The crisis explained in a tweet

Setting capital requirements for banks regulators cared about perceived risks, and not about how bankers react to these http://bit.ly/PcPq63

Registering a complaint with the Financial Ombudsman Service in UK

Sir, http://www.financial-ombudsman.org.uk/

The current capital requirements for banks are based on perceived risk, and are set considerably higher for when lending to “risky” subject than when lending to an “infallible”. 

This does not make sense, and it discriminates against those who are already discriminated against by being perceived as "risky", like small businesses and entrepreneurs, and benefits those who are already benefitted by virtue of being perceived as "infallible", like the triple-A rated and some temporarily lucky sovereigns.

That discrimination translates into that bank lending to the “infallible” can be leveraged many times more on bank equity than lending to the “risky”, and which in its turn signifies that the “risky”, on top of the higher risk margins already paid to the bank, have also to compensate the banker for this regulatory opportunity cost. That cost can often signify well over a hundred basis points… in fact it could be qualified as the mother of all interest rate manipulation schemes. 

Now if you absolutely cannot convince the regulator to stop discriminating based on perceived risks, then try at least to convince them of not using the perceived risks as such, but instead base their capital requirements on how bankers react when they see these perceive risks. 

And then, please remind them of Mark Twain’s banker, you know he who lends you an umbrella when the sun shines but wants it back the minute it looks like it could rain. Perhaps then they would be able to understand that if some bank assets should require higher capital than others, it is the assets perceived as absolutely the safest… and not the poor “risky” who have never ever caused a major bank crisis.

Thanks

Me, as a bank investor!

As an investor in a bank the first thing I want from it is to dedicate itself exclusively to lending to what is officially considered as “risky”, like small business and entrepreneurs, and for which the bank is required to have capital... meaning I count. 

I abhor my bank to lend to anything that is officially considered as “absolutely safe” for 4 reasons: a.- it will probably mean they will be less careful, b.- they can do so with much less bank capital and so therefore as a shareholder I become less important, c.- it is only in what is considered as not risky that the banks can build up exposures that can lead me to lose it all, d.- if I want to invest in something perceived as “absolutely not risky”, I do not need a bank for that... anyone can read a credit rating.

By the way, I suppose you have heard about risk-adjusted returns?

There are two completely different narratives explaining the crisis.

One narrative, the one favored by Matt Taibbi and alike is “It was all criminal intent… those banksters… they have to be destroyed…in fact everything in our society is rotten and it has to be destroyed”

The other, the one I know to be truer is “Of course, as always plenty of criminal action and human frailty was present, but is was primarily a consequence of almost criminal regulatory stupidity”.

Guess which version gets the highest ratings in our polarized reality show world?

You´ve got it! Mine does not even come close.

Run for your lives! A baby has peed in the pool!

I really do not care much about The Libor Affair, an interest rate manipulation scandal that has some winning and others losing, not really of much importance in the grand scheme of things.

And so, when compared to other official interest manipulations, like what happens when regulators dole out risk weights based on perceived risks to set the specific capital requirements for banks, The Libor Affair is basically the same as a little baby peeing in a big swimming pool. If chemical elements are used to detect it, and water turns blue, then everyone screams, though in fact no one really needs to care that much about it.

What really should upset us all is The Basel Affair, the greatest and most dangerous interest rate manipulation ever.

The complaint I presented to the Consumer Financial Protection Bureau CFPB

Introduced by means of:

https://help.consumerfinance.gov/app/tellyourstory

I refer to the Equal Credit Opportunity Act (Regulation B) in order to present the following complaint: 

Banks consider credit risk information, like that contained in credit ratings, when setting interest rates, amount of loans and other contractual terms… this causes a natural market based discrimination of those perceived as risky. We all know well Mark Twain’s description of a banker: that as the one who lends you the umbrella when the sun shines, and wants it back, urgently, when it looks like it is going to rain. 

But when bank regulators use the same credit risk information, in order to also determine the capital requirements for the banks, then they produce artificial regulatory discrimination in favor (a subsidy) of those already favored by being perceived as not risky, and against (a tax) those already being disfavored by being perceived as risky. And I argue that this regulatory discrimination is contrary to the spirit of the Equal Opportunity for Credit. 

The discrimination occurs in the following way. If a bank is allowed to have less capital when lending to the not risky that signifies he can leverage its equity more and therefore obtain larger returns on equity when lending to the “not-risky”. If a bank is forced to have more capital when lending to the risky that signifies it can leverage less its equity and therefore obtains lesser returns on equity when lending to those perceived as “risky”. To make up for this regulation and present the banks with the same opportunity of returns on their equity, the “risky” need to pay an additional interest rate, and this additional is quite substantial. 

The capital requirement regulations are explained in terms of making the banks safer, but that is not the case, in fact it makes the banks more unsafe. There has never ever been a major bank crisis that has resulted from excessive exposures to what was perceived as risky, think of Mark Twain’s banker, they have all resulted from excessive exposures to what was ex ante considered not risky, but, ex post, turn out to be very risky. And in that respect it allows for excessive leverage buildup precisely in those areas that contain the greatest risk and consequences of bad surprises, namely the lending to what is perceived as “not-risky”. 

Let me just end by commenting on the great contradiction that the discrimination of those perceived as risky, like the small businesses and entrepreneurs, really signifies in “a land of the brave”. 

Please help stop that odious discrimination. To deny those perceived as risky fair access to bank credit, is an act of regulatory violence.

PS. https://subprimeregulations.blogspot.com/2013/11/have-risk-weights-of-current-bank.html

PS. Just in case, the returns on equity I speak of are of course the risk-adjusted ones.

PS. You doubt what I say? Ask regulators these questions.

A brief summary of my thoughts on banks and risks

Capital requirements for banks which are lower when the perceived risk of default of the borrower is low, and higher when the perceived risk is high, distort the economic resource allocation process. This is so because those perceptions of risk, have already been cleared for, by bankers and markets, by means of interest rates and amounts of exposures. 

All current dangerous and obese bank exposures, are to be found in areas recently considered as safe and which therefore required these banks to hold little capital. What was considered as “risky” is not, as usual, causing any problems. This is not a crisis caused by excessive risk taking by the banks, but by excessive regulatory interference by naïve and nanny type regulators. 

And, if that distortion is not urgently eliminated, all our banks are doomed to end up gasping for oxygen and capital on the last officially perceived safe beach… like the US Treasury or the Bundesbank.

Bank regulators have no business regulating based on perceptions of risks being right, their role is to prepare for when these perceptions turn out to be wrong. 

You do not regulate banks based on perceived risks but based on what banks might do with the perceived risks.

A nation that cares more for history, for what is has got, for the haves, for their baby-boomers, for "The Infallible", the AAA rated or sovereigns, than for the future, for what it can get, for their young, for the not-haves, for "The Risky", the small businesses or the entrepreneurs, is a nation on its way down.