Friday, July 31, 2009

Capital requirements for banks could use a "credit risk - credit purpose" matrix

On July 29 2009, in Venezuela, the financial regulator, Sudeban, issued a norms by which the risk weights used to establish the capital requirements of the banks were lowered to 50%, when banks lend to agriculture, micro-credits, manufacturing, tourism and housing. As far as I know this is the first time when these default risk-weights and which resulted from the Basel Committee regulations, are also weighted by the purpose of the loan.

The way it is done Venezuela lack a lot of transparency and it could further confuse the risk allocation mechanism of the markets (though in Venezuela that mechanism has already almost been extinguished) but, clearly, a more direct connection between risk and purpose in lending is urgently needed.

In this respect the Venezuelan regulator is indeed poking a finger in the eye of the Basel regulator who does not care one iota about the purpose of the banks and only worry about default risks and, to top it up, have now little to show for all his concerns.

I can indeed visualize a system where the finance ministry issues “purpose weights” and the financial regulator “risk-weights” and then the final weight applicable to the capital requirements of the banks are a resultant of the previous two.

Does this all sound like interfering too much? Absolutely, but since this already happens when applying arbitrary “risk weights” you could also look at this as a correction of the current interference.

Friday, July 24, 2009

Mark to market the government’s bail-out efforts

In order to bring some transparency to what the government is doing in bailouts it should sell in the market, at 100% of nominal value, a portion of the instruments they have received in return for their bailout funds; and compensate any differences in the market value of these instruments with a tax-credit. How would it work?

Let us say the government has received $100 in shares of GM. If these shares are worth that amount the government would get their money back immediately but, if not, buyers would ask to receive a tax credit. If the market only asks for a 10% tax credit, meaning $10 in tax credit to purchase the GM shares for $100 then the government is not doing so bad but, if the market asks for 90% in tax credits, then clearly the government is pouring money down the drain.

That would certainly pressure the government into doing better. Problem though is that most probably government would never dare to have their own actions marked to market that way.

Thursday, July 23, 2009

The risk in not running the risk of the risky

The current crisis detonated because of investments in assets of the safest type, houses and mortgages; in the safest country, the US; and in the safest type of zero-risk instruments, triple-A rated, that turned out bad. Even so the immense majority of financial experts, even Nobel Prize winners, explain the crisis as the result of “excessive risk-taking”. They are wrong; the crisis is clearly the result of an extremely misguided excessive risk-aversion.

Looking to help the large international banks to compete better with the smaller local banks, and wanting also to avert a new bank crisis, the regulators from some developed countries got together behind closed doors in Basel and came up with what they thought was the brilliant idea of determining the capital requirements for the banks, based on how the credit rating agencies rated a loosely defined default risk of borrowers and securities.

We are not talking about something insignificant. According to the regulations known as Basel II and that apply or at least inspire most banking regulations in the world, in order to lend funds to a corporation that does not have a credit rating a bank is required to hold 8 percent in capital, but, if lending to someone rated AAA it is only required to have 1.6 percent. As you understand, these regulations, approved in June 2004, started a wild chase after the AAAs… and here we find ourselves where the global losses in what was supposed to be risk-free exceed many times what has been lost in what was considered to be more risky… among others because what is perceived as risky by itself always inspires more care.

This regulatory system is still applicable, causing immense hardships in the world economy. In tandem with how the ratings of borrowers worsen the banks need to obtain more capital and since bank equity is scarce, they try to obtain it freeing themselves from clients for whom because these have even worse credit ratings, they are required to hold even more capital. With that all bank clientele that is perceived as more risky, but that is just as or even more important to the economy, is exposed to additional pressures, just when they least need it.

Companies that are presenting difficulties and have to restructure their liabilities are among those most affected by these puritan and intrusive regulatory inventions. Clearly if the difficulties of a borrower seem to be unsurpassable the best things to do, for all, is to speedily cut it off from credit, but, if after having analyzed it, the decision is taken to help it out, it does not make any sense making it even more difficult for it, like by imposing higher capital requirements on its creditor banks. It should be just the opposite, not only because these companies need to be treated with delicacy, but also since normally, they have been more scrutinized than the majority of firms that show themselves off as representing zero risk.

It is natural that creditors would charge more or less for a loan in accordance with how they perceive the risk but… on account of what does a regulator arbitrarily intrude in the decision? Is by any chance a job in a company rated B- less important than a job in a company rated AAA?

Risk is the oxygen of all development and in this respect regulations oriented to conserve what has been developed because it is more likely to be perceived as less risky, are unacceptable. Less risky for whom? For the world? How naïve! There is nothing so risky for the world than to refuse to run the risk of the risky.

The triple-A ratings have, in only about four years, without leaving much development in its wake, taken over the precipice more capital than all that lent by the World Bank and the International Monetary Fund since their creation sixty years ago. I have for years debated and fought these regulations from Basel, in the World Bank, in the United Nations and on the web… while others lose their time and our oil revenues in such absolute irrelevancies as a Banco del Sur.

Translated from El Universal, July 23, 2009

Tuesday, July 21, 2009

Something´s terribly wrong

When parents seem to give more importance to their children´s credit score than their school grades, like setting them up to the fact that they will have to work their whole life in just to pay interests, something´s terribly wrong

Tuesday, July 14, 2009

The danger with financial literacy programs

They usually start with the "A"... as in AAA

Sunday, July 12, 2009

Thursday, July 9, 2009

Let´s give Darwin a hand and tax those prone to sickness and subsidize those who rate healthy!

If the regulators of the insurance companies would decide to follow the regulatory paradigm concocted by the Basel Committee, then they would pick three health inspection agencies to rate the health of the insured and require the insurance companies putting up more capital when insuring someone with a low health rating and letting it of the almost off the hook if the insured is deemed to be in tip top form.

Since equity costs a lot, especially in times of crisis, the above is equivalent to placing a de-facto tax on those prone to sickness or giving a de-facto subsidy to those who rate healthy, both these on top of what the market already charges for any differences in health

With their minimum capital requirements based on a vaguely defined and extremely narrow concept of risk and as measured by their three amigos the credit rating agencies, the Basel Committee subsidizes anything that finds it easier to dress up in AAA clothing and castigates what is perceived as higher risk.

With these regulations they drove in a wedge that further increases the differences between the unsustainable status-quo and the sustainable future we all must try to reach, which of course requires a lot of risk-taking.

The misguided risk-aversion these regulations was the major force behind channeling in just a couple of years more than two trillion dollars into the supposedly safest asset, houses, into the supposedly safest country, the USA and into the supposedly safest instruments, AAAs…for no particular good reason at all.

All in all these Basel financial regulations add up to a crime against humanity and against common-sense.