My proposal on capital requirements for banks

The Basel II bank regulations were built upon the pillar of a basic capital requirement of 8 percent, adjusted with risk-weights, based on the ex-ante perceived risk of default. Higher perceived risk, higher capital, and lower perceived risk lower capital. 

I have for years argued that this serves no useful purpose, and that it is outright dangerous because it stimulates the creation of excessive exposure to what is perceived as “not-risky” which is precisely what has caused and will cause all bank crises. Current Basel III proposal does nothing or very little to correct this fundamental fault. Here is what I propose. 

First of all, the capital requirement for all type of bank assets should be the same, for instance 8  to 12 percent, and this because the regulator has no role acting like a supreme risk manager for the world by arbitrarily assigning risk-weights, and which can only bring confusion to the market. 

But also if we want to try to have the banks fulfill their societal purpose, we could contemplate reducing somewhat those capital requirements, for instance with up to 4 percent, when the banks engage in loans that for instance serve the creation of jobs or environmental sustainability. 

The above is because if we taxpayers are going to shoulder some of the risks of a bank failing, as we indeed must, then we should at least make certain that if a bank fails, it does so while trying to do something useful for us.

Of course we need a transition period in order to allow the banks to obtain all that capital they should have held, had it not been for the minuscule risk-weights assigned by the regulator. And, in order not to squeeze those perceived as “risky”, like the small businesses and entrepreneurs, more than they are being squeezed, we should, during this transition period, reduce the basic capital requirement, for instance to 5 to 6 percent, which allows for a leverage of 20 to 1. 

A temporary reduction in the basic capital requirement would clearly create some risk, but so does government stimulus financed with public debt, and I firmly believe it is preferably to have our banks take the lending decisions than government bureaucrats.

My question at the Civil Society Townhall Meeting at the IMF and the World Bank:

The following is the question I made on September 22, at the Civil Society Townhall Meeting at the IMF and the World Bank: 

“Mme Lagarde, Mr. Zoellick, if bank regulators had defined a purpose for our banks, before regulating these, we might have had a different bank crisis, but none as large, systemic and dangerous as this one. 

And so I ask the World Bank and the IMF, our global development and stability agents, when are you going to require the regulators in the Basel Committee to openly and explicitly define the purpose of our banks… so as to see if we all agree.”

And Mme Lagarde answered: 

“On the purpose of banks, it is a very good debate to have, and it is one that I think the Vickers Commission Report is actually helping to build--what are banks for, and what are the state guarantees or general deposit guarantees intended for? Is it to actually guarantee the savers and the depositors, or is it something that is intended to fuel and benefit other activities that are really within a completely different realm of activities? 

My sense is that the most critical mission for the banks--and that is what we are trying to say when say that banks have to rebuild their capital buffers--is to actually finance the economy, first and foremost, and that should be really the critical mission” 

And here is how Mr. Zoellick answered: 

“Your point about the Bank regulators is a particularly intriguing one, and let me share with you a little anecdote. 

Bank regulators come out of the world of central banks, and central banks will be the last bastion to fall in openness and transparency. When Pascal Lamy, who is head of the WTO, who has dealt with civil society groups for many years, as I did, starting in the trade area--and I met with Mario Draghi at that time, head of the Financial Stability Board--we shared with him a story that some union groups had come to Basel and tried to get in the door and talk to people, and they were met with screams of uncertainty. And we have suggested--and I'll just pass this along--that they also have to build some outreach mechanism through the Financial Stability Board and openness and transparency. And I will just share this from my own learned experience. Some institutions--central banks in particular because of the sensitive market information--build in cultures of this, and it is understandable, but then, on the policy level, as you suggest, people need to get used to being more open about it. And I just think that that is something, again, that we can try to work with you with as a general principle. I think the world will move more in this direction, but it will take some time on it. 

And I agree with Christine's response to you about the fact that the good news is, as the discussion in Britain showed, that people are starting to debate the exact purpose of banks.” 

You can find the question in the video, minute 48:40, with Mme Lagarde´s answer minute 55:20 and Mr. Zoellick´s on 1.04:15. http://www.imf.org/external/am/2011/mmedia/view.aspx?vid=1176766541001

From both answers you can deduct what I have always and most loudly criticized about the Basel Committee, namely that they have regulated the banks without defining or even considering what is the purpose of the entities they regulate… How on earth can you regulate something well without defining its purpose?

The Basel Committee watchdog, is now to probe how banks measure assets? You´ve got to be kidding!

The following is from a statement of Stefan Walter, secretary general of the Basel Committee on Banking Supervision, on September 20 

"If risk-weighted assets are not calculated in the correct way then the integrity of the (capital rules) is compromised" …. “The Basel Committee of international banking regulators is to launch a study into how banks measure assets for meeting capital safety rules… will focus on how banks determine risk-weighted assets under existing rules, not on whether the regime itself should change.” 

It looks like the Basel Committee is beginning to understand the horrible dimension of its mistakes, but, what an amazing lack of fortitude! …now it wants to blame the banks… without referencing its own madness when determining the risk-weights of Basel II and how these are used. 

Basel Committee Members, You tell us! You who determined that capital requirements for banks when lending to a triple-A rated sovereign should be zero, and to sovereigns like Greece only 1.6 percent; you who assigned a risk-weight of only 20 percent for anything private sector related to a triple-A rating and therefore allowed the banks to have only 1.6 percent in capital and leverage up 62.5 to 1 when investing in securities collateralized with lousy awarded mortgages to the subprime sector …. How do you think banks should determine risk-weighted assets under existing rules? 

You should not need a study for that… just ask yourselves! For heaven´s sake, you ARE the regulators!

“That used to be us” misses completely that us used to be risk-takers.

Thomas L. Friedman and Michael Mandelbaum recently authored the book “That used to be us: How America Fell Behind in the World It Invented and How We Can Come Back” 

From the comments I have heard, I have not read the book yet, the authors, like most other thinkers, fail to understand the most fundamental cause the US, as well as the Western World, is falling behind, namely a growing risk-adverseness, and which is represented most clearly in the current bank regulations. 

Even though banks already take consideration of the risks of default they perceive when they set their risk-adjusted interest rates, and amounts the lend, the regulators ordered the banks to have higher capital when lending to those perceived as “risky” than when lending to those perceived as “not-risky”. 

Suffices to say, that translates into a subsidy to bank lending to those already favored by the market, like “good” sovereigns and the triple-A rated, and into a tax on bank lending to those already disfavored by the market, like the small businesses and entrepreneurs. 

Those regulations are inexplicable since whatever is perceived as “risky” does not carry in it the potential to cause a systemic crisis, only what is perceived as “not risky” can. 

Those regulations have been designed without a single word being stated about what the purpose of our banks should be, and much less with respect to how much risk they should take to fulfill their vital capital allocation role. 

One of the reasons the truth has not come out, is because the world has been caught into a linguistic trap. Most experts attribute the crisis to excessive risk-taking, but which considering that all the significant losses originated in what was ex-ante perceived as “not-risky”, must clearly be wrong. 

The US, and the Western Word, became what they are because of risk-taking, and without it the US, and the Western World, will stall and fall. 

With respect to this odious wall of regulatory discrimination against risk-taking, that needs to disappear if we are going to have a chance to Come Back, we can only shout out: “Mr. Regulator. Tear down that wall” 

PS. Here´s a short video that explains the current regulatory madness it in an apolitical red and blue! http://bit.ly/mQIHoi

The lending to Solyndra LLC conundrum

If banks lend to Solyndra LLC, directly, that solar panel maker which after given a $535 million federal loan guarantee recently filed bankruptcy, they need to hold 8 percent in capital, but, if they lend to the US government so that it can relend those funds to Solyndra LLC, the banks need no capital at all… Is this really the way you want it to be? 

Mr. Regulator. Tear down this Basel wall! 

PS. A video explaining current regulatory madness it in an apolitical red and blue! http://bit.ly/mQIHoi

Basel bank regulations are un-American, un-European and un-Western World

I do indeed think that current regulations are un-American, but I guess my reasons are not exactly those of Jamie Dimon.

Yes! It is un-American, because by allowing banks to leverage more their capital when earning the risk-adjusted-interest-rate from those perceived as “not-risky” than when earning the same rate from those perceived as “risky”, Basel regulations have introduced a silly and unproductive risk-adverseness that is not compatible with a “ the land of the brave”

Yes! It is un-American, because allowing banks to leverage immensely more their capital when lending to the government than when lending to their small businesses and entrepreneurs, is stealth communism, absolutely not compatible with “the home of the brave”

Yes! It is becoming even more un-American, because allowing some banks to be named Systemically Important Financial Institutions, SIFIs, against a token additional 2.5 percent equity paid over many years, and thereby awarding them a “Too-big-to-fail” franchise, and relegating de facto all other banks to the group of Systemically Un-Important Institutions, SUFIs, is, or should be, an un-American discrimination

PS. Here´s a video that explains a small part of the craziness of our bank regulations, in an apolitical red and blue! http://bit.ly/mQIHoi

Bank regulations and 9-11

It might be because I am a bit too risk-adverse that I have always felt that as long as the Western World remains brave, and willing to take risks, it will survive any threat, no matter how big these are, but, if it becomes coward and risk-adverse, then any minor cold could signify its demise. In this respect, with anguish, I must alert about the damages that the regulators are doing to our banks, the frontline financiers of our risk-takers. 

The banks have always discriminated based on what they perceive as the risk of default, which of course includes the information provided by the credit ratings. That they do by means of: the higher interest rates charged, the lower amounts lent, the shorter length of the loans, more collaterals required, the longer time allotted to investigate the credit worthiness of the borrowers, and of course the bankers´ own personal risk-adverseness... never heard about the banker lending the umbrella when the sun shines and taking it back when it rains? 

Therefore, when the bank regulators, the Basel Committee for Banking Supervision and friends, imposed capital requirements for banks based on the perceived risks of default, which allowed for much lower bank capital when the perceived risk of default was low as to what was required when the perceived risks were high, the regulators added a new, very arbitrary and dangerous, layer of risk adverseness. 

Those capital requirements discrimination signified that the risk-adjusted premiums for lending to what was perceived as not risky could be leveraged on bank capital much more that what the risk-adjusted premiums for lending to those perceived as risky could be. 

The immediate result was to generate a stampede of bank lending to the “not-risky”, like “approved” sovereigns and risk-free AAAs, which created the current crisis … and to provoke a withdrawal from lending to the “risky”, like the job creating small businesses and entrepreneurs, which keeps us from getting out of our current crisis. 

The saddest part of it all is that, more than three years into the crisis, the problem here mentioned is not even discussed and much less a part of the reforms of our bank regulations. Basel III still has the bank regulators acting as risk-adverse global risk managers…in other words diggings us deeper in the hole. 

In these days when we are remembering the horrors of 9-11, we need then to be aware that the bank regulators, unwittingly, are engaging in regulatory terrorism that will weaken the Western World much more than other better known forms of terrorism. 

Risk-taking is the oxygen of any development and movement forward… and, if you don’t move forward you fall…and so what’s it going to be Western World?

Ps. A video that explains a small part of the craziness of our bank regulation in an apolitical red and blue! http://bit.ly/mQIHoi