Saturday, March 23, 2013

There is plentiful of vested interest in hiding a major bank regulatory stupidity.

In my country Venezuela, during many decades, the interest rate charged by banks was fixed by the government, and was the same for all borrowers, independently of the risk that each one of them was perceived to represent. Under such circumstances, a system of capital requirements for banks based on perceived risks, more-risk-more-capital less-risk-less-capital, makes sense. 

But, when banks already clear for perceived risks, by means of interest rates, amounts of exposure and other contractual terms, then re-clearing for the same perception in the capital requirements, makes absolutely no sense. 

And yet capital requirements based on perceived risks, is the pillar of the Basel Committee’s bank regulations. How on earth could this have happened? Why was, and is, this never questioned? 

The unhappy Barings’ Bank trader Nick Leeson writes in his memoirs: “And they never dared ask me any basic questions, since they were afraid of looking stupid about not understanding futures and options.” And if we add that most or perhaps all of the discussion on bank regulations take place in a mutual admiration club, where one does not harshly question colleagues, do I need to explain more? 

The current capital requirements for banks allow banks to earn immensely higher expected risk adjusted returns on equity when lending to “The Infallible” than when lending to “The Risky” and this creates a distortion that makes it impossible for banks to allocate economic resources efficiently. 

It dooms the banks to end up, sooner or later, with extremely high exposures to something wrongly perceived as safe and little capital to back it up with. Like in AAA rated securities backed with lousily awarded mortgages or in loans to Greece. 

It also dooms those actors within the real economy who are perceived as “risky”, like small businesses and entrepreneurs, to have less and more expensive access to bank credit. 

On the web site of Nick Leeson we find the question: “How could one trader bring down the Barings banking empire that had funded the Napoleonic Wars?”

And we could just the same ask: How could an idea so stupid it will bring down all the economies of the Western World find approval among experts? 

Well think about all banks regulators, all academicians, all ministry of finance bureaucrats, all central bankers, all finance journalists, all “financial crisis 2007-08 experts” and so many more who have not said a word questioning these loony capital requirements, and you will understand that there is huge amount of vested interest in banding together to silence this most embarrassing truth. 

But, the truth needs to come out, and the responsible need to be held accountable, so as to help us out of the current crisis, and so to make it less possible that a small group of expert global regulators will again be allowed to mess it all up this much. 

How can we help? Easy, ask any potential silencer to explain to you the rationale behind capital requirements, beyond what that fuzzy “more-risk-more-capital less-risk-less-capital, it sounds logical” provides. 

If he can’t, then tell him “So I should assume you do not understand it? ... And send me his name. 

If you would ever get an answer that makes sense, please send it to me, and if correct, I would as they say, have to eat my hat and much humble pie.