Tuesday, November 30, 2004

Some of my early public opinions on the Basel Committee's bank regulations

Background: It was John Kenneth Galbraith with his "Money: Whence it came, where it went” (1975), plus the fact that in Venezuela, my homeland, as a corporate strategy and financial advisor I began to receive some very bad vibes from bank regulations coming out from Basel, that got me hooked on this theme. I quote Galbraith:

"Banks opened and closed doors and bankruptcies were frequent, but as a consequence of agile and flexible credit policies, even the banks that failed left a wake of development in their passing"

"As the regulations affecting the activities of the banking sector are increased, the possibilities of this democratization of capital would decrease. There is obviously a risk in lending to the poor."

June 1997, in an Op-Ed VenezuelaIf we insist in maintaining a defeatist attitude which definitely does not represent a vision of growth for the future, we will most likely end up with the most reserved and solid banking sector in the world, adequately dressed in very conservative business suits, but presiding over the funeral of the economy. I would much prefer the regulators to put some blue jeans on and try to help to get the economy moving.”

October 1998, Op-Ed Venezuela: “In many cases even trying to regulate banks runs the risk of giving the impression that by means of strict regulations, the risks have disappeared. Sometimes it is good faith... sometimes it is only pure faith… Frequently, in matters of financial regulations, the most honest, logical and efficient is simply to alert about the risks and allow the market, by assigning prices for them, to develop its own paths. I do not propose, not for a moment, that the State abandons completely the regulatory functions, much the opposite, what I propose is that it assumes it correctly. History is full of examples of where the State, by meddling to avoid damages, caused infinite larger damages

November 1999, Op-Ed Venezuela: “The possible Big Bang that scares me the most, is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause its collapse

July 2000. Extracted and translated from Op-Ed in Venezuela: "Financial regulations. Banking, in addition to promoting savings, offering reasonable returns and certainty of recovery, must fulfill the functions of supporting economic growth and democratizing access to capital. In terms of banking regulation, it would seem that the country has forgotten these last two functions, accepting, without blinking, the Basel regulations, much more appropriate for the banking of an already developed country than for ours. There is nothing wrong with being a developing country, what is wrong is believing that by simply adopting different positions, you can reach another level of maturity – like a little girl who borrows her mother's lipstick to feel grown up."

March 2001, Op-Ed Venezuela: “Beware of bank consolidation” (an early manifestation against too big too fail and govern banks, and against too few bank regulation criteria) “Today, when the world seems to be asking much for bank mergers or consolidations, I wonder if we on the contrary should be imposing on banks special reserves depending on their size. The bigger the bank is, the worse the fall, and the greater our need to avoid being hurt

September 2002, Op-Ed Venezuela: “The riskiness of country risk: What a nightmare it must be to be a sovereign risk evaluator! If they underestimate the risk of a given country, it will most assuredly be inundated with fresh loans and leveraged to the hilt. If on the contrary, they exaggerate the country’s risk level, it can only result in making access to international financial markets more difficult and expensive. Any mistake will turn out to a self-fulfilling prophecy. Any which way, either extreme will cause hunger and human misery.”

January 2003, while an ED of the World Bank, in a letter published by the Financial Times: “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

March 2003, in a formal discussion at the Executive Board of the World Bank: “The financial sector’s role, the reason why it is granted a license to operate, is to assist society in promoting economic growth by stimulating savings, efficiently allocating financial resources satisfying credit needs and creating opportunities for wealth distribution. Similarly, the role of the assessor –in this case, the World Bank– is to fight poverty, and development is a task where risks need to be taken.

From this perspective I have the impression that the Financial Assessment Program Report might revolve too much around issues such as risk avoidance, vulnerabilities, stress tests and compliance with international regulations, without referring sufficiently to how the sector is performing its social commitments.

Risk aversion comes at a cost - a cost that might be acceptable for developed and industrialized countries but that might be too high for poor and developing ones. In this respect the Bank has the responsibility of helping developing countries to strike the right balance between risks and growth possibilities…. In this respect let us not forget that the other side of the Basel [Committee’s regulatory risk weighted capital requirements] coin might be many, many developing opportunities in credit foregone.

The sole chance the world has of avoiding the risk that entities such as the Basel Committee, accounting standard boards and credit rating agencies introduce serious and fatal systemic risks, is by having an entity like the World Bank stand up to them, instead of sort of fatalistically accepting their dictates."

April 2003, in a formal written statement delivered as an ED of the World Bank: “The Basel Committee dictate norms for the banking industry… 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.

April 2003, commenting on the World Bank's Strategic Framework 04-06 "A mixture of thousand solutions, many of them inadequate, may lead to a flexible world that can bend with the storms. A world obsessed with Best Practices may calcify its structure and break with any small wind."

"Nowadays, when information is just too voluminous and fast to handle, market or authorities have decided to delegate the evaluation of it into the hands of much fewer players such as the credit rating agencies. This will, almost by definition, introduce systemic risks in the market"

May 2003, in comments made at a workshop for regulators at the World Bank There is a thesis that holds that the old agricultural traditions of burning a little each year, thereby getting rid of some of the combustible materials, was much wiser than today’s no burning at all, that only allows for the buildup of more incendiary materials, thereby guaranteeing disaster and scorched earth, when fire finally breaks out, as it does, sooner or later. 

Therefore 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. 

Knowing that “the larger they are, the harder they fall,” if I were regulator, I would be thinking about a progressive tax on size”

May 2003, in the same workshop above: “Be careful, when looking for ways of avoiding a bank crisis, you could be inadvertently slowing development. I have been sitting here for most of these five days without being able to detect a single formula or word indicating that growth and credits are also a function of bank regulations.” 

May 2003, Op-Ed Venezuela: “In a world that preaches the worth of the invisible hands of the market, with its millions of mini-regulators, we find it so strange that the Basel Committee delegates, without protest heard, so much responsibility in the hand of so very few and human-fallible credit rating agencies… Perhaps we need to include a label that states: Warning excessive banking regulations from the Basel Committee can be very dangerous for the development of your country

Paraphrasing George Clemenceau: Regulation of the financial system is too important to be left in the hands of regulators and bankers.

October 2004, in a written statement delivered as an ED at the Board of the World Bank: “We believe that much of the world’s financial markets are currently being dangerously overstretched, through an exaggerated reliance on intrinsically weak financial models, based on very short series of statistical evidence and very doubtful volatility assumptions

November 2004, in a letter published by the Financial Times: “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. Please, help us get some diversity of thinking to Basel urgently; at the moment it is just a mutual admiration club of firefighters”

PS. My 2019 letter to the Financial Stability Board

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