Jaime Caruana, go home. You and your Basel II colleagues have done enough damage, and should not now block the fixes.

Jaime Caruana was the Chairman of the Basel Committee for Banking Supervision at the time Basel II regulations were approved in June 2004; and since I consider these the most outrageous, dumb and irresponsible bank regulations ever, I of course think that he should have retired a long time ago.

But no, ten years later, now as the General Manager of the Bank of International Settlements he still refuses to accept any responsibility. 

Let me for instance refer to his speech “Stepping out of the shadow of the crisis: three transitions for the world economy” given on the occasion of the BIS’s Annual General Meeting in Basel on 29 June 2014 

There he states: “A reliable financial system requires more than resilience. Resilience is the starting point, but let me mention some other key elements. The first is confidence in banks’ risk management. This goes all the way from the overall risk culture to the risk models themselves. The large reported dispersion in risk-weighted asset calculations suggests that there is still plenty of scope for inconsistency, and perhaps even for gaming the rulebook.” 

Not even a hint of the possibility that in fact it was the regulators’ who with their risk-weighted capital requirements for banks, the pillar of Basel II, gamed the rulebook and upset risk-models.

He also says: “ Stringent regulation can alleviate this problem. Constraints on modelling assumptions can improve comparability and curb arbitrage.”

Yes but who will constrain the regulators from arbitraging against their short term credit risk monsters, ignoring the risk-taking the economy needs? 

He also holds: “If calibrated rigorously, the leverage ratio can create a credible backstop for the risk-weighted ratios.” 

Yes but why was this not there in Basel II, and why is it there now only as a backstop, something which allows the risk-weights to distort more than ever on the margins?

He also says: And, implemented consistently, global minimum regulatory standards can reduce the risk of fragmentation along national borders and increase credibility. 

Indeed, but unfortunately, with wrong regulations, like Basel II, that can also increase the global systemic risk in banking.

And he suggests: “to encourage a prudent risk culture, one that allows for diversity and risk sensitivity, but penalises and prevents attempts to game regulations.”

Obviously Caruana has no idea that a prudent risk culture for regulators starts by defining which the objectives of that which is being regulated are, so as to know what they cannot risk distorting with their regulations. If Caruana and his colleagues had known that, then they would have understood that the last thing they could do was to distort the allocation of bank credit to the real economy… as they so blithely did and do!

As is those foremost responsible for gaming bank regulations to suit their own beliefs and not having been penalised for it, are the Basel Committee and the Financial Stability Board members.  

Jaime Caruana… by not being willing to admit the mistakes of Basel II, and occupying a crucial post, you are standing in the way of what needs to be corrected… so go home!

Today 10 years since Basel II doomed the banks to a crisis, and the Western world's economies to call it quits and begin their downward spirals

G10 signs up on Basel II

With their portfolio invariant risk-weighted bank capital requirements, the Basel Committee regulators obviously think that financial stability is obtained by stopping banks from lending to “the risky”. What a dangerous lunacy! It is precisely the willingness to take risks that has made the Western World what it is.

http://www.americanbanker.com/bankthink/a-decade-of-perverse-incentives-spawned-by-basel-risk-weighting-1068255-1.html

http://www.eluniversal.com/opinion/140626/hoy-10-anos-de-la-firma-de-basilea-ii

http://teawithft.blogspot.com/2014/06/today-marks-10th-anniversary-of-basel.html

Who supervises that FDIC, Fed, OCC, with their risk-weights, do not distort allocation of bank credit to the real economy?

The FDIC writes: “The Federal Deposit Insurance Corporation (FDIC), the Federal Reserve Board (Board), and the Office of the Comptroller of the Currency (OCC) (collectively, the agencies), under the auspices of the Federal Financial Institutions Examination Council (FFIEC), are requesting comment on proposed revisions to the risk-weighted assets [used to determine the regulatory capital banks should hold].”

And in a reference material titled “New Capital Rule: Community Bank Guide” we read:

“This guide summarizes significant changes from the current general risk-based capital rule for exposures commonly held by community banking organizations, and it provides relevant information regarding the treatment of more complex exposures such as securitization exposures, equity exposures, and exposures to a foreign government or bank. Community banking organizations become subject to the new rule on January 1, 2015. 

The new rule takes important steps toward improving the quality and increasing the quantity of capital for all banking organizations as well as setting higher standards for large, internationally active banking organizations. The agencies believe that the new rule will result in capital requirements that better reflect banking organizations’ risk profiles, thereby improving the overall resilience of the banking system. The agencies have carefully considered the potential impacts on all banking organizations, including community banking organizations, and sought to minimize the potential burden of these changes where consistent with applicable law and the agencies’ goals of establishing a robust and comprehensive capital framework.”

All of which leads us to ask again, for the umpteenth time… who is in charge to supervise that the risk- weighing of bank assets does not distort the allocation of bank credit to the real economy?

How can anyone think of "a robust and comprehensive capital framework" that does not even consider the consequences of distortions which could be much more dangerous for the overall safety of the economy than the presence of unsafe banks?

Do these risk weights really consider any unexpected events and losses banks could suffer or are they based on the same risk perceptions used by the banks to clear for expected risks? 

Public letter to King Felipe VI of Spain, on his first day of work, about banking regulations that discriminate against many of his subjects.

Dear King Felipe VI of Spain.

I am not your subject, but inasmuch as for two brief years I was honored to occupy as Executive Director the chair that together with seven other countries represented Spain in the World Bank, and for many other reasons, I am concerned about the welfare of Spain.

Today, after having heard a few paragraphs of your speech yesterday and that indicates that you may be interested in the topic I will touch on, I post this letter on the web with the same hope that it will reach you that you might have of putting it in a bottle and put her to navigate the oceans ... but who knows :-)

The message I want to convey to you is that all those of your subjects who cannot obtain the best credit ratings, among others because of the cost that this process alone implies, are being hideously discriminated against in their access to bank credit, not only by bankers, which would be natural and traditional, but in this case, and without any justification, by banking regulators.

This occurs inasmuch as regulators allow banks to maintain a much lower share capital when they finance an "infallible" than when they finance a "risky" ... which means that banks obtain a much higher risk-adjusted return on their capital financing the infallible than financing the risky ones… which results in the infallible ones obtaining more credit at lower rates than normal, while the risky ones receive fewer credits and at rates comparatively higher than normal.

And such regulatory discrimination becomes especially heavy in times when banks are extremely short of social capital, especially because they have suffered large losses in activities considered non-risky and for which they were allowed to have very little capital.

And as a direct consequence of all this, a multitude of medium and small companies, as well as entrepreneurs, do not have that fair access to bank credit that would allow them to create the jobs that the youth of Spain need so much, so as not to become a lost generation.

I do not want to take more time, if you want you can find much more on the subject on this site, and of course I am at your service. However, before I say goodbye, let me explain why I previously argued that this regulatory discrimination is totally unjustified.

It just turns out that no significant banking crisis has ever been unleashed in history as a result of over-lending to what was considered risky, all such crises have resulted from over-lending to what was viewed as very safe from a point of view credit, such as the real estate sector, the AAAristocracy or, forgive me for having to remember, one or another infallible sovereign.

Your Majesty, just ask the regulators to explain to you where the heck they find causation between a lender being rated ex ante as risky, from a credit point of view, and a bank failure.

Why don't I speak directly to regulators? I have dealt with it for over a decade… hundreds of times… by all means possible… but those who think they are geniuses don't like to hear about the possibility that they are totally wrong. Perhaps you could be luckier… at least as you begin your first day on the job as King.

By the way ... Good luck!

Sincerely,

Per Kurowski

Note: While this letter travels the web, any suggestion is appreciated so that, if it reaches the hands of Felipe VI, at least it complies with the most basic formalities.

I'm not in the habit to write to kings, but I've done it before, in 2009

Translated from my letter in Spanish 

The capital control the IMF supports

Overwhelmed by what is happening in my country Venezuela, I briefly pause to refer to the war that incompetent and pusillanimous regulators in the Basel Committee and the Financial Stability Board, have declared against what they consider is the risk of banks.

The pillar of their current banking regulations are shareholder capital requirements against the various bank assets, according to the perceived credit risk.

For example the Basel II rules allow banks to lend huge sums to "infallible" sovereign against zero capital; huge amounts to private borrowers rated AAA against only 1.6% equity; while, against small loans to businesses or entrepreneurs, they are required to hold 8% in capital.

Since the perceived credit risk is already considered by the banks in the interest rates they charge, the above translates into banks being able to earn much higher risk adjusted returns on equity when lending to the "safe" than when lending to the “risky".

And, as a result, the portfolio of banks each day focuses more on what is perceived as “safe”, while bank credit to “the risky”, the credit needed to finance our future, becomes more each day scarce.

If one insures against all risks, one runs the risk that after paying all insurance premiums, you do not have anything left to eat with. In that sense you must always before analyzing risks define what the most important objective, so as to better understand what risks you cannot help but to assume.

And the citizens have a vital interest in that bank credits are awarded to the real economy efficiently, because on that will depend their future jobs. And therefore, avoiding the risk of banks to fail, you should never include something that makes it difficult to properly allocate banking credits.

If bank capital requirements were somewhat lower for projects that had very good potential of generating new-and-different-jobs-ratings, then I might understand ... but only to avoid the risk of bankruptcy of some banks… never!

And even when those regulations function as de facto capital controls, channeling bank credit to the "safe" and away from "risky", the International Monetary Fund, who has so much history opposing capital controls, plays along as if it does not understand.

Of course the IMF, among its explicit responsibilities, has to seek to ensure financial stability, and so that there can be some confusion with respect of avoiding bankruptcy of some banks. But even if so, a simple empirical study on the causes of banking crises, would have indicated the IMF that these never ever result from excessive lending or investment to what is perceived risky, but exclusively because of excessive exposures to what is ex ante believed to be absolutely safe, but is not so, ex post.

And the World Bank is complicit in the silence. As the first development bank in the world it must know that without risking open doors behind which, hopefully, we can find what can help propel us forward, we will only be stuck in the past,

Also, today, when the issue of inequality has been made so fashionable by Piketty, do not ignore that discriminating against the weak, the “riskier”, can only increase inequality.

Translated from El Universal

Janet Yellen why are bank capital requirements based on credit ratings and not on job creation ratings?

Bank lending to small businesses has never had anything to do with causing the latest or any other financial crises for that matter; and risk-weighted capital requirements for banks makes it impossible for “the risky” small businesses to access bank credit in a fair way… 

Now knowing that, as Federal Reserve Chair Janet L. Yellen must know, how can you give a speech such as that delivered at the National Small Business Week Event at the U.S. Chamber of Commerce in May 2014?

She speaks much of the importance of job creation. Indeed, if I had been invited and allowed to make a question, that one would be… why do you base capital requirements for banks on perceived credit risk ratings and not on job creation ratings?

Risk-weighted capital requirements creates a competitive disadvantage for community banks; as well as for their clients usually perceived as "riskier" .

Inasmuch the clients of the community banks belong more to the category of “risky”, like medium and small businesses, entrepreneurs and start-ups, whose fair access to bank credit is discriminated against, by banks being required to hold more capital against them that against the “safe”… and inasmuch larger banks have more access to borrowers perceived as "safe", or can easier structure operations as “safe”, and therefore benefit from lower capital requirements... which means being able to leverage their equity much more…. we can indeed argue that current regulations place community banks in a competitive disadvantage.

And so if community banks want to survive, they need to protest and fight against the whole concept of risk weighted capital requirements… and that should not be so difficult since the de-facto discrimination against the fair access to bank credit of “the risky”, should not be permitted under Equal Credit Opportunity Act (Regulation B).

And besides, community banks, ask your regulators to show you evidence of when excessive bank exposures to those ex ante perceived as "risky" have ever set off a major crisis. They will not be able to do so!

And agreeing in much from different perspectives with Thomas Hoenig of the FDIC, I guarantee that letting the Too-Big-To-Fail-Banks roam within regulations different from that of the community banks, will only, medium term, condemn the latter, and their loan officers, to extinction.

Frankly... in the "Home of the brave"... who came up with the idea of discriminating against the "risky" risk-takers who have made this country, so that they do not have any longer a fair access to bank credit? 

Don’t you understand how utterly immoral and dumb current bank regulatory discrimination is?

Suppose a busybody ministry of economy came up with the idea that in order to strengthen the competitiveness of the nation’s private sector, and make really sure the firms employed the best and brightest, they were going to give special tax incentives for hiring students with grades over a specified level. 

What would happen?

All those who had not achieved that great level of grades would scream bloody murder and accuse the ministry for discriminating against them, for something which they were already being discriminated in the job market. And if by any chance the ministry would still be able to impose its nutty and odiously discriminatory plan… you would automatically begin to see some inexplicable inflation in the level of grades.

And that is basically what the risk-weighted capital requirements for banks concocted by the Basel Committee for Banking Supervision do:

First: These capital requirements odiously discriminate, for a second time, against those who because of being perceived as risky already get smaller loans and pay higher interest rates.

Second: Borrowers have always wanted to be perceived as safer than what they are… but now the lenders dangerously have a vested in sharing that interest in too... so the credit rating agencies will be pressured for better ratings from both sides.  

Third but foremost: By allowing banks to earn higher risk-adjusted returns on equity when lending to “the safe” these capital requirements distort the allocation of bank credit to the real economy

And fourth: It all serves absolutely no purpose, since never ever do bank crises result from excessive exposures to what is perceived as risky, but always from excessive exposures to something erroneously ex ante perceived as absolutely safe.

The Western World's growing risk aversion

 The Western World was built-up with massive amounts of risk taking.

1988, the Basel Committee for Banking Supervision introduced in it massive risk aversion.

https://subprimeregulations.blogspot.com/2010/10/god-make-us-daring.html

1964: Nikita Khrushchev, First Secretary of the Communist Party of the Soviet Union; Tage Erlander, Swedish Prime Minister; (translator)

50 years later.

2014: David Cameron British Prime Minister; Angela Merkel German Chancellor; Fredrik Reinfeldt Swedish Prime Minister; Mark Rutte Dutch Prime Minister 

@ECB Mario Draghi: Europe urgently needs to stop the discrimination in favor of “the safe” and against “the risky”.

Europe, much more than quantitative easing, “targeted long-term refinancing operations” or lower rates would need Mario Draghi to declare 

“From now on we the ECB will not admit bank regulators treating lending to medium and small businesses, entrepreneurs and start-ups, as intrinsically more risky for Europe, than lending to the “infallible sovereigns”, the housing sector and the AAAristocracy”

That refers to the need of stopping the distortion that risk-weighted capital requirement produce in the allocation of credit in the real economy ,something which is the number one reason for having caused the crisis (AAA rated securities Greece), and the number one reason for which the young unemployed Europeans might be doomed to become a lost generation.

Would that endanger the banks? Of course not! Who has ever heard about a bank crisis caused by excessive exposures to what was ex ante considered risky, these have always resulted from excessive exposures to what was ex ante considered “absolutely safe” but that ex post turned out not to be.

How can Christine Lagarde, of the IMF, say such things on the Amartya Sen Lecture?

Invited to speak on the Amartya Sen Lecture, ChristineLagarde said “In more unequal societies, too many people lack the basic tools to get ahead—decent nutrition, healthcare, education, skills, and finance. This can create a vicious cycle”

Yes! Indeed. And IMF should be ashamed of not criticizing the risk-weighted capital requirements for banks that so discriminates “the risky”, the medium and small businesses, the entrepreneurs and the start-ups from a fair access to bank credit.

Twice I have told her about it, here and here, and yet, acknowledging the problem, she seemingly does not care.

Here for discussion is an alternative, less distorting, risk-weighted bank capital requirement regulation.

I have for more than a decade strongly opposed the Basel Committee’s risk-weighted capital requirements for banks. 

This primarily because these seriously distort the allocation of bank credit in the real economy, but also because they make little empirical sense, since what historically have caused all major bank crises, are not big bank exposures to what ex ante is considered risky, but always too large exposures to what was erroneously perceived ex ante as absolutely safe.

But since it seems that regulators do not feel they are doing their job if they don’t do risks weighting, my criticism has not been sufficiently considered.

In that respect let me here briefly express a simple alternative of risk-weighing the capital of a bank.

Though it would not increase the ultimate long term safety of the banks, because of the fundamental regulatory mistake of confusing ex-post risks with ex-ante perceptions, it could at least produce much less distortion in the allocation of bank credit.

1. Calculate the risk-weighted size of the bank’s balance sheet. 

2. Divide that number by the gross balance sheet of the bank. 

3. Multiply the resulting ratio times a basic capital requirement, for instance Basel II’s 8 percent.

4. Make the resulting percentage the general capital requirement for that bank in particular and to be applied to all its assets.

5. Make a medium term plan on how to increase that percentage for that particular banks, to for instance Basel II's 8 percent.

Comments? perkurowski@gmail.com

No! Bank regulators, much more than they deregulated, just regulated amazingly bad.

Here is an interview by Econ Focus of Richmond Fed with Mark Gertler, which repeats the falsehood of bank regulators believing too much in the market.

Gertler: The biggest mistakes probably involved too much deregulation.

Econ Focus: What do you think is the best explanation for the policies that were pursued? 

Gertler: At the time, I think it was partly unbridled belief in the market — that financial markets are competitive markets, and they ought to function well, not taking into account that any individual is just concerned about his or her welfare, not about the market as a whole or the exposure of the market as v a whole. 

I am sorry. That is simply not true. 

Anyone with any reasonable belief in the market being able to allocate credit adequately in the economy… would never ever have interfered by means of setting the capital requirements for banks based on risks which were already cleared for by banks. 

That resulted in banks earning much higher risk-adjusted returns on equity when financing what is ex ante perceived as “safe”, than when financing what is ex ante perceived as “risky”, something which of course distorts all common sense out of bank credit allocation.

For instance, Basel II had it that if a European bank made a loan to a medium and small business, an entrepreneur or a start up, then it needed to hold 8 percent in capital, a leverage of 12.5 to 1, but, if it purchased AAA rated securities, then it needed to hold only 1.6 percent in capital, a leverage of 62.5 to 1. And that of course had Europe buying the securitized subprime mortgages like if there was no tomorrow… and so did the investment banks when authorized by the SEC to follow the Basel rules.

In other words... bank regulators did not believe in the markets... they believed in themselves being the Masters of the Universe, capable of managing risks for the whole banking world.

In other words... bank regulators instead of concerning themselves with any "unexpected losses", which is what they should do, decided to also manage the expected losses.

In other words... bank regulators were just amazingly bad. In terms of Bill Easterly... God save us from the tyranny of experts.