most Systemic Important Global Bank in the world, would be to have an additional 1% or risk-weighted assets in equity… I would gladly say… “Sure, bring it on!”

But the saddest part of the story is, sine qua nom, that the more regulators insist on the risk-weighing of assets the less access to bank credit will those who most need it and who we most want to have access to it, namely “The Risky”, like medium and small businesses, entrepreneurs and start-ups.

Here is THE QUESTION for Janet Yellen during her US Senate confirmation hearings as Chair of the Federal Reserve

Ms. Janet Yellen

Is it not a fact that, with the sole exceptions of when pure fraud was present, all major bank crises have always resulted from excessive exposures to what was ex ante perceived as “absolutely safe”, and never ever from excessive exposures to what was ex ante perceived as “risky”?

And, if so, can you please explain to us the rationale behind the pillar of current regulations, the risk weighting of the capital requirements, which allow banks to hold much much less capital against what is ex ante perceived as “absolutely safe” than against what is perceived as risky?

Could it not be that in reality it should perhaps be the complete opposite?

Is it correct that in the “home of the brave” we impose this type of bank regulations which discriminate against those perceived as “risky”? And by the way, is such thing really allowed under the Equal Credit Opportunity Act, “Regulation B”?

Finally, do not these regulations created such distortions that it makes it impossible for the banks to allocate credit efficiently in the real economy? 

PS. Oh I almost forgot. I remember the Constitution of the United States of America, in Section 8 states “The Congress shall have the power to…fix the Standard of Weights and Measures.” Can you please refresh our minds as to when we delegate fixing the risk-weights to the Fed?

PS. Oh and I almost also forgot too. The US Constitution in its section 9 states: “No Title of Nobility shall be granted by the United States”. Now, is that not something that de facto happens when we sort of recognize the existence of an AAAristocracy or AAArisktocracy?

Have the risk weights used in current bank regulations really been approved by the US Congress, in accordance to the Constitution?

As a Venezuelan I regretfully know much too much about the violations of a Constitution, but I cannot say that I know much about the Constitution of the United States.

For instance, the Constitution of the United States of America, in Section 8 states, “The Congress shall have the power to…fix the Standard of Weights and Measures.”

And I know that bank regulators, by setting risk weights determine how much capital (equity) banks need to hold against different assets... which means that banks will be able to obtain different risk adjusted returns on equity for different assets.

And so I ask, did the United States Congress really approve those risk weights? I say this because I find that concept to be anathema to “The Home of the Brave”.

And I also ask because the US Constitution, in its section 9 states: “No Title of Nobility shall be granted by the United States”… and that seems precisely what the US might have allowed by allowing regulatory preferences, much lower risk weights, on loans to the Sovereign (the Monarch) and to an AAAristocracy... or more precisely an AAArisktocracy.

And what are those risk weights? The sovereign, meaning the government, meaning bureaucrats deciding on the use of bank credit was given 0%, the “AAArisktocracy” 20%, and WE THE PEOPLE are deemed to be 100% 

But what do these risk weights really signify? The answer is quite straightforward. Those with low risk weights will have even more access at even easier terms to bank credit, than what the natural order of banking would give them. And so those with higher risk weights will, consequentially, have less even access to bank credit and have to pay even more for it, than what the natural order of banking would give them.

And so, in words of Mark Twain, this means that bankers are even much more prone than usual to lend out the umbrella when the sun shines, and to take it back when it rains.

And the tragic consequences for the US are many:

It increases the inequality gap between The Infallible and the Risky

It stops bank from financing the future and make them mostly refinance the past.

And in the case of the sovereign, it translates into an effective subsidy of the interest rates paid by the Government, and so everyone is flying blind, not knowing what the real not subsidized risk free rate would be.

And at the end of the day this piece of regulation guarantee excessive bank exposures to what’s ex ante perceived, decreed or concocted as safe, but which might turn out risky, and when that happens are held against especially little capital, and so will result in especially severe bank crises.

And the list goes on...

The silly doubling down on ex ante perceived risks is killing the Western economies... and not so softly

The interest rates, the size of the exposures and all other terms of assets that banks put on their balance sheet, are a function of their ex ante perceived risks, like those reflected in credit ratings.

But current bank regulations also determines that the capital (equity) banks are required to hold against those assets, are also to be a function of risk weights determined from ex ante perceived risk, like those of credit ratings.

And that fundamental mistake of doubling down on the same ex ante perceived risks, like those in credit ratings, potentiating risk aversion, is killing the western economies as we knew them... and not so softly.

Trusting excessively ex ante perceived risks, regulators have allowed banks to hold much much less capital against assets perceived ex ante as “absolutely safe”, than against assets perceived as risky. And that resulted in that banks earn much much higher risk adjusted returns on equity on “The Infallible”, like exposures to sovereigns, housing sector and the AAAristocracy, than on The Risky, like medium and small businesses, entrepreneurs and start ups.

And that means that banks have dangerously leveraged up much too much on The Infallible and, equally dangerously, much too little on The Risky.

And so when one of “The Infallible” ex post turns out to belong to “The Risky”, as always happens sooner or later, often precisely because it has had too much access to bank credit, then the banks stand there naked with almost no capital.

And so “The Risky”, those who on the margins of the real economy most need and should have access to bank credit, in order to help our economies to move forward, they will not get it.

In essence this all means that banks will not help to finance the western economies future, but only help to refinance its past.

Senator Patrick Moynihan is quoted with saying “There are some mistakes it takes a PhD to make”. Unfortunately most of us equally seem to believe “There are mistakes, so dumb, these just cannot be made by a PhD”.

We baby-boomers extract as much equity as possible from the risk-taking our parents allowed banks to take, while refusing now to allow banks to take the risks our grandchildren need.

Why the Bank of England, BoE, like most other bank regulators, is pissing outside the pot.

I invite you to read the Bank of England publication “Bank capital and liquidity”

It states: “It is the role of bank prudential regulation to ensure the safety and soundness of banks, for example by ensuring that they have sufficient capital and liquidity resources to avoid a disruption to the critical services that banks provide to the economy.”

But, if that comes with avoiding that those in the real economy who most need and deserve access to bank credit, do not get it, only because they are perceived as more “risky”, then the regulators are most definitively pissing outside the pot.

The regulator divides here the balance sheet of the bank in 3 categories: Cash and Guilts, Safer loans, and Riskier loans.

If then, as they do, they allow banks to hold much much less capital against Guilts and Safer loans than against Riskier loans, that simply means that banks will be earning much much higher expected risk adjusted return on Guilts and Safer loans, that on Riskier loans.

And that means that “The Infallible” will have even more access to bank credits, which could turn these into risky, and make it very dangerous for the banks, while “The Risky” will get even less access to bank credit and make it very dangerous for the real economy.

“The Infallible” are the sovereigns, the housing sector and the AAAristocracy. “The Risky” are medium and small businesses, entrepreneurs and start-ups.

This is the mumbo jumbo that the Basel Committee bet our whole western world banking system on. Shame on it!

Here is the document which describes the risk-weight functions of Basel II

An Explanatory Note on the Basel II IRB Risk Weight Functions, Bank for International Settlements, July 2005

And these are the 3 papers referenced therein:

A risk-factor model foundation for ratings-based bank capital rules, by Michael B. Gordy, October 2002

Robert C Merton, On the pricing of corporate debt: The risk structure of interest rates. 1974, Journal of Finance 29, 449 - 470. 

Oldrich Vasicek, O. (2002) Loan portfolio value. RISK, December 2002, 160 - 162

All put together, does not make any sense!

And on that the Basel Committee, and the Financial Stability Board bet our whole western world banking system. Shame on it! How could they?

And that same crazy risk-weighing function is still part of Basel III

I wonder who wrote that “Explanatory Note”. “The confidence level is fixed at 99.9%, i.e. an institution is expected to suffer losses that exceed its level of tier 1 and tier 2 capital on average once in a thousand years”. That must indeed be the Bank Regulator’s real New Clothes.

Come on Mario Draghi, Adair Turner, Mark Carney, Stefan Ingves, Michel Barnier, or anyone else involved with bank regulations... have a go at explaining it to us! I bet you do not understand it either... but your egos stop you from recognizing that.

Is being consistent better than being right? Is the quest for consistency not just a cover up for mediocrity?

We read: “The members of the Financial Stability Board´s Regional Consultative Group for Europe were updated by the Basel Committee on Banking Supervision on the findings of the regulatory consistency assessment of risk-weighted assets for market risk and credit risk in banks’ portfolios, and shared national perspectives on regulatory consistency of risk weights.”

Of course we like consistency, but what is more important, that all these European countries are consistent in their assessment of risk-weighted assets for market risk and credit risk in banks’ portfolios, or that some in the group, could get it right, even if this meant acting inconsistently?

Has the biodiversity of opinions no longer any value? Is this quest for consistency not just a cover up for mediocrity?

Anything you distort I can distort better, I can distort anything better than you. Yes I can, yes I can, yes I can!

So sings the Basel Committee for Banking Supervision and the Financial Stability Board, while proceeding to distort all common sense out of how banks allocate credit in our real economy.

For this they concocted capital requirements based on the same ex ante perceived risks which were already being cleared for by the market.

And with this they made banks earn much much higher expected risk adjusted returns on equity on assets perceived as “absolutely safe” than on assets perceived as “risky”.

And with that they caused banks not to finance the risky future but only refinance the safer past.

And all for nothing, because that only doom banks to end up gasping for oxygen in dangerously overcrowded “absolutely safe havens”.

If they young would just look up from their iPads for a second, and understand what is being done to them, I would not like to be in the Great Distorters' shoes.

But she knew how to aim!

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.