When will judges in Europe or in America drag bank regulator X in front of a court, in order to ask these questions?

Judge: Is bank capital to be there primarily to cover for unexpected losses?

The regulators’ expected answer: “Yes your honor”

Judge: What has more potential to deliver unexpected losses that which is perceived as safe, or that that is perceived as risky?

The regulators’ expected answer… after a while: “Perhaps that which is perceived as safe your honor”

Judge: What has caused major bank crisis, excessive exposures to what was perceived as risky or excessive exposures to what was wrongly perceived as safe?

The regulators’ … after a while, in a very low voice: “The latter your honor”

Judge: So why have you imposed higher capital requirements for banks for what is perceived as risky than for what has perceived as risky?

The regulators’ possible answer: “That was not my idea your honor… it was probably some consultant, and it sounded so logical; more risk more capital - less risk less capital”

The judge: But don’t banks already consider credit risks when they set their interest rates and amounts of exposure?

The regulators’ possible answer: “Yes your honor but we want to be doubly sure they have the right incentives to avoid credit risks.”

Judge: Do you understand how that distorted the allocation of bank credit to the real economy and hindered the fair access to credit of those perceived as risky like SMEs and entrepreneurs?

The regulators’ possible answer: “Yes your honor but our responsibility was exclusively to the safety of the banks and not the real economy.”

Judge: Do you understand how many young persons could now go without a job in their whole lives only because of that distortion?

The regulators’ possible answer: “Your honor, my lawyers have advised me not to answer that.”

Gillian Tett, if you find yourself in a silo, you should be careful throwing stones at those in other silos.

Gillian Tett, she could almost be my daughter, in her book “The Silo Effect”, has a chapter titled “When gnomes go blind”. In it she describes the surprise of regulators when hearing that UBS “had secretly accumulated $50 billion worth of subprime mortgages on its balance sheet” which ended up in “taking the total hit to almost $19 billion” 

And she writes “it was the banking gnomes at UBS had collectively fooled themselves; but then she quotes a report by Tobias Straumann stating “This [story]… fits perfectly into a pattern that has repeated itself again and again in the past. In reality, the biggest losers in a financial crisis are not those who have exposed themselves to major risks with their eyes open, but rather the ones who believed [they had] their affairs well under control”

And which means what? That what is truly dangerous is not what is perceived risky but what is erroneously perceived as safe. 

And which means what? That the risk-weighted capital requirements for banks based on perceived credit risks makes absolutely no sense… precisely what I have been arguing for years, namely that what is perceived as risky, is not dangerous, precisely because it is perceived as risky.

And also any bank regulator who did not understand that allowing banks to leverage their capital 62 times to 1, if only an AAA to AA credit rating was present, created for even the most conservative bankers an irresistible temptation, was clearly blind, probably because of living in a mutual admiration club silo.

Since 2007, I have written more than a hundred letters commenting on articles penned by Gillian Tett about how risk weighted capital requirements for banks, assisted by credit ratings utterly distort the allocation of bank credit to the real economy. You can find the letters here: From her little silo she has ignored all of them.

Tett’s previous book “Fool’s gold” contained the same mistake… sometimes you really get caught up in your own personal little silo.

Do I also find myself in a silo? Of course I do! Only that mine is a nicer one J

Why on earth do regulators (and some reporters) refuse to discuss the issue of how current bank capital requirements distort the allocation of credit to the real economy? I can only refer to John Kenneth Galbraith: “If one is pretending to knowledge one does not have, one cannot ask for explanations to support possible objections.”

Lord Adair Turner’s awakening as a bank regulator has at least begun, and that’s good news.

In June 2010, during a conference given by Adair Turner at the Brookings Institute, I asked him the following: 

"Big companies in consolidated sectors, like BP in oil, tend to have much better credit ratings than those participating in developing markets, like wind energy. Do you really think the banks will perform better their societal capital allocation role if regulators allow them to have much lower capital requirements when lending to the consolidated sectors than when lending to the developing? Do you think we can reach a meaningful financial regulatory reform without opening up the discussion on the issue of risk in development?"

Lord Turner responded: "The point about lending to large companies development, I'm not sure. I'm trying to think about that. I mean we try to develop risk weights, which are truly related to the underlying risks. And the fact is that on the whole, lending to small and medium enterprises does show up as having both a higher expected loss but also a greater variance of loss. And, of course, capital is there to absorb unexpected loss or either variance of loss rather than the expected loss. I think, therefore, it's quite difficult for us to be as regulators, skewing the risk weights to achieve, as it were, developmental goals. There are some developmental goals, for instance, in a renewable energy, which I'm very committed to wearing one of my other hats on climate change, where I do think you may need to do, you know, in a straight public subsidy rather than believing that we can do it through the indirect mechanism of the risk weights. So I may have misunderstood your question, but I'm sort of cautious of the sort of the leap to introducing developmental roles into -- I thinks we, as regulators, have to focus simply on how risky actually is it?"

Lord Turner did not understand what I was referring to, and what was wrong:

Lord Turner: “we try to develop risk weights which are truly related to the underlying risks”. No! The real underlying risk with banks is not the risk of their assets, but how banks manage the perceived risks of their assets.

Lord Turner: “capital is there to absorb unexpected loss or either variance of loss rather than the expected loss”

Yes “capital is there to absorb unexpected loss”, and that is why it is so ridiculous to base the capital requirements for banks on something expected, like the perceived credit risks.

Now Lord Turner in his recent book, “Between Debt and the Devil”, though he still evidences he does not understand the distortions in the allocation of bank credit to the real economy the risk weighted capital requirements produce, he seems to become more flexible about using other criteria. From the “I think we, as regulators, have to focus simply on how risky actually is it” he now states: “We need to manage the quantity and influence the allocation of credit bank create… Capital requirements against specific categories of lending should ideally reflect their different potential impact of financial and macroeconomic stability. 

Though Turner has not yet reached as far as banks actually having a social purpose more important than that of just not failing, like financing job creation and the sustainability of our planet, this is a good and welcome start. And I say so especially because Lord Turner’s awakening might reflect what hopefully might be going on in other regulators' minds.

Lord Turner even though he gets it that “it is rational for banks to maximize their own leverage, increasing the returns on equity”, still fails to understand how allowing different leverages, much higher for safe assets than for risky, make banks finance more than usual what is perceived as safe, and much less than usual what is perceived as risky… which is precisely why banks finance so much houses and so little the SMEs and entrepreneurs, those that help create the jobs needed to pay mortgages and utilities.

Lord Turner also mentions in his book the issue of inequality. For the hopefully revised and corrected sequel to his book, I would suggest he thinks about the following quote from John Kenneth Galbraith’s “Money: Whence it came where it went” 1975. 

“The function of credit in a simple society is, in fact, remarkably egalitarian. It allows the man with energy and no money to participate in the economy more or less on a par with the man who has capital of his own. And the more casual the conditions under which credit is granted and hence the more impecunious those accommodated, the more egalitarian credit is… Bad banks, unlike good, loaned to the poor risk, which is another name for the poor man.”

But clearly Galbraith was referring to credit to producers and not to consumers. 

And of course I wish Lord Turner, like so many other, stops referring to the financial crisis as a result of free markets running amok. Free markets would never ever have authorized banks to leverage over 60 to 1 when investing in AAA rated securities, or when lending to Greece. Markets were not free. Banks were not deregulated. Banks were utterly misregulated.

PS. Cross your fingers. There might be something there that wasn't there before :-)

My sincere Christmas wish: That our bank regulators wake up and understand what they are doing to our children.

On December 24, 1941, in Washington DC, Winston Churchill ended his Christmas speech to war torn England with: “By our sacrifice and daring, [our] children shall not be robbed of their inheritance or denied their right to live in a free and decent world.”

I absolutely do not pretend being something like Winston Churchill but, here in Washington, on December 24, 2015, 74 years later, I assure you all that: By us not daring to allow our banks to dare, we are robbing our children of their inheritance and denying their right to live in a free and decent world.

I pray our bank regulators in 2016 wake up to understand how much their credit risk weighted capital requirements for banks, distort the allocation of bank credit to the real economy.

By allowing banks to earn higher risk adjusted returns on what is perceived as safe than on what is perceived as risky banks do not any longer finance the riskier future but only keep to refinancing the safer past.

In essence we are placing a reverse mortgage on our economies, which will extract its value, without allowing the risk taking needed for something new to take its place.

Fight for the American dream giving opportunities to everyone, but not by using a bank in my backyard

I refer to a great report produced by a AEI/Brookings Working Group titled “Opportunity, responsibility and security: A consensus plan for reducing poverty and restoring the American Dream”

With respect to Opportunity it states: “The concept of ‘opportunity’ draws nearly universal support among Americans, and it’s the core concept of the American Dream. We endorse Truslow Adams’ definition of opportunity as the state of affairs when “each man and each woman shall be able to attain to the fullest stature of which they are capable,” regardless of offer opportunity, in this sense, to all its residents… Progressives generally believe that government should be more active and can be more effective than do conservatives. But this difference shouldn’t obscure the fact that nearly all Americans would prefer to live in a society in which opportunities for self- advancement are more widely available, especially to those at the bottom of the income distribution, than is now the case. 

I have no objections, but, from what I have seen, both conservatives and progressives have ignored how regulators affected the opportunities of The Risky to access bank credit.

Regulators, with their credit risk weighted capital (equity) requirements, allow banks to earn much higher risk adjusted returns on assets perceived as safe, than on assets perceived as risky. And that of course distorts the allocation of bank credit in favor of The Safe, those already favored by banks with lower interests and larger loans, and against The Risky, those already punished by banks with higher interests and smaller loans. And that, by impeding The Risky the opportunity of fair access to bank credit, is of course great driver of inequality.

Why is that so ignored by all who write against increased inequality and in favor of opportunities? Could it be a symptom of let’s fight against inequality, and let’s give everyone opportunities, but never ever with the bank in my backyard doing that?

Per Kurowski’s (that’s me) Paris COP21 action plan, would have much more immediate environmental (and job creating) impact

Regulators currently tell banks: “More credit risk, more capital (equity) – less credit risk, less capital. 

And so right now our banks earn much higher risk adjusted return on equity on what is perceived or made out to be safe, than on what is perceived as risky. All for no good reason at all. 

Q. What has credit risk to do with the worthiness of something having access to bank credit? A. Nothing! 

Q. What assets are least likely to detonate major banks crises? A. Those ex ante perceived as safe!

In Paris, during COP21, I would have suggested that we tell bank regulators to stop favoring the access to bank credit of The Safe, and quit discriminating against the access to bank credit of The Risky.

Instead they should base their capital requirements of banks on sustainability and job creation – Sustainable Development Goal’s (SDGs) ratings. That way banks would earn higher risk adjusted returns on equity when financing what we most need and want them to finance. Otherwise, why on earth should society support banks so much?

Of course SDGs ratings could be gamed, as credit risk ratings often are, as carbon trading often is. But yet there would be much more oversight about the SDG ratings of projects than what there currently is of the credit risk ratings produced by 3 human fallible credit rating agencies.

Friends, would it not be nice to put some much needed worthy social impact purpose back into our banks?

Please help me stop our banks from mostly refinancing our safer past, and make them work harder on our sustainable future.

Understand what originated the bank crisis and what stops the economies from recovering in 157 words

Bank regulators told our credit risk adverse banks: 

“If you take on Safe assets, we will allow you to leverage your equity and the support you receive from the society more than 60 to 1 times but, if Risky assets then you cannot leverage more than 12 to 1.” 

And that of course meant banks would be earning much higher risk adjusted returns on equity on assets perceived or made out to be Safe, than on “Risky” assets. 

It was like telling children: “If you eat up your ice cream then you can have chocolate cake too but, if you eat spinach, then you must eat broccoli too. 

And so banks built up excessive dangerous financial exposures to “Safe” assets, like AAA rated securities and loans to Greece, which detonated the crisis. 

And so banks are reluctant to hold Risky assets, like loans to SMEs and entrepreneurs, which makes it impossible to get out of the crisis.” 

And, amazingly, most describe what happened and is happening with our banks in terms of deregulated entities and failed markets.

I have not seen “The Big Short” but I am sure it comes up short explaining what happened. If not, I will apologize.

This is the film "The Big Short"

And this is my short explanation of the subprime crisis.

In June 2004 the Basel Committee, with Basel II, decided that any bank that held securities rated AAA to AA (or lent to investors guaranteed with such securities) needed to hold only a meager 1.6 percent in capital (equity) against these. That meant banks could leverage their equity (and the support they received from society) with the expected risk adjusted profit margin of these securities, a mindboggling 62.5 times to 1.

For instance, if banks thought they could earn a reasonable 1 percent expected risk adjusted return on such securities, then they would be expecting to earn a 62.5 percent yearly return on their equity.

Basel II regulations applied to the European banks and, due to a decision taken by the Security Exchange Commission in April 2004, also to American investment banks.

This mother of all incentives set up the mother of all demands for AAA to AA rated securities collateralized with mortgages to the subprime sector.

And it was really not the “good” mortgages that the intermediaries were most after in order to package. The worse they were, meaning the higher interest rates they carried, the larger their profits.

Let me explain the deal! If you convinced risky and broke Joe to take a $300.000 mortgage at 11 percent for 30 years and then, with a little help from your friends the credit rating agencies, you could convince risk-adverse Fred the banker that this mortgage, repackaged in a securitized version, and rated AAA, was so safe that a six percent return was quite adequate, then you could sell Fred that mortgage for $510.000. This would allow you and your partners in the set-up, to pocket a tidy profit of $210.000

I am almost sure that “The Big Short” is based on the growing overabundance of these lousy mortgages packaged in highly rated securities... but not on the cause for their overabundance.

I heard in the film trailer "The banks' got greedy"... but in fact there was and is no rational market in the world, that has the strength to say NO! to the kind of temptations offered by the regulators.

And this is tragic. If the truth does not come out, and there is plentiful of interests in the truth not coming out, for instance among all bank regulators, then we have missed a very good opportunity to learn that we should not leave the regulations of our banks in the hand of a small mutual admiration club of experts.

For a starter, current regulators have not yet even defined the purpose of our banks before regulating these. Is that not criminally stupid?

The Basel Committee insists in not caring one iota about whether its risk-weighted capital requirements distort the allocation of bank credit to the real economy.

In December 2015 The Basel Committee on Banking Supervision has now released its “Second consultative document: Standards: Revisions to the Standardised Approach for credit risk”. It is issued for comments by March 11, 2016.

The introduction states: “This is the Committee’s second consultation on Revisions to the Standardised Approach for credit risk. The Committee wishes to thank all respondents for their extensive feedback on its first consultative document, which was published in in this second consultative document aim to address the issues raised by respondents with respect to the initial proposals. These revised proposals also seek to achieve the objectives set out in the first consultative document to balance simplicity and risk sensitivity, to promote comparability by reducing variability in risk-weighted assets across banks and jurisdictions, and to ensure that the standardised approach (SA) constitutes a suitable alternative and complement to the Internal Ratings-Based (IRB) approach.”

I was one of very few citizens who responded to their first consultative document, and my objections have not been even remotely considered much less responded to. I ended then my comments with:

“Regulators, please, before you keep on regulating, go back and define the purpose of banks. It has to be more than to just be safe mattresses. It has to at least include not distorting the allocation of bank credit. 

With these credit risk adverse regulations, banks are financing less and less the risky future; and only refinancing more and more the safer past. That has to stop, for the good of our children and grandchildren. “A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926 

In 1999, in a Op-Ed in I wrote: 'The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause the collapse of our banks'. 

We have already seen too many low-risk-weights AAA bombs detonate with disastrous consequences. So when are you bank regulators going to stop trying being the self appointed risk managers for the world? You’re doing a lousy job at it, and not being held accountable for it.”

And so with this 2nd consultative document it is clear that the Basel Committee still does not care one iota about whether their risk-weighted capital requirements distorts the allocation of bank credit to the real economy.

And it is clear that the Basel Committee is still utterly fixated on the risks of bank assets and ignore the much more important risk of whether banks can adequately manage those perceived risks. In day-to-day terms they find motorcycles to be much more dangerous than cars for the system, even though many more die in car accidents than in motorcycle accidents.

And it is clear that they are still trying to base the capital banks should primarily hold against unexpected losses, on estimates about the expected credit losses. And it is clear they cannot understand that the safer something is perceived the larger the potential of it to deliver unexpected bad news.

And since expected credit risks are already cleared for by banks with interest rates and size of exposures, the Basel Committees insistence on also clearing for those risks in the capital requirements, evidences they have no understanding of that any risk, even if perfectly perceived, will cause the wrong actions if excessively considered.

The way the Basel Committee has seemingly circled its wagons against any outside real criticism, I am not too optimistic about my chances to influence them. Nevertheless I have to try doing so, and so I will send them these comments and perhaps some others before March 11, 2016.

PS. Since they also refer to the use of credit rating agencies, let me quote a letter I wrote and that was published in the Financial Times January 2003. It included: “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds. Friends, as it is, the world is tough enough.”

And so, if anything, it would be much more logical to make the capital requirements for banks based not on the credit ratings being correct, in which case there is no problem, but based on the possibilities of credit ratings being wrong… let us say about 8 percent on all assets.

PS. Do I have any credential to be opining here? I think so. As an Executive Director of the World Bank 2002-2004, in October 2004, in a formal statement I wrote: "We (I) believe that much of the world’s financial markets are currently being dangerously overstretched through an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions"

If earth suffers an immediate threat to its existence, let us pray bank regulators are not part of our first response team.

In 1988 the Basel Accord (Basel I), for the purpose of determining the capital requirements of banks, introduced the ludicrous out of this world concept of a zero percent weight for the sovereigns and a 100 percent weight for the private sector.

That could only have the effect of banks lending more and in better terms to the sovereign than to that private sector that usually is from which the sovereign gets its strength; and which implied bank regulators thought that government bureaucrats could use bank credit more efficiently than for instance SMEs and entrepreneurs. Unless one is a full-fledged statist or a communist, such a concept should have been totally unacceptable.

Myself, coming from being a corporate financial consultant primarily in Venezuela, had very little to do with bank regulations but, in 2004, when I was just awakening to what the Basel regulations contained, in a letter that was published in the Financial Times I wrote: “We wonder how many Basel propositions it will take before they start realizing the damage they are doing by favoring so much bank lending to the public sector. In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits.”

But now soon 30 years after that initial Basel Accord correcting that zero risk weighting flaw seems finally to have come up on a decision agenda.

In March 2011 the issue appeared at a roundtable of the IMF which concluded with José Viñals, IMF Financial Counselor and Director of Monetary and Capital Markets Department, stating: “The emphasis put by the panelists on issues such as the interconnectedness between sovereigns and banks, regulation and its impact on financial risk, the need for joint and credible sovereign-bank stress testing, debt issuance strategies, and the role of the central banks in mitigating liquidity versus credit risk have clearly demonstrated the need for us to look at sovereign risk in a much broader context of issues and vulnerabilities than we have done so far.” 

And then it pops up in October 2011, in a speech by Hervé Hannoun the Deputy General Manager Bank for International Settlements titled “Sovereign risk in bank regulation and supervision: Where do we stand?” Hannoun, first things first, clears regulators from any responsibility: “market participants’ complacent pricing and accumulation of sovereign risk in the decade up to 2009 was a market led phenomenon that cannot be attributed to the Basel standards.” But then he anyhow opines: “However it becomes crucial for regulators and supervisors of large banks to clarify that although sovereign assets are still a relatively low risk asset class, they should no longer be assigned a zero risk weight and must be subject to a regulatory capital charge differentiated according to their respective credit quality." That said he finally returns to the original sin stating:"A key objective for governments in advanced economies is to earn back the quasi-risk-free status of their debt"

Also the then General Secretary of the Prudential Supervisory Authority of Banque de France, Danièle Nouy in April 2012 wrote: “it appears that current regulatory framework does not require from financial institutions to hold significant regulatory capital against sovereign risk, inadequately assuming sovereign debt as a low-risk and even a risk-free asset class. Furthermore, some regulatory initiatives, while globally enhancing standards, could create further incentives to encourage financial institutions to hold sovereign debt. In addition to considering better reflection of sovereign risk in financial regulation, supervisory practices also appear as a crucial tool to address the issue of heightened sovereign risk and its potential impact on financial stability.” 

And in a speech delivered on May 5, 2015 Stefan Ingves, the current chair of the Basel Committee wrote: “A discussion of the risk-weighted capital framework would not be complete without a discussion of the Committee's work on sovereign risk… the Basel Committee's oversight body - agreed to initiate a review of the existing regulatory treatment of sovereign risk, including potential policy options... I think we can all agree that there is no such thing as a risk-free asset. When we talk about this issue we talk about ‘sovereign-risk’ - not about ‘sovereign risk-free’”

And Jens Weidmann, the President of the Deutsche Bundesbank in a speech on December 10, 2015 titled “A central banker’s take on improving the euro area’s stability” “While bail- outs and monetary financing are prohibited under the Maastricht treaty, sovereign debt is nonetheless treated as risk-free in the capital regime for banks. Danièle Nouy, the chairwoman of the European banking supervision, said: ‘Sovereigns are not risk-free assets. That has been demonstrated, so now we have to react.’ I totally agree with her. Sovereign debt in banks’ balance sheets needs to be backed by capital, just as is the case for any private debtor. But perhaps it is even more important to put a lid on banks’ exposures to a single sovereign.” 

Oh boy, this all sure is in slow motion... in the getting it and in the reacting to it, I can only conclude in that if earth suffered an immediate threat to its existence I sure wish bank regulators are not part of our humans’ first response team.

Of course I wish for the statist/communist favoring of the bank borrowings of the sovereign to disappear but, because of the temporary huge bank capital scarcity that could produce, I must pray it is carried out in such a way that it does not further increase the squeeze on the access to bank credit of those in the private sector perceived as “risky”. They have it hard enough as it is.

And sadly, the current bunch of bank regulators have given us enough evidence they do not understand what banks are for. In fact they have never even defined the purpose of banks before regulating these... and how stupid is not that?

PS. November 2018: In Europe by means of the European Commission’s “Sovereign Debt Privilege”, the risk weight assigned to all Eurozone sovereign debtors is still 0%, this even when that debt is de facto not expressed in a domestic (printable) currency. Oh boy, this all sure is no motion at all.

PS. How would government finances look if house prices had not gone up the last decades?

This is the farmer sowing his corn,
 That kept the cock that crowed in the morn, 
That waked the priest all shaven and shorn,
 That married the man all tattered and torn,
 That kissed the maiden all forlorn, That milked the cow with the crumpled horn,
 That tossed the dog,
 That worried the cat,
 That killed the rat,
 That ate the malt
 That lay in the house that Jack built...That was taxed by the taxman

'

PS. My letter to the Financial Stability Board dated March 2019

A dangerous regulatory madness descended upon our banks. To my despair it is still mostly unnoticed

When any borrower pays a bank interests, that payment contains an expected net profit margin for the bank, and of course, that margin, is after taking into account all expected credit risks.

And it used to be that all borrowers competed on equal terms for access to bank credits, by offering banks their respective, equally valued, net profit margins.

But that was before. Beginning 1988, with the Basel Accord, and exploding in 2004, with Basel II, bank regulators, in order to make banks safer, so they thought and still think, came up with credit risk weighted capital requirements for banks.

This signified banks had to hold more capital against what was perceived as risky, than against what was perceived as safe; meaning banks could leverage their equity (and the support they received from society) much more when holding assets perceived as safe that when holding assets perceived as risky.

And so, suddenly, the net profit margins offered by those perceived as safe, were and are worth to banks, much more than the net profit margins offered by those perceived as risky.

And that leads of course that those perceived as safe, and who therefore already enjoy more and cheaper access to bank credit, are favored even more; while those who because they are perceived risky already suffer less and more expensive access to bank credit, are even more disfavored.

The consequence is tragic.

Since major bank crisis never result from excessive exposures to something ex ante perceived as risky, but always from excessive exposure to something wrongly believed to be safe, it guarantees that when crisis occur, banks will stand there with especially large exposures and especially little capital to cover themselves up with.

And by distorting the allocation of bank credit in favor of what is perceived as safe it impedes banks from sufficiently financing that which is perceived as risky, like SMEs and entrepreneurs. And that denies the real economy the kind of risk taking it needs in order to move forward and not stall and fall.

And of course, by denying "the risky", usually those with less, fair access to the opportunity of bank credit, it is a major driver of inequality.

How did this happen? The clearest explanation is that bank regulators full of hubris, never cared to concern themselves with defining the purpose of banks before regulating these.

Though not a bank regulator, I have been objecting, in a thousand ways, for soon two decades, these credit bank regulations; but I have yet not been able to extract one clear or unclear explanation, one valid or invalid justification, or anything that looks like a public answer to my objections by any regulator. I know some of them are concerned, but seemingly it is a too hot potato for them to handle.

Our current bank regulators simply do not have the courage to stand up for what they have done.

Our banks have a purpose that is much more important than just being safe, and that is to help finance a good future for our children and grandchildren. God make us daring!

PS. And all those on the road of becoming the oldies of turn, they should never forget that the most important part of any pay-as-you-go pension system, is the how-it-goes-part.

PS. Since in Basel I the risk weight for sovereigns (governments) was set as zero percent, while the risk weight for that private sector that gives the sovereign its strength was set to be 100 percent, another explanation is that these regulators are just simple statist or communist infiltrators.

Professor Richard Thaler, do not give lousy regulatory Econs, the excuse of only having misbehaved cause they are Humans

Professor Richard Thaler opens his great and fun ”Misbehaving” with ”Virtually no economists (Econs) saw the financial crisis of 2007-08 coming” and then explains that it all has much to do with human behavior (Humans).

But hold it there Professor, plain lousy Econs should not be given the easy way out justifying it all with them only having misbehaved because they are Humans.

That a bank crisis had to explode, sooner or later, was perfectly predictable. 

It used to be that each dollar in net risk adjusted margin paid by those perceived as safe and those perceived as risky was worth the same.

But with the introduction of credit-risk weighted capital requirements for banks that changed.

For instance in Basel II, the net risk adjusted margin dollars paid by those rated AAA to AA were worth 62.5 equity leverages (ELs), while the dollars paid by unrated borrowers, for instance SMEs, were only worth 12.5 ELs.

And so of course banks would sooner or later have too much assets against little capital in what was perceived as safe, and too little assets exposure against decent capital in what was perceived as risky.

And any econ, with his Optimization +Equilibrium = Economics should be able to tell you that.

The problem with the regulators in the Basel Committee for Banking Supervision, the Financial Stability Board and the IMF is that they were plain lousy Econs

Basel II data for calculating the Els:

AAA-AA rated had a 20% risk-weight which times Basel II’s basic capita requirement of 8% results in a specific 1.6 capital requirement meaning bank equity could be leveraged 62.5 times to 1. 

Unrated borrowers had a 100% risk-weight which times Basel II’s basic capita requirement of 8% results in a specific 8% capital requirement, meaning bank equity can then be leveraged 12.5 times to 1. 

PS. I just remembered I made a similar argument to Professor Thaler backin 2008

Our current bank regulatory tragedy: Interference without a purpose

Bank regulators have two choices. They can allow everyone to compete equally for the access to bank credit; or they can interfere in the allocation of bank credit by favoring one group’s access, which of course affects negatively those not favored.

And of course interference, though arrogant and dangerous, could be justified if it was done with the purpose of trying to make the real economy stronger... like for instance when financing projects that have special potential to deliver job creation, or the sustainability of our planet.

Unfortunately, current bank regulators, with their credit risk weighted capital requirements for banks, are interfering with the allocation of bank credit without a real purpose. The only thing they achieve with that, is allowing those who because they are perceived as safe already have ample access to bank credit, to find even more generous conditions; and to make it even more difficult for those who because they are perceived as risky already find it harder to access bank credit.

And by doing so regulators are not making banks any safer either, since all-major bank crises result from excessive financial exposure to something ex ante believed safe but that ex-post turned out to be risky.

And so too much credit, in too generous terms, against too little bank capital is given to those perceived as safe, like governments and corporates with high credit ratings; and too little credit, in too expensive terms, to those perceived as risky, like our absolutely vital SMEs and entrepreneurs.

What a tragedy! Let us pray the Basel Committee, the Financial Stability Board and the IMF wake up in time, before our stalling economies really fall into pieces.

Professors around the world, please, we are urged you teach our bank regulators a good Statistics 101.

Please, professors in statistics, explain to our bank regulators in the Basel Committee and the Financial Stability Board that when you try to make banks safe, you should be interested in what has made banks fail, and not in whether bank clients have failed.

As is, regulators have set higher credit risk weighted capital requirements for banks when lending to those perceived as being risky from a credit point of view; namely to those poor unlucky ones who anyhow have to pay more for credit and get smaller loans. And of course that means that “The Risky” receive even less credit and have to pay even more for it.

While those ex ante perceived as safe, but who are always those who detonate all major bank crises when they suddenly ex post turn out to be risky, their access to bank credit has been subsidized by the fact banks need to hold much less equity when lending to them. And of course that means banks might lend too much and at too low risk premiums to “The Safe”, and that, when disaster strikes, we find our banks standing naked there with little or no capital to cover themselves up with.

In fact, empirically, any statistic research could conclude in out that banks should in fact hold more capital when lending to The Safe than when lending to The Risky.

Professors, as you can see our bank regulators can’t seem to understand that the safer an asset is perceived ex ante, the bigger its potential to deliver ex post those unexpected losses that the bank capital is supposed to help cover. The banks themselves should, of course manage any expected credit losses.

So you see current bank regulators need a good Statistics 101. Can we count on you to lend us a hand? Please?

Mark Carney, if you are so concerned about climate change risk, suggest capital requirements for banks should depend on it.

We read: Speaking at the COP21 Paris Climate Change Conference Mark Carney, FSB Chair, said “The FSB is asking the Task Force on Climate-related Financial Disclosures to make recommendations for consistent company disclosures that will help financial market participants understand their climate-related risks. Access to high quality financial information will allow market participants and policymakers to understand and better manage those risks, which are likely to grow with time.” 

Bullshit! If Mark Carney was really concerned about environmental sustainability (and about job creation for our young) he would suggest to base the capital requirements for banks on that, instead of as currently basing these on nonsensical credit risks that are anyhow cleared for by banks.

Frankly, if there is a real need for a Task Force, that should be one to determine the regulatory stupidities that distort the bank credit allocations to the real economy. Such Task Force might very well suggest getting rid of regulators like Mark Carney.

PS. As I have said before... if climate change regulation is to be handled by a task force in any way similar to the Basel Committee... then we're toast. 

16 tweet-sized fundamental mistakes with regulatory credit-risk weighted capital requirements for banks… and counting

The regulators are regulating the banks without having defined the purpose of the banks. 

Regulators ignored that banks need and should allocate credit efficiently to the real economy.

Regulators ignore that for the society, what is not on the balance sheet of banks, could be as important as what is.

To allow bank equity to be leveraged with net margins of assets differently, distorts the allocation of bank credit.

The scarcer the bank capital is, the greater the distortions produced by the risk weighted capital requirements.

Bank capital is to cover for unexpected losses, yet regulators base the requirements on expected credit risks.

The safer something is perceived the greater is its potential for unexpected losses.

The risk of a bank has little to do with perceived risk of assets, and much to do with how the bank manages risks.

Banks clear for credit risk with interest rates and exposures, so to also do in the capital double-counts that risk.

Any perfectly perceived risk causes the wrong actions if the risk is excessively considered.

The standard risk weights that determine the capital requirements for banks are, amazingly, portfolio invariant.

The undue importance given to few information sources, credit rating agencies, introduced a serious systemic risk.

That imposing similar and specific regulations on any system stiffens it and increases its fragility was ignored.

Any regulatory constraint that can be gamed will be gamed and benefit the worst gamers in detriment of lesser gamers.

A risk weight of zero percent for the sovereign, and of 100 percent for the private sector, is pure unabridged statism.

Impeding “the risky” to have fair access to bank credit blocks opportunities and thereby increases inequality

Consequences: Too much bank credit against too little capital to whatever is perceived or can be construed as being safe, and too little credit to what is perceived as risky. In other words banks that do not finance the “risky” future, but only refinance the “safer” past.

Questions: Of these mistakes how many have been sufficiently debated and corrected? How many of the responsible for these mistakes have been held accountable?

Excuse me Stefan Ingves. Are you a raving statist? Are you a raving communist?

In 1988, with the Basel Accord, Basel I, the bank regulators of the all important G10 decided that, for the purpose of defining the capital requirements of banks, the risk weight for the sovereign, meaning the government, was to be zero percent, while the risk weight for the private sector, meaning the citizens, was set at 100 percent. What a lunacy!

Mr Stefan Ingves, Chairman of the Basel Committee on Banking Supervision and Governor of the Sveriges Riksbank, in remarks made on May 5, 2015 to the 8th Meeting of the Regional Consultative Group for Europe, had this to say about “Sovereign risk”

“A discussion of the risk-weighted capital framework would not be complete without a discussion of the Committee's work on sovereign risk - a topic which is clearly of relevance to Europe. At its meeting earlier this year, the Group of Central Bank Governors and Heads of Supervision - the Basel Committee's oversight body - agreed to initiate a review of the existing regulatory treatment of sovereign risk, including potential policy options.

In many cases sovereign exposures are in fact relatively low credit risk assets and also highly liquid. 

Yes, they do receive a lower capital charge than other asset classes, but this is generally warranted. But - and this is an important but - I think we can all agree that there is no such thing as a risk-free asset. When we talk about this issue we talk about "sovereign-risk" - not about "sovereign risk-free"

For this reason the Committee will consider potential policy options related to the existing treatment of sovereign risk. It is important to note that this review will be conducted in a careful, holistic and gradual manner.”

Let me here concentrate on “Yes, sovereigns exposures do receive a lower capital charge than other asset classes, but this is generally warranted.”

Mr. Stefan Ingves, why is that generally warranted?

If sovereigns exposures receive a lower capital charge than other assets that means banks will be able to leverage more their equity and the support they receive from society when lending to the sovereign than when lending to the private sector, meaning to the citizens. 

And that of course means banks will be able to earn higher expected risk adjusted returns on equity when lending to sovereigns than when lending to the private sector, meaning to the citizens.

And that of course means banks will tend to favor lending to the sovereigns than to the private sector, meaning the citizens.

And the only possible rational explanations for that must be if you believe government bureaucrats more able than citizens to use bank credit.

Do you Stefan Ingves believe that? Are you a raving statist? Are you a raving communist?

Who has ever heard about a zero percent risk free sovereign? They even tell you in your face that they have an inflation target, so as to pay you off with money worth less and, if that does not suffice, that they will then increase your taxes to service their debt.