A letter from a citizen to Mme Christine Lagarde

Dear Mme Christine Lagarde.

I wish you all the best of luck as the new Managing Director of the International Monetary Fund… albeit that luck I wish not only for yourself, but also because at this moment it really behooves us all that you’ll have lots of it.

But, just as another of the most humble stakeholders in the IMF, an ordinary citizen, and since IMF has a fundamental role in leveraging knowledge and ideas with respect to the world’s financial system, I would beg you to consider the following that I feel is crucial for yours and our chances of success.

Currently the “capital requirements for banks” are set by discriminating borrowers based on their “perceived risk of default”, mostly as perceived by the credit rating agencies. More perceived risk, more capital, and vice-versa.

But, this is not logical, given the fact that what regulators need not to concern themselves much with the risks that are perceived, but should concern themselves mostly with the risks that are not perceived.

And, it is also not logical, given the fact that there has never ever been a financial crisis resulting from excessive lending to what is perceived as “risky”, since, except for cases when fraudulent behavior has been present, they have all resulted from excessive lending to what is perceived as “not-risky”. Just look at the current crisis, 100% caused by leveraging the perceived as "not-risky" and then discovering these, later, as being very-risky!

And, it is also not logical, given that those perceived as “risky” are already compensating the capital accounts of the banks by means of paying higher risk-adjusted interest rates.

And, it is also not logical, given that it imposes on those deemed as “risky”, like the small business and entrepreneurs, the need to pay additional interest margins to banks, which I currently calculate in the order of 270bp, just to compensate for the regulatory advantages given to those who are perceived as “not-risky”, the triple-A rated.

And, it is also not logical, given that those deemed as “risky”, like the small business and entrepreneurs, with little or no access to capital markets, are often those whose credit needs we most expect our banks to serve.

Mme Lagarde, if you absolutely think bank regulators must interfere by defining capital requirement for banks in ways that discriminate among borrowers, then… why not have the regulators discriminate the capital requirements for banks based on the potential of the different borrowers to generate the next generation of decent jobs?

Again, wishing you (and us) the best of luck

Yours sincerely,

Per Kurowski

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

Our crazy bank regulations explained in red and blue