The curious case of the not curious journalists

Even though absolutely all major bank crisis have resulted from excessive exposures to what was ex ante perceived as absolutely safe, and none from excessive exposures to what was ex ante perceived as risky, current capital requirements for banks are much higher for what is perceived as risky than for what is perceived as safe. And that sounds quite curious indeed.

And one could have thought that financial journalists, like those at the Financial Times, would find that sufficiently curious so as to at least ask a bank regulator for a satisfactorily understandable explanation.

But no, they do not. Is not that quite curious too?

On dangerous bulls, friendly cows, and silly current bank regulations

One entrance says “Beware, dangerous bull here” 

The other “Welcome, only friendly cows here”

If the visitors cannot read you could take some further measures to enlighten them about a danger but, if they can, should you do more? 

Should you on top of it all,  fine all those who visit the bull, and pay a premium to those visiting the cows?

At what point should you substitute your own vigilante concerns for those of any possible visitors?

And, if you do so, at what point will no one ever visit the bull and so that it could become even shyer of humans and therefore more dangerous? 

And, if you do so, at what point might so many be visiting the cows so that the visitors, or even the cows, might get trampled to death?

Those questions reflect some of the difficulties which were not considered by regulators with respect to their capital requirements for banks based on ex-ante perceived risk. 

If bankers can read and understand those perceived risks, how much more must a regulator do in order to fulfill his duty?

Cannot it be so that if regulators also layer their concerns on to of those of the bankers, the whole banking system might overdose on perceived risks?

And if it does, could that not mean that the bulls of bankers, the “risky”, the small businesses and entrepreneurs, will never get any bank credit and the real economy starts to crumble?

And if it does, could that not mean that some of the cows of banking, the “safe” sovereigns and AAAristocrats, get too much credit and therefore become dangerous?

Basel Committee and Financial Stability Board, do our banks, and the real economy, live on different planets?

Can banks really be safe if the real economy is bad? What about banks’ role in allocating resources to the real economy? Is the risk of banks not supporting adequately the real economy really irrelevant?

I ask this again (for the umpteenth time) because again the Financial Stability Board has produced a consultative document titled “Principles for An Effective Risk Appetite Framework” which navel gazes on a banks internal risk assessments, and completely ignores referencing to any purpose of the banks, other than that stupid one of avoiding risks.

Members of the Basel Committee, and of the Financial Stability Board, we can assure you that if our banks run into trouble while assisting our real economy growing sturdy, we can live with that, but, if our banks are safe, but for instance our kids do not have jobs, that is unacceptable.

Right now this save the banks and forget the real economy fixation, is murdering the developed economies which became developed precisely because of a lot of risk taking.

Currently regulators allow banks to hold less capital against some assets, those perceived as “safe”, than against other, those perceived as “risky”; and that allows banks to earn a higher risk-adjusted return on equity when lending to “The Infallible” than when lending to “The Risky”; and that has introduced distortions which makes it impossible for banks to efficiently allocate resources in the real economy. 

Basel Committee and Financial Stability Board, is it you do not understand, or is it you just don’t care?

Basel Committee and Financial Stability Board, your own “Risk Appetite Framework” is totally screwed up.

Hey! Regulators! Leave them banks alone! All in all you're just another brick in the wall.

Regulators turned our banks into cash-cows milking machines

Allowing banks to lend to what is perceived as “absolutely safe” holding less capital than when lending to what is perceived as “risky”, allows banks to earn a higher expected risk adjusted return on equity when lending to what is perceived as absolutely safe than when lending to what is perceived as risky.

And that of course makes banks want to lend even more than usual to The Infallible, the sovereign and the AAAristocracy, and to lend much less than usual to what is perceived The Risky, the small and medium businesses and entrepreneurs.

And that in all essence means that banks are extracting the benefits of the risk-taking of the past, without investing in the risk-taking needs of the future.

In other words banks are using the past as a cash-cow; in other words regulators allowed banks using something like the mother of all a reverse mortgages, and which guarantees that our economies will extract as much equity it can for current consumption as is possible, and so leave much less for the next generation. 

Damn the bank regulators, nobody authorized them to do what they are doing.

God make us daring!

FT, the Financial Times of London, is not interested in possibly the greatest financial horror story ever.

Banks are allowed by their regulators to hold much less capital (equity) against assets which are ex ante perceived as absolutely safe, like loans to some sovereigns and to the AAAristocracy, than against assets perceived as “risky”, like loans to small and medium businesses and entrepreneurs.

That translates directly into banks being able to earn a much expected higher risk-adjusted return on its equity when lending to “The Infallible” than when lending to “The Risky”.

And that translates directly into the danger that some of The Infallible might get too much bank credit and as a result run into problems which, if and when this occurs, will catch banks standing there naked, with precious little capital to cover them up with, signifying a huge systemic bank crisis.

And that also translates directly into The Risky getting much less access to bank credit and having to pay much higher margins than what would have been the case in the absence of these regulations, signifying, among other, less job opportunities for our youth.

That very dangerous risk-aversion, or call it exaggerated embracement of safety, which is destabilizing our banks, and threatening the future of economies developed based on risk-taking, could be the greatest financial horror story ever.

Strangely enough, the journalists in the Financial Times of London, and to whom collectively I have written more than a thousand letterson the subject, seem not to be much interested.

I wonder why?

In other words, helped along by FT and other, the Baby Boomers’ après nous le deluge regulatory mentality, has the world consuming its past without creating its future

Will there be a mega bank run January 2015?

On January 1, 2015, the Basel Committee has indicated that banks should report their leverage ratio, not based on risk-weighted assets, but simply on total assets, and as of course, the banks should have done all the time.

And that would mean that a lot of banks which have presented themselves to society with an acceptable 8 /15 to 1 asset to capital ratio will, unless they take precautions, then have show that naked, without risk weighting, their real leverage might well be in the 20/40 to 1 range. 

And that should scare the hell of a market that, day by day, like in Cyprus, is seeing more signs reading “bank creditors, caveat emptor, you won’t be bailed out like before”.

The US banks, thanks to FDIC requiring more capital, are on the way of being able to show the lowest leverages. Most European banks, being more firmly in the hands of the Basel Committee, or vice-versa, seem will not be so lucky.

Go back over the last five years, and you will find innumerable comments, by experts, including regulators, referring to the low leverages of banks, without them having the faintest idea of how the modern Basel II leverages had been construed, and without the faintest idea that current leverages, after risk-weighting, can in no way be compared with the historical leverages based on un-weighted assets. 

At least it looks like the time of funny leverages is soon over.

Comments on Basel Committee's “The regulatory framework: balancing risk sensitivity, simplicity and comparability” of July 8, 2013

Basel Committee for Banking Supervision

Sir,

These are comments made in reference to your July 8, 2013 consultation document “The regulatory framework: balancing risk sensitivity, simplicity and comparability”

I would like to begin by clearly stating that for a long time I have completely objected the capital requirements for banks based on ex ante perceived credit risks. I consider these capital requirements to be totally insane and much responsible for causing the current bank crisis, as well as for impeding us getting out of it.

And to that effect I enclose a short opinion recently published in the Journal of Regulation and Risk - North Asia, Volume V Issue II Summer 2013. The “Mistake” that shall not be named

That said I would also like, just as an example of what I criticize, refer to the following in the document.

“73. For example, in increasing ex ante risk sensitivity and expanding risk coverage, the framework has progressively sought greater alignment of regulatory capital with economic capital. This approach is implicitly premised on the suitability of economic capital as an appropriate measure for regulatory purposes. But the relationship between economic capital and regulatory capital may need reexamination in the light of the recent shift in the focus of regulation and supervision from ensuring the soundness of individual institutions to, additionally, safeguarding the stability of the banking system.”

First, what are you saying? That “safeguarding the stability of the banking system” was not understood to be the role of the Basel Committee for Banking Supervision before? Do those who appointed you really agree with that statement?

Second, your regulatory capital based on ex ante perceived credit risk, even in the case of an individual bank, is an utterly incomplete reflection of economic capital, since it does not consider facts like the size of the exposures, meaning the portfolio diversification/concentration, or the duration of those exposures, for instance the interest rate risk.

And then let me briefly and partially answer some of your specific questions

Q1. Does the current framework, with its reliance on the risk-based capital at its core, appropriately balance the objectives set out in paragraph 29?

No! The core of the current framework, risk-based capital is completely wrong.

For instance, when in 29 you write “These ideas should be assessed against the primary aims of the capital adequacy framework: that is, the capital adequacy framework should…. take into account the effects of capital requirements on banks' risk-taking incentives, eg when faced with regulatory constraints on their capital (and therefore the size of their balance sheet), to seek higher-risk assets as a means of boosting expected returns”, you do not seem to comprehend the real problem.

The fact is that banks, “when faced with regulatory constraints on their capital”, primarily seek assets which have a low capital requirement, in order to boost expected risk-adjusted returns on equity

Q2. Are there other objectives that should be considered in reviewing the international capital adequacy framework?

Yes, like the little matter of the purpose of the banks; like that the capital adequacy framework should not be allowed to distort the bank credit allocation to the real economy. 

Q3. To what extent does the current capital framework strike the right balance between simplicity, comparability and risk sensitivity, given the costs and benefits that greater risk sensitivity brings?

To no degree at all, especially since the “greater risk sensitivity it brings” is only a quite arrogant ex-ante presumption.

Q4. Which of the potential ideas outlined in Section 5 offer the greatest potential benefit in terms of improving the balance between the simplicity, comparability and risk sensitivity of the capital adequacy framework?

In my opinion, a simple leverage ratio of 8 to 10 percent, complemented by a reporting requirement which includes; a report of risk adjusted leverage based on standardized risk-weights, and issued strictly for approximate comparative purposes; and some additional information on its portfolio diversification and duration, and that can be helpful for the market to get a sense of the risk structure of the bank.

The transition to such a reality though would have to be managed with a lot of intelligence in order not to make things worse.

Q5. Are there other ideas and approaches that the Committee should consider?

Yes!

How did Basel I, II and III evolve? How can we make sure that the serious mistakes in them and that I attribute to incestuous group-think within a mutual admiration club, are not repeated?

There is a need for a critical mass of qualified creditors in the market who know they will not be bailed out automatically from a bank problem.

Who authorized the Basel Committee to act as a risk-manager of our banks and the world?

If you want to do it right, you need to work with a whole set of new regulators who have no vested interest in defending what has been done in the past… remember, neither Hollywood nor Bollywood would ever dream of entrusting a Basel III to those responsible for Basel II flop.

Am I to harsh and impolite in my criticism? Considering the suffering and the millions of unemployed youth resulting directly from your faulty regulations, I do not think so.

Sincerely

Per Kurowski

http://subprimeregulations.blogspot.com/

Rockville, Maryland, USA

PS. If you want to download the whole journal from which my opinion was extracted you can go tohttp://www.scribd.com/doc/149858219/Journal-of-Regulation-Risk-North-Asia-Volume-V-Issue-II-Summer-2013

My opinion in The Journal of Regulation and Risk North Asia Volume V Issue II Summer 2013

Here is the link to "The 'Mistake' that dares not to speak its name", my opinion about the Basel Committees' bank regulations.

And here the link where you can download, for free, the whole journal

In it, I would also recommend the articles by Andrew G. Haldane and Thomas M. Hoenig

Mr. President, Mr. Prime Minister. Here is how to best help to create jobs for our youth

Our banks, for reasons that have not been adequately explained, because regulators themselves do not understand these, allow banks to hold much less capital (equity) against exposures perceived ex ante as “absolutely safe”, than against exposures perceived as “risky”.

That allows banks to earn much higher expected risk-adjusted returns on equity when lending to “The Infallible”, like sovereign and the AAAristocracy, than when lending to “The Risky”.

That distorts and makes it impossible for banks allocate economic resources efficiently in the real economy. 

And it also serves no purpose, since all bank crises in history have resulted exclusively from excessive exposures to what was erroneously perceived ex ante as absolutely safe, none from excessive exposures to what was perceived as “risky”.

And that hinders “The Risky”, the small and medium businesses and entrepreneurs, those who could perhaps generate of those jobs our youth urgently need, from having access to bank credit in competitive terms.

And therefore we must urgently eliminate this regulatory discrimination against risk taking. We did not get to where we are by avoiding risks, much the contrary.

In order to do that, the best route includes a mixture of:

Increasing capital requirements for banks, on exposures to “The Infallible”

Temporarily lowering capital requirements for banks, on exposures to “The Risky”

Creating the incentives needed to stimulate and facilitate important capital increases in the banks.

If regulators just cannot resist from interfering, ask these to give banks instead the incentives of lower capital requirements, based on potential-of-job-creation-for-our-youth ratings.

As is, banks do not finance the future they only refinance the past. God make us daring!

Mr. Fed some few questions on Basel III, bank capital, mortgages, jobs, "the absolutely safe", and the "risky"

And so Mr. Fed you will still allow banks to hold less capital against mortgages than against loans to businesses, only because, like the Basel Committee, you feels the former poses less risk for our banks. But frankly, Mr. Fed, long term, for the economy, and for the banks… how safe are houses without jobs?

And Mr. Fed you will equally still allow for capital requirements that are much smaller for exposures to what is considered (ex-ante) absolutely safe, than for exposures considered "risky".

Mr. Fed, could it really be that you do not understand that allowing banks to earn higher expected risk adjusted returns on their equity on assets perceived as “absolutely safe”, than on assets perceived as “risky”, introduces the mother of all distortions, which makes it impossible for banks to allocate resources efficiently in the real economy? 

Mr. Fed could it really be that you do not understand how the previous distortion destroys most of the effects on the real economy your quantitative easing programs could produce? 

Mr. Fed could it really be that you do not understand that the most important factor in keeping the banking system strong and healthy is a strong and healthy real economy?

Mr. Fed could it really be that you do not understand that there are no dangers for the banking system in waters perceived as risky, and that all the dangers to it lie in waters perceived as absolutely safe.

Mr. Fed do you not know Mark Twain said “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so”?

Is not the interest that is not earned on public debt because of public policies a tax?

In terms of taxation, who is affected by a higher real tax rate?

Someone earning 5 percent in interest on public debt and, supposing a tax rate of 20 percent, then has to pay 1 percent in taxes, resulting in net earnings of 4 percent, or, 

Someone only earning only 3 percent on public debt, because of QEs, lower capital requirements for banks when lending to sovereign, and other fancy stuff causes lower interest rates on public debt.

You tell me, or better yet, tell them!

Three Qs and As on our banks

Q. What is the first worst that can happen to our banks, excessive exposures to the risky?

A. No, the “risky” never poses any risk of excessive exposures, The first worst is when something considered as “absolutely safe”, and to which therefore bank exposures could be huge, blows up in their face.

Q. What is then the second worst?

A. That when the first worst happens, the banks would not have the capital needed to cover for the losses.

Q. But, if then regulators, by setting quite decent capital requirements for banks for holding what is perceived as “risky”, but almost nonexistent for exposures to what is perceived as “absolutely safe”, make it more likely that the first worst and the second worst come together… is that not sort of dumb?

A. Yes, indeed, I take it back. The first worst thing that can happen to our banks, are dumb regulators.

Conclusion: Throw out Basel's capital requirements for banks based on perceived risk and use a simple and straightforward leverage ratio of between 8 and 10%