Who supervises that FDIC, Fed, OCC, with their risk-weights, do not distort allocation of bank credit to the real economy?

The FDIC writes: “The Federal Deposit Insurance Corporation (FDIC), the Federal Reserve Board (Board), and the Office of the Comptroller of the Currency (OCC) (collectively, the agencies), under the auspices of the Federal Financial Institutions Examination Council (FFIEC), are requesting comment on proposed revisions to the risk-weighted assets [used to determine the regulatory capital banks should hold].”

And in a reference material titled “New Capital Rule: Community Bank Guide” we read:

“This guide summarizes significant changes from the current general risk-based capital rule for exposures commonly held by community banking organizations, and it provides relevant information regarding the treatment of more complex exposures such as securitization exposures, equity exposures, and exposures to a foreign government or bank. Community banking organizations become subject to the new rule on January 1, 2015. 

The new rule takes important steps toward improving the quality and increasing the quantity of capital for all banking organizations as well as setting higher standards for large, internationally active banking organizations. The agencies believe that the new rule will result in capital requirements that better reflect banking organizations’ risk profiles, thereby improving the overall resilience of the banking system. The agencies have carefully considered the potential impacts on all banking organizations, including community banking organizations, and sought to minimize the potential burden of these changes where consistent with applicable law and the agencies’ goals of establishing a robust and comprehensive capital framework.”

All of which leads us to ask again, for the umpteenth time… who is in charge to supervise that the risk- weighing of bank assets does not distort the allocation of bank credit to the real economy?

How can anyone think of "a robust and comprehensive capital framework" that does not even consider the consequences of distortions which could be much more dangerous for the overall safety of the economy than the presence of unsafe banks?

Do these risk weights really consider any unexpected events and losses banks could suffer or are they based on the same risk perceptions used by the banks to clear for expected risks? 

The capital control the IMF supports

Overwhelmed by what is happening in my country Venezuela, I briefly pause to refer to the war that incompetent and pusillanimous regulators in the Basel Committee and the Financial Stability Board, have declared against what they consider is the risk of banks.

The pillar of their current banking regulations are shareholder capital requirements against the various bank assets, according to the perceived credit risk.

For example the Basel II rules allow banks to lend huge sums to "infallible" sovereign against zero capital; huge amounts to private borrowers rated AAA against only 1.6% equity; while, against small loans to businesses or entrepreneurs, they are required to hold 8% in capital.

Since the perceived credit risk is already considered by the banks in the interest rates they charge, the above translates into banks being able to earn much higher risk adjusted returns on equity when lending to the "safe" than when lending to the “risky".

And, as a result, the portfolio of banks each day focuses more on what is perceived as “safe”, while bank credit to “the risky”, the credit needed to finance our future, becomes more each day scarce.

If one insures against all risks, one runs the risk that after paying all insurance premiums, you do not have anything left to eat with. In that sense you must always before analyzing risks define what the most important objective, so as to better understand what risks you cannot help but to assume.

And the citizens have a vital interest in that bank credits are awarded to the real economy efficiently, because on that will depend their future jobs. And therefore, avoiding the risk of banks to fail, you should never include something that makes it difficult to properly allocate banking credits.

If bank capital requirements were somewhat lower for projects that had very good potential of generating new-and-different-jobs-ratings, then I might understand ... but only to avoid the risk of bankruptcy of some banks… never!

And even when those regulations function as de facto capital controls, channeling bank credit to the "safe" and away from "risky", the International Monetary Fund, who has so much history opposing capital controls, plays along as if it does not understand.

Of course the IMF, among its explicit responsibilities, has to seek to ensure financial stability, and so that there can be some confusion with respect of avoiding bankruptcy of some banks. But even if so, a simple empirical study on the causes of banking crises, would have indicated the IMF that these never ever result from excessive lending or investment to what is perceived risky, but exclusively because of excessive exposures to what is ex ante believed to be absolutely safe, but is not so, ex post.

And the World Bank is complicit in the silence. As the first development bank in the world it must know that without risking open doors behind which, hopefully, we can find what can help propel us forward, we will only be stuck in the past,

Also, today, when the issue of inequality has been made so fashionable by Piketty, do not ignore that discriminating against the weak, the “riskier”, can only increase inequality.

Translated from El Universal

Janet Yellen why are bank capital requirements based on credit ratings and not on job creation ratings?

Bank lending to small businesses has never had anything to do with causing the latest or any other financial crises for that matter; and risk-weighted capital requirements for banks makes it impossible for “the risky” small businesses to access bank credit in a fair way… 

Now knowing that, as Federal Reserve Chair Janet L. Yellen must know, how can you give a speech such as that delivered at the National Small Business Week Event at the U.S. Chamber of Commerce in May 2014?

She speaks much of the importance of job creation. Indeed, if I had been invited and allowed to make a question, that one would be… why do you base capital requirements for banks on perceived credit risk ratings and not on job creation ratings?

Risk-weighted capital requirements creates a competitive disadvantage for community banks; as well as for their clients usually perceived as "riskier" .

Inasmuch the clients of the community banks belong more to the category of “risky”, like medium and small businesses, entrepreneurs and start-ups, whose fair access to bank credit is discriminated against, by banks being required to hold more capital against them that against the “safe”… and inasmuch larger banks have more access to borrowers perceived as "safe", or can easier structure operations as “safe”, and therefore benefit from lower capital requirements... which means being able to leverage their equity much more…. we can indeed argue that current regulations place community banks in a competitive disadvantage.

And so if community banks want to survive, they need to protest and fight against the whole concept of risk weighted capital requirements… and that should not be so difficult since the de-facto discrimination against the fair access to bank credit of “the risky”, should not be permitted under Equal Credit Opportunity Act (Regulation B).

And besides, community banks, ask your regulators to show you evidence of when excessive bank exposures to those ex ante perceived as "risky" have ever set off a major crisis. They will not be able to do so!

And agreeing from a different perspective with Thomas Hoenig of the FDIC, I guarantee you that letting the Too-Big-To-Fail-Banks roam in regulations distinct from that of the community banks, would only, medium term, condemn the community banks and bankers to disappear.

Frankly... in the "Home of the brave"... who came up with the idea of discriminating against the "risky" risk-takers who have made this country, so that they do not have any longer a fair access to bank credit? 

Don’t you understand how utterly immoral and dumb current bank regulatory discrimination is?

Suppose a busybody ministry of economy came up with the idea that in order to strengthen the competitiveness of the nation’s private sector, and make really sure the firms employed the best and brightest, they were going to give special tax incentives for hiring students with grades over a specified level. 

What would happen?

All those who had not achieved that great level of grades would scream bloody murder and accuse the ministry for discriminating against them, for something which they were already being discriminated in the job market. And if by any chance the ministry would still be able to impose its nutty and odiously discriminatory plan… you would automatically begin to see some inexplicable inflation in the level of grades.

And that is basically what the risk-weighted capital requirements for banks concocted by the Basel Committee for Banking Supervision do:

First: These capital requirements odiously discriminate, for a second time, against those who because of being perceived as risky already get smaller loans and pay higher interest rates.

Second: Borrowers have always wanted to be perceived as safer than what they are… but now the lenders dangerously have a vested in sharing that interest in too... so the credit rating agencies will be pressured for better ratings from both sides.  

Third but foremost: By allowing banks to earn higher risk-adjusted returns on equity when lending to “the safe” these capital requirements distort the allocation of bank credit to the real economy

And fourth: It all serves absolutely no purpose, since never ever do bank crises result from excessive exposures to what is perceived as risky, but always from excessive exposures to something erroneously ex ante perceived as absolutely safe.

@ECB Mario Draghi: Europe urgently needs to stop the discrimination in favor of “the safe” and against “the risky”.

Europe, much more than quantitative easing, “targeted long-term refinancing operations” or lower rates would need Mario Draghi to declare 

“From now on we the ECB will not admit bank regulators treating lending to medium and small businesses, entrepreneurs and start-ups, as intrinsically more risky for Europe, than lending to the “infallible sovereigns”, the housing sector and the AAAristocracy”

That refers to the need of stopping the distortion that risk-weighted capital requirement produce in the allocation of credit in the real economy ,something which is the number one reason for having caused the crisis (AAA rated securities Greece), and the number one reason for which the young unemployed Europeans might be doomed to become a lost generation.

Would that endanger the banks? Of course not! Who has ever heard about a bank crisis caused by excessive exposures to what was ex ante considered risky, these have always resulted from excessive exposures to what was ex ante considered “absolutely safe” but that ex post turned out not to be.

How can Christine Lagarde, of the IMF, say such things on the Amartya Sen Lecture?

Invited to speak on the Amartya Sen Lecture, ChristineLagarde said “In more unequal societies, too many people lack the basic tools to get ahead—decent nutrition, healthcare, education, skills, and finance. This can create a vicious cycle”

Yes! Indeed. And IMF should be ashamed of not criticizing the risk-weighted capital requirements for banks that so discriminates “the risky”, the medium and small businesses, the entrepreneurs and the start-ups from a fair access to bank credit.

Twice I have told her about it, here and here, and yet, acknowledging the problem, she seemingly does not care.

Here for discussion is an alternative, less distorting, risk-weighted bank capital requirement regulation.

I have for more than a decade strongly opposed the Basel Committee’s risk-weighted capital requirements for banks. 

This primarily because these seriously distort the allocation of bank credit in the real economy, but also because they make little empirical sense, since what historically have caused all major bank crises, are not big bank exposures to what ex ante is considered risky, but always too large exposures to what was erroneously perceived ex ante as absolutely safe.

But since it seems that regulators do not feel they are doing their job if they don’t do risks weighting, my criticism has not been sufficiently considered.

In that respect let me here briefly express a simple alternative of risk-weighing the capital of a bank.

Though it would not increase the ultimate long term safety of the banks, because of the fundamental regulatory mistake of confusing ex-post risks with ex-ante perceptions, it could at least produce much less distortion in the allocation of bank credit.

1. Calculate the risk-weighted size of the bank’s balance sheet. 

2. Divide that number by the gross balance sheet of the bank. 

3. Multiply the resulting ratio times a basic capital requirement, for instance Basel II’s 8 percent.

4. Make the resulting percentage the general capital requirement for that bank in particular and to be applied to all its assets.

5. Make a medium term plan on how to increase that percentage for that particular banks, to for instance Basel II's 8 percent.

Comments? perkurowski@gmail.com

No! Bank regulators, much more than they deregulated, just regulated amazingly bad.

Here is an interview by Econ Focus of Richmond Fed with Mark Gertler, which repeats the falsehood of bank regulators believing too much in the market.

Gertler: The biggest mistakes probably involved too much deregulation.

Econ Focus: What do you think is the best explanation for the policies that were pursued? 

Gertler: At the time, I think it was partly unbridled belief in the market — that financial markets are competitive markets, and they ought to function well, not taking into account that any individual is just concerned about his or her welfare, not about the market as a whole or the exposure of the market as v a whole. 

I am sorry. That is simply not true. 

Anyone with any reasonable belief in the market being able to allocate credit adequately in the economy… would never ever have interfered by means of setting the capital requirements for banks based on risks which were already cleared for by banks. 

That resulted in banks earning much higher risk-adjusted returns on equity when financing what is ex ante perceived as “safe”, than when financing what is ex ante perceived as “risky”, something which of course distorts all common sense out of bank credit allocation.

For instance, Basel II had it that if a European bank made a loan to a medium and small business, an entrepreneur or a start up, then it needed to hold 8 percent in capital, a leverage of 12.5 to 1, but, if it purchased AAA rated securities, then it needed to hold only 1.6 percent in capital, a leverage of 62.5 to 1. And that of course had Europe buying the securitized subprime mortgages like if there was no tomorrow… and so did the investment banks when authorized by the SEC to follow the Basel rules.

In other words... bank regulators did not believe in the markets... they believed in themselves being the Masters of the Universe, capable of managing risks for the whole banking world.

In other words... bank regulators instead of concerning themselves with any "unexpected losses", which is what they should do, decided to also manage the expected losses.

In other words... bank regulators were just amazingly bad. In terms of Bill Easterly... God save us from the tyranny of experts.

What caused regulators to concoct crazy risk-weighted bank capital requirements? Lack of testosterone, cortisol, cocaine, hubris or ideology?

The pillar of current bank regulations are the risk weighted capital requirements for banks. For instance in Basel II: 0 percent when lending to an “infallible sovereign”; 1.6 percent when lending to a slightly less “infallible sovereign”, or to a private member of the AAAristocracy; and 8 percent when lending to “a risky” medium and small businesses, or to an entrepreneur or a start-up.

John Coates a PhD research fellow in neuroscience at the university of Cambridge in his “The hour between dog and the wolf: How risk taking transform us, body and mind” writes “The financial system, as we have recently discovered to our dismay, balances precariously on the mental health of [financial] risk-takers. And he mentions testosterone, cocaine and hubris as risk-taking inducers; and cortisol as a risk-aversion generating hormone.

It would be interesting to hear John Coates opinion of what he thinks was present in the bodies’ of bank regulators when they concocted their regulations.

For instance, was it cortisol which made regulators so adverse to banks taking any kind of risks? Clearly, by allowing banks to earn so much higher risk-adjusted returns on equity when lending to the “absolutely safe” than when lending to “the risky”, they evidenced they were so insanely risk-adverse against banks running into short term problems, they even preferred to risk the misallocation of bank credit, something which had to guarantee that our real economy, and our banks, would run into problems long term.

Or was it testosterone, cocaine, or hubris which turned our bank regulators, those who foremost should be on the outlook for unexpected losses, into some risk taking monsters?  Allowing banks to leverage their equity 62.5 to 1 when lending to a private corporation, only because of AAA ratings, or to a nation with ratings such like those Greece had; or to even assume the existence of “infallible sovereigns” and in which case they allowed banks to leverage their capital infinitely… points at nothing else but insane risk-taking. Unless they are plain dumb something external must have influenced regulators to blind themselves to the fact that financial crises are never caused by excessive exposures to "the risky", but always by excessive bank exposures to something erroneously thought as "absolutely safe"

Coates refers to Lord Owen, a former British foreign secretary and a neurologist by training describing the “hubris syndrome” as “a disorder of the possession of power, particularly power which has been associated with overwhelming success, held for a period of years and with minimal constraint on the leader [which] can result in disastrous leadership and cause damage on a large scale. And Coates further clarifies it writing “This syndrome is characterized by recklessness, an inattention to detail, overwhelming self-confidence and contempt for others.”

I do not know about testosterone, cortisol or cocaine but,  since I quite recently heard one of the most important bank regulators saying “if bankers don’t like it let them be shoemakers” I would settle for the hubris of bank regulators, that which made them think they could act as risk managers for the whole world, as being the principal cause of the financial crisis… sprinkled of course with a heavy dose of ideology.

In Bill Easterly´s terms... God save us from the tyranny of experts!

This financial crisis did not disprove the efficient market hypothesis.

One of the most mentioned aspects about the current bank crisis is that in much it was a consequence of Alan Greenspan believing blindly in the efficient markets hypothesis, a hypothesis that became so thoroughly discredited.

Sorry… what efficient markets? With respect to the allocation of bank credit, the markets were completely distorted by the risk-weighted capital requirements, and so that hypothesis had no chance to be proven or disproven.

The capital requirements were and are much lower for what is perceived as absolutely safe, than for what is perceived as risky, and so the risk-adjusted returns on bank equity are much higher on assets perceived as absolutely safe than on assets perceived as safe.

In terms of the equity markets this would be something similar to the government multiplying the profits of investors, by paying them bonuses or similar subsidies, whenever they invested in shares with low volatility and not in shares with high volatility. Do you really think that would allow for an efficient market hypothesis to work free at its leisure?

I am not saying that the markets behave efficiently all the time but that, this time at least, it was clearly not the fault of markets, but the fault of dumb regulators.

PS. These comments were inspired by reading Chapter 1, "Primordial Seeds" in James Owen Weatherall's "The Physics of Wall Street" and which contains a fascinating description of the origins of the hypothesis and of its first and almost forgotten originator Louis Bachelier.

PS. I should acknowledge Tim Harford's arguments that though not the same do point in the same direction.

Would you buy a used bank regulation, Basel III, from those who previously sold you the lemon of Basel II?

A bank regulation like Basel II, based on capital requirements that are much lower for assets perceived ex ante as “absolutely safe” than for assets perceived as “risky” is, in terms of how bank regulations come, a real lemon.

Suffice to say that the current crisis, just like all the other bank crises in history, has resulted from excessive bank exposures to what was ex ante erroneously perceived as “absolutely safe”, like AAA rated securities, housing sector and sovereigns like Greece, and not from what was ex ante perceived as “risky”, like medium and small businesses, entrepreneurs and start-ups.

And of course these regulations also distort the allocation of bank credit to the real economy, something which is dearly being payed by all those young unemployed who could turn into a Lost Generation

The problem though is that the same men who are to blame for the Basel II lemon are still in charge and now working on Basel III, applying the same principles… though in a more complex and even less understandable way.

Below just four of them

Stefan Ingves, the current Governor of Sveriges Riksbank, the Swedish Central Bank, and the Chairman of the Basel Committee for Banking Supervision.

Mark Carney, the current governor of the Bank of England and the current Chairman of the Financial Stability Board.

Jaime Caruana, the former chairman of the Basel Committee, now promoted to General Manager of the Bank of International Settlements.

Mario Draghi, the former chairman of the Financial Stability Board (FSB) now promoted the current President of the European Central Bank, ECB.

Damn you, thick as a brick bank regulators.

Even though never ever have a bank crisis resulted from excessive exposures to what is perceived as “risky”, as these have always, no exceptions, resulted from excessive exposures to what has erroneously perceived as “absolutely safe”, our thick as a brick regulators require banks to hold immensely much more capital when lending to the medium and small businesses, the entrepreneurs and start-ups, than when lending to the “infallible sovereigns”, the AAAristocracy or the housing sector… and so of course no one is out there financing the creation of the jobs our young ones so urgently need. Damn you regulators!

They, the future, they do not need sissy risk adverse capital requirements based on credit ratings, they need capital requirements based on job creating ratings, and on planet earth sustainability ratings.

They do not need a bubble in our safe past... they need bubbles in their risky future!

Who is Mark Carney to talk about providing equal opportunity to all citizens?

We read Mark Carney the governor of the Bank of England saying “there is growing evidence that relative equality is good for growth. At a minimum, few would disagree that a society that provides opportunity to all of its citizens is more likely to thrive than one which favours an elite, however defined”

Who is he to talk about this? As a chairman of the Financial Stability Board, Mark Carney has approved for years risk-weighted capital requirements for banks, which discriminate against bank lending to “the risky”, those already discriminated against, precisely because they are perceived as “risky”, and favors bank lending to the “absolutely safe”, those already favored, precisely because they are perceived as “absolutely safe”.

Two simple questions on Basel II and III to Stefan Ingves, Mark Carney, Mario Draghi and other bank regulators.

Question 1: Do you really think that risk-weighted capital requirements for banks, which allow banks to earn higher risk-adjusted returns on equity when lending to "the safe" than when lending to "the risky", do not dangerously distort the allocation of bank credit to the real economy?

Question 2: If no bank crisis ever has resulted from excessive bank exposures to what was ex ante perceived as "risky", and these have always resulted from too large exposures to what was ex ante perceived as "absolutely safe", why do you require a bank to hold more capital when lending to "the risky" than when lending to the "absolutely safe"?

How come XXX, who graduated as a financial expert from YYY, did not know this?

Anyone with some basic financial knowledge must know that banks allocate their portfolio to what produces them the highest risk-adjusted return on their equity; and that constitutes in its turn the best possible (or least bad) way of allocating bank resources to the real economy.

What I cannot for my life figure out is how come a financial professional does not understand that if bank regulators allow banks to hold much less shareholder’s capital against some assets, for instance those perceived as “safe”, than against other assets, for instance those perceived as “risky”, then the banks will earn higher risk adjusted returns on “safe” assets than on “risky” assets, which will distort the allocation of bank credit, and guarantee that the banks will hold too much “safe” assets and too little “risky” assets.

And of course when banks hold “too much” of a “safe” asset, then that asset could turn into a very risky asset for the banks. This is by the way something empirically well established. Never ever has a major bank crisis resulted from excessive exposures to what was perceived ex ante as “risky”, these have all, no exceptions, resulted from excessive exposures to what was ex ante, erroneously perceived as safe... like AAA-rated securities, Greece, etc.

And of course holding “too little” of the “risky” assets, like of loans to medium and small businesses, entrepreneurs and start ups, is very bad for the real economy which thrives on risk-taking, and is therefore, in the medium term, something also very risky for the banks.

How come all those reputable tenured finance professors in so reputable universities did not care one iota about the allocation of bank credit in the real economy was being so completely distorted by the risk-weighted capital requirements for banks? 

When stress testing banks in Europe, what is not on the balance sheets, is more important than what is on!

When managing risks, before discussing risk avoidance, one need to establish very clearly what risks one cannot afford not to take.

And, in bank supervision, a risk one cannot afford to take is that of banks allocating credit inefficiently to the real economy.

But since our current crop of bank regulators never ever asked themselves what the purpose of our banks was before regulating these, they never thought about that.

And so they allowed banks to hold much less capital when lending to “the safe”, like to sovereigns”, to the AAAristocracy or to the housing sector, than when lending to “the risky” job creating medium and small businesses, entrepreneurs and start ups.

And that meant banks earn much higher risk adjusted returns on equity when lending to “the safe” than when lending to “the risky”.

And that means the banks do not lend anymore to the “risky”… especially now when the banks are suffering from too little capital… the result of lending too much against too little capital to some “safe” who turned out risky, like Greece.

And that means the real economy is suffering… and our unemployed youth is running the very clear and present danger of becoming a lost generation-

And so when stress testing banks regulators should look at what is not on the balance sheets, which causes real stress in the economy… and so that they better understand what they did and why they should be ashamed of themselves.

By the way, Timothy F. Geithner’s recent book “Stress Test” completely ignores this distortion, which comes to show how little they understood and how little they still understand of what is going on.

“A ship in harbor is safe, but that is not what ships are for” John A Shedd, 1850-1926.

PS. The ECB released a detailed description of the Comprehensive Assessment and, of course it is not comprehensive enough to include what I here have referred to.

PS. The most adverse, the truly frightening scenario, which will NOT be stress tested for, is the what happens if bank regulators keep on distorting the allocation of bank credit as they do now.

When are small businesses going to ask regulators why banks need to hold more capital when lending to them?

Read Fed’s Chair Janet L. Yellen’s speech “Small Businesses and the Recovery” delivered at the National Small Business Week Event, U.S. Chamber of Commerce, Washington, D.C. on May 15, 2014

And then reflect that even though never ever has a bank crisis detonated because of excessive bank exposures to “risky” small businesses, nevertheless the regulators require the banks to hold much more capital when lending to them than when lending to the “infallible sovereign” the AAAristocracy or the housing sector.

And that means that banks can obtain much higher risk-adjusted returns on equity when lending to the “infallible sovereign”, the AAAristocracy or the housing sector, than what they can obtain lending to “risky” small businesses.

And that means that small businesses will have access to less bank credit, or to more expensive bank credit, only in order to make up for this competitive disadvantage imposed by regulators.

When are the “risky” medium and small businesses, entrepreneurs and start-ups ask for the why of this regulatory nonsense?

Young unemployed Europeans, you cannot afford having Mario Draghi, Mark Carney and Stefan Ingves hanging around.

Mario Draghi is the former chairman of the Financial Stability Board (FSB) and the current President of the European Central Bank, ECB.

Mark Carney is the current governor of the Bank of England and the current Chairman of the Financial Stability Board.

Stefan Ingves is the current Governor of Sveriges Riksbank, the Swedish Central Bank, and the Chairman of the Basel Committee for Banking Supervision.

These three gentlemen all believe that what is really risky is what is perceived ex ante as risky, which is something like believing the sun revolves around the earth... because any correct reading of financial history would make it clear that what is really risky ex post, is what is ex ante perceived as absolutely safe.

And that is why they have approved of risk weighted capital requirements for banks which allow banks to have much much less capital when lending to “The infallible”, like to sovereigns, the AAAristocracy or the housing sector, than when lending to “The Risky”, like to medium and small businesses, to entrepreneurs and start ups.

And that is why banks can earn much much higher risk adjusted returns when lending to “The Infallible” than when lending to “The Risky”.

And that is why banks cannot allocate bank credit efficiently to the real economy.

And that is why so many young Europeans are out of jobs and without real prospects of being able to land themselves some decent jobs, in their lifetime.

And that is why you must, urgently, let the Copernicus', the Galileo's, and the Kepler’s of financial regulations in.

Those who before they start avoiding risks might have asked themselves: "What risk is it that we can the least risk our banks not to take?"; and have answered that with…“the risk that banks do not lend to the risky medium and small businesses, to entrepreneurs and start ups... those who most need bank credit... those who are best positioned to find the luck we need to move forward”

Young of Europe... if you do not rock this regulatory boat you're lost! 

Holy moly! I always suspected bank regulators regulated from an ideological position, but I had never heard such a confession.

I arrived to Washington in November 2002 to take up a two year position, until October 2004, as one of 24 Executive Directors at the World Bank.

I was then already warning about the distortions that capital requirements for banks based on perceived risks would cause in the allocation of credit to the real economy… and already predicting that it all had to end with a big AAA-Bang.

As an example in November 2004, in a letter published by the Financial Times I wrote: “Our bank supervisors in Basel are unwittingly controlling the capital flows in the world. How many Basel propositions will it take before they start realizing the damage they are doing by favoring so much bank lending to the public sector (sovereigns)? In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits."

That because already in 1988 with Basel I the Basel Accord regulators gamed the equity requirements for banks in favor of the sovereigns, meaning the governments, meaning their bosses. This they did by allowing banks to hold much less equity against loans to the infallible sovereigns than against loans to the risky citizens.

But over the years in hundred of conferences, I never got anyone reasonably high up to explain the why they did it… that is, until May 1 2014, at Brookings Institute, during a presentation of Jean Pisani-Ferry’s book “The Euro crisis and its aftermath”, Jörg Decressin, a deputy director in the IMF’s European Department, a former deputy director of IMF's Research Department gave me a very straightforward answer… bless him. 

I could not believe what I heard… and neither will you.

My question: (audio 58.30-59.30)

"I am Per Kurowski, a Polish citizen, A European, at least since last Monday, since I suffered a little intermezzo due to a minor problem with the translation of my birth certificate (from Venezuela).

In Sweden we heard in churches psalms that prayed for “God make us daring!” And risk-taking is definitive something that has made and created Europe.

But in June 2002 the Basel Committee introduced capital requirements which really subsidized risk aversion, and taxed risk-taking. For instance a German bank when lending to a German business man need to hold 8 percent in capital but if they lent to Greece they needed zero. 

And those capital requirements distorted the allocation of bank credit in the whole Europe. That is not mentioned in the book. Would you care to comment?"

Decressin’s answer: (audio 1.03.50 – 1.05.37) 

"The capital requirements taxing entrepreneurs… 8% on entrepreneurs, 0% on governments

You raise a very good question and an answer to this revolves around: 

Do you believe that governments have a stabilizing function in the economy? Do you believe that government is fundamentally something good to have around?

If that is what you believe then it does not make sense necessarily to ask for capital requirements on purchases of government debt, because you believe that the government in the end has to have the ability to act as a stabilizer, when the private sector is taking flight from risk, that is when the government has to be able to step in and the last thing we want is then for people also to dump government debt and basically I do not know what they would do, basically buy gold. 

If on the other hand your view is that the government is the problem then you would want a capital requirement, so it depends on where you stand 

I think the issue of the governments being the problem was very much a story of the 1970s and to some extent the 1980s. The problems we are dealing with now are more problems in the private sector, we are dealing with excesses in private lending and borrowing and it proves very hard for us to get a handle on this. We have hopes for macro prudential instruments but they are untested, and only the future will show how we deal with them when new credit booms evolve.”

Jean Pisani-Ferry… agreed and left it at that. 

Holy Moly! I always suspected it, but I never believed I would be able to extract a confession from regulators that they really are regulating from an ideological position!!!

And sadly I had no chance to ask back: Are you Mr. Decressin arguing that we must help government borrowings ex ante, so that government can better help us ex post? As I see it then, when we might really need the government, it will not be able to help us out because by then it would itself already have too much debt… like Greece.

In short, the structural reform most needed to make Europe grow, is to throw out the bank regulators and their risk aversion, and their pro-government and anti-citizens ideology!

The audio: http://www.brookings.edu/events/2014/05/01-european-crisis-aftermath#

Who authorized the regulators to apply their ideology when regulating banks?

How does this square with the frequent accusations of IMF representing the extreme neo-liberalism?

Am I new to the problems of the euro and the eurozone? Judge yourself!

PS. Jean Pisany-Ferry's completely ignored this problem in his book. The approval in June of 2004 of Basel II, is not even listed among the 119 dates and events presented in the “Euro crisis timeline”. A timeline which begins in February 1992 with the signing of the Maastricht Treaty and ends on December 18, 2014, with the European Council reaching an agreement on the Single Resolution Mechanism.