How dumb can we allow our bank regulators to be?

The Financial Stability Board in its meeting on June 24, 2013 in Basel declared:

“Despite important progress in strengthening the resilience of the global financial system, some parts of the system remain in a state of incomplete repair. Some jurisdictions need to continue to improve the capitalisation of their banking systems.”

But, of course, not a word that it was them, and their chums at the Basel Committee who, with that mother of all bad inventions, namely the capital requirements for banks based on perceived risk, allowed the banks to explode their balance sheets on what was perceived as “absolutely safe” holding almost no capital; and completely ignoring the fact that all major bank crisis, no exclusions, have detonated because of excessive exposures to what was perceived as “absolutely safe”, but turned out not to be.

1.6 percent in capital, a 62.5 to 1 leverage when lending to Greece but 8 percent capital, five times less, a 12.5 to 1 leverage when lending to a German unrated entrepreneur. How dumb is one allowed to be?

These regulators should all be sent home… disgraced... and paraded with a dunce cap, a cone of shame, on their heads.

PS. This was written before I knew that EU authorities had assigned all eurozone sovereigns, including Greece, a 0% risk weight, which meant allowing infinite leverage.

PS. My letter to the Financial Stability Board

But when will Europe debate “Regulatory Abuse of Market Regulation”?

In Europe the European Parliament, and others related, are debating a “Market Abuse Regulation”. That is OK, though I must wonder about when they will begin debating “Regulatory Abuse of Market Regulation”?

Allowing banks to hold much less capital when lending to “The Infallible” than when lending to “The Risky”, as Basel II and III regulations do, allow banks to earn much higher expected risk-adjusted return on their equity when lending to the AAAristocracy than when lending for instance to small- and medium-sized enterprises… and that, as anyone should be able to understand, is as abusive to the market as can be!

Ask the regulators!

You tell me, is Mario Draghi being shameless, or is he just ignorant?

In a speech before the French National Assembly in Paris, 26 of June 2013, Mario Draghi, the President of the ECB, said:

“The ECB has been very active in responding to the crisis. We have robustly defended the stability of our monetary union and therefore of our money. And we stand ready to act again when needed.

However, it is important to acknowledge that there are limits to what monetary policy can achieve. This is not a question of the scope of our mandate. It is fundamentally about what different institutions are empowered to do.

One pertinent example is the current shortage of credit for many households and small- and medium-sized enterprises. Credit provision requires funding, capital and a positive risk assessment. The central bank can help ensure funding and address macroeconomic risk. But it cannot provide capital, nor can it affect banks’ assessment of the creditworthiness of individual borrowers.

Similarly, monetary policy cannot create real economic growth. If growth is stalling because the economy is not producing enough or because firms have lost competitiveness, this is beyond the power of the central bank to fix.”

And I repeat: “the current shortage of credit for many households and small- and medium-sized enterprises… The central bank … cannot provide capital, nor can it affect banks’ assessment of the creditworthiness of individual borrowers”

And this is the same Mario Draghi who for many years chaired the Financial Stability Board, that which fully endorsed the Basel bank regulations.

The central bank, though more precisely the regulators, do “not affect banks’ assessment of the creditworthiness of individual borrowers”, but, since they decide how much bank equity goes with each one of those assessments, they decide how much risk-adjusted return on equity banks should expect from each individual borrower. 

And since Basel regulations, allow banks to hold much less capital when lending to “The Infallible” than when lending to “The Risky”, the banks earn much higher expected risk-adjusted return on equity when lending to the AAAristocracy, than when lending to the “many households and small- and medium-sized enterprises”

And that constitutes precisely the fundamental cause for “the current shortage of bank credit to many households and small- and medium-sized enterprises”.

And that is so especially now, given the immense bank capital shortage that has resulted from for instance having allowed banks to lend to ("almost infallible") Greece holding only 1.6 percent in capital, something which implies a mindboggling allowed leverage of equity of 62.5 times to 1.

And so, you tell me, is Mario Draghi being shameless, or is he just ignorant?

Why, why, why? What is this Basel Committee bank regulation lunacy?

What if the Department of Education ordered that all teachers who were teaching those perceived as brighter should receive a substantial bonus, not payable to those teaching those perceived as less intelligent?

And I ask that because something like that it is precisely what the bank regulators of the Basel Committee do when they allow banks, doing normal banking business, to earn a much higher risk adjusted return on their equity when lending to “The Infallible”, like to the AAAristocracy, than when lending to “The Risky”, like to small businesses and entrepreneurs. Tell me what lunacy is this?

And I ask that because those regulations translates into “The Infallible” having even more access to bank credit at even lower interest rates, and “The Risky”, having even less access to bank credit at even higher rates.

And I ask that because no major bank crises ever has resulted from excessive exposures to “The Risky” they have all, no exceptions, resulted from excessive exposures to what was erroneously thought as belonging to “The Infallible”.

And I ask that, because our real economy did not get prosperous, nor did we get our jobs when young, by the banks lending solely to “The Infallible”. We need our banks to lend to “The Risky”, with reasoned audacity.

The Basel Committee seems to be drowning in in-house surrealism. Put it out of its misery

Risk weighted capital requirements are insane, since the perceived risks they are based on, are already been cleared for in interest rates, amounts of exposure and other terms. 

And not only am I saying it. Anat Admati and Martin Hellwig recently wrote “the studies that support the Basel III proposals are based on flawed models and their quantitative results are meaningless. For example, they assume that the required return on equity is independent of risk”.

And now the Basel III reformers are introducing a simple, transparent, non-risk based leverage ratio of 3 percent to act as a credible supplementary measure to the risk-based capital requirements.

And they argue they do that to “reinforce the risk-based requirements with a simple, non-risk-based "backstop" measure.” “reinforce”? They’ve got to be joking. "Supplementary" as they say,  perhaps somewhat, though the fact remains that capital requirements will still be based on perceived risk and therefore still favor “The Infallible” those already favored by banks and markets, and discriminate against “The Risky” those already discriminated against by banks and markets.

And read this! “Implementation of the leverage ratio requirement has begun with bank-level reporting to supervisors of the leverage ratio and its components from 1 January 2013, and will proceed with public disclosure starting 1 January 2015.” And which means that before January 1st 2013 we the public, will not have the right to know how really leveraged our banks are.

The Basel Committee seems to be drowning in in-house surrealism, and some ministers or central bankers should show some mercy and put it out of its misery

Why can´t a sequestration begin cutting where it could be most productive?

G8, for the unemployed young ones sake, please wake up! We do not pray “God make us daring” for nothing.

G8, the world has not reached this far by avoiding taking risks. Current bank regulations which by allowing banks to hold much less equity against assets perceived as “absolutely safe” than against assets perceived as “risky”, allow banks to earn much higher expected risk-adjusted returns on equity when lending to The Infallible than when lending to The Risky. 

That has castrated our banks which makes it impossible for these to allocate economic resources efficiently in the real economy. That dooms our youth to unemployment. Never forget The Infallible of today were The Risky of yesterday.

That does not make our banks safer either, as it only guarantees that any absolutely safe-haven will, sooner or later, become dangerously overpopulated, and then catch our banks with their pants down, meaning with no capital. Just consider how Basel II did Europe in.

G8, please wake up and throw away current bank regulations issued by the Basel Committee. We do not pray “God make us daring” for nothing.