With their regulatory repression of banks, the Basel Committee and the Financial Stability Board are slaying our economies.

“Banks if you lend to a risky small business or an entrepreneur (broccoli) we will force you to hold more equity (spinach) but, if you lend to our dear safe mother government (ice-cream), we will reward you by allowing you to hold much less equity (chocolate-cake).”

The economies of Europe, of the whole Western world, are unwittingly being submitted to euthanasia by bank regulators too dumb (hopefully) to understand what they are doing.

Our economies, dieting solely on carbs, are being immobilized by growing obesity (as evidenced for instance by  negative interest rates) and any of these days they will suffer a heart-attack.

What I would be tempted to say to Mario Draghi of the ECB, if I were Yanis Varoufakis of Greece

Mr. Mario Draghi.

You were the chairman of the Financial Stability Board for some years. In this respect, and especially since we have never heard you say otherwise, you were in full agreement with current bank regulations.

These regulations allowed any European bank to leverage much more when lending to the Government of Greece, or to other sovereigns, than when doing any other type of lending in Europe. For instance, Basel II restricted banks to leverage their equity to not more than 12 to 1 when lending to any unrated small business or entrepreneur in Europe, while allowing a leverage of more than 60 to 1 when lending to our government.

And so bankers became too interested in tempting our government with credit; and sadly our government-officials/politicians were unable to resist the sirens, and got too much into debt; and those Greek small businesses or entrepreneurs, those who with their activities are to generate the fiscal income needed to pay for our government’s expenses, they have had their fair access to bank credit severely curtailed.

And so I hold that you, Mario Draghi, are directly co-responsible for Greece’s current tragic predicaments.

Therefore, please allow me to speak with somebody else in the ECB.

PS. What is not included in the Memorandum on Economic and Financial Policies.

PS. Mr. Yanis Varoufakis, ask your own Greek bank regulators the following:

"Why on earth should a bank, operating in Greece, be allowed to lend to well-rated corporations elsewhere, or to sovereign governments, holding less equity than when lending to Greek SMEs and entrepreneurs?

I mean that does not sound right. That sound like a regulatory tax on our “risky” borrowers and a regulatory subsidy to strange “safe” borrowers."

ECB, IMF: Unbelievable, Greece’s “Memorandum on Economic & Financial Policies” does not include what Greece most needs

For more than a decade and still at this particular moment any European bank, including Greek banks, has been required to hold much more equity when lending to any Greek small business or entrepreneur, than when lending to any European sovereign or European corporation that possesses a good credit rating. 

And therefore European and Greek banks, scarce of equity, are not lending sufficiently to Greek small businesses or entrepreneurs… nor for that matter to other European small businesses or entrepreneurs.

And anyone who believes Greece (and Europe) can be pulled out of its current problems, by not giving fair access to its small businesses or entrepreneurs, has no idea of what goes on in the real economy. 

If there is something Greece (and Europe) needs, urgently, is to get rid of those odiously discriminating risk adverse equity requirements, those which have banks not financing the risky future any longer, but trampling stale water, only refinancing the supposedly safer past.

“A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926 

God make us daring!

PS. In relation to this you might be interested in: “Who did Europe in!”

PS. Here is a more complete explanation of what is wrong.

PS. Here is an alternative action plan for the ECB.

The sad tale about the rookie instructors in the Basel Committee's bank driving school

More perceived credit risk more bank equity… less perceived credit risk less bank equity. Does that not sound logical? It does, and that is precisely why intuition manages to overtake understanding.

Let me try to explain it all with the help of the following image of a two driving wheel car sometimes used by driving schools.

Suppose the driving student is an expert driver, let’s call him a banker, and the driving instructors  is  a rookie who does not know even how to drive well on his own, let’s call him the regulator.

And let us also suppose that the car came with a manufacturing defect, namely the instructor's driving wheel not overriding the student's... and nobody at the driving school cared to check for that.

And now they are out on the street. The banker sees a credit risk danger, and averts it by turning his driving wheel, taking on small exposures and setting the risk premiums high so as to compensate for the added risk.. all as one should normally drive. 

But, seeing the same perceived credit risk, the scared rookie regulator also turns his driving wheel, that of equity requirements. The result will be a dangerous over-reaction to perceived credit risks… either too much steering the car into safety or too much steering it away from the risks that are natural when driving.

You might argue the regulator has accelerating and breaking pedals too he could use. Not so! In this case the regulators of the Basel Committee stated that, making the driving also depend on the speed, was much too complicated for them, and so the driving lessons were to be “portfolio invariant”.

And with bankers already hating velocity where risks seem high… they now do almost no lending at all to “risky” SMEs and entrepreneurs, to those who are those most in need of fair access to bank credit.

And with bankers loving to speed when it seems safe, they crash, where they usually crash, someplace seemingly “very safe”. Unfortunately, now the crashes causes much more tragedy because, when driving around in AAA rated securities, sovereigns like Greece, real estate in Spain and similar "safe"terrains, they are now allowed to drive with little use of safety belts, bank equity.

And here we are biting our nails, thinking about what still lies waiting for us around ultra-safe corners.

ECB, swap the European sovereign bonds you acquired with QEs, for fresh bank equity in European private banks.

My heart goes out to the so many who are unemployed in Europe, as a direct consequence of banks not lending to SMEs and entrepreneurs, this a direct consequence of being required to hold much more of very scarce bank equity when doing so, than when lending to the “infallible sovereigns” or to the AAArisktocracy.

My heart goes out to pension funds, widows and orphans, who do not find a “safe” place for their investment and savings because, as a direct consequence of those same bank equity requirements, they must now compete with banks eager to access debt issued by the “infallible sovereigns” or by the AAArisktocracy.

And growth in Europe is so dismal that even those classified as “infallible sovereigns”, are offering negative rates, which of course is a “haircut”.

I have no idea whether it would be politically viable but, if I was the ECB, and or a government in Europe, the following is the proposal I would put on the table for its urgent discussion:

Assign the same 100% risk weight to all bank assets, so as to allow banks to allocate credit efficiently to the European real economies. 

That would signify an 8 percent equity requirement for all bank assets, which would open up a very significant need for new bank equity.

Let the ECB temporarily fill that hole by subscribing bank equity, paying with the sovereign bonds it has acquired as a consequence of QEs.

In due time ECB would resell those bank shares to the markets. While these shares are in possession of ECB, it will refrain from exercising any voting rights.

Banks can do whatever they want with those bonds… but since holding sovereign bonds would now require them to have 8 percent in equity we can safely assume they would resell these as well as other sovereign bonds they had, to pension funds and widows and orphans.

Banks would as a consequence immediately be able to look again at credit request from the tough "risky" risk takers Europe needs in order to have a future. Enough with not financing the future and just refinancing history J

Bankers, having then to service the dividend aspirations of much more equity, could of course see their bonuses slightly constrained J

And I guess that adequately capitalizing banks, is of some interest not only of those sovereigns in the periphery J

What would happen to current market value of bank shares? We do not know, but perhaps their dramatically increased safety would more than compensate for their much lower allowed leverage, and prices could even go up. Who knows, perhaps even pension funds, widows and orphans could become buyers of European bank shares J

Western world... listen!

God make us daring!

Or do like Chile did!

Western world, it behooves you to understand the following about current bank regulations, and to do something about it.

Banks are currently allowed to hold much less equity against assets perceived as safe than against assets perceived as risky.

That means that banks are allowed to leverage their equity much more with assets perceived as safe than with assets perceived as risky.

That means bank currently obtain much higher risk adjusted returns on equity with assets perceived as safe than with assets perceived as risky.

And that, compared to equity requirements which do not discriminate based on ex ante perceived credit risks, means that banks will lend too much at too low rates to what is perceived as safe, and too little at relative too high rates to what is perceived as risky.

And the supposedly “safe” are sovereigns, basically considered as infallible, the members of the AAArisktocracy, and the housing sector.

And the supposedly “risky” are for instance all those SMEs and entrepreneurs we so much depend on for our economies to move forward, so as not to stall and fall.

And all for nothing! Major bank crises result always from to large exposures to what is erroneously perceived ex ante as safe, and never ever from too large exposure to what is perceived as “risky”.

And the distortions this regulation has created is destroying the Western world that has become what it is, not by risk avoidance, but by the reasoned and sometimes the unreasonable risk taking of our forefathers.

“A ship in harbor is safe, but that is not what ships are for” John Augustus Shedd, 1850-1926

How did this monstrous regulatory mistake happen?

First and foremost because regulators concerned themselves with the risk of the assets of banks, which is what bankers should be concerned with, and not with the risk that bankers are unable to manage the perceived risks, or the risk perceptions being faulty, and which is what regulators should be concerned with.

Second by allowing the regulations to take place in a small mutual admiration club of “experts” with no accountability.

Third, by allowing ideology to infiltrate bank regulations to such an extent so as to make it possible for regulators to declare some sovereigns to be infallible, to have a zero risk weight.

Fourth by the fact we live in a world that finds it difficult to imagine, or does not want to recognize, the possibility of experts being so utterly wrong. 

How can we correct for it? Not easy, but it will clearly not happen by allowing the failed regulators to keep on regulating.

And please do not ask bankers to correct it. For them, being able to earn the highest risk-adjusted returns on equity by lending to the “safe”, is a dream come true. 

In 1999, in an Op-Ed 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”

That AAA-bomb detonated in 2007-08 and its poisonous radiation is still killing our economies. For those coming after us… please do something! 

@PerKurowski

A former Executive of the World Bank (2002-2004)

http://teawithft.blogspot.com

http://subprimeregulations.blogspot.com/

http://financefordevelopment.blogspot.com

http://www.theaaa-bomb.blogspot.com

http://bombaaaa.blogspot.com

PS. Any editing suggestion that could make the explanation more understandable is appreciated on perkurowski@gmail.com

The 2007-08 crisis resulted not because of a natural Black Swan, but because of one bred by the Basel Committee.

“Martial arts legend Bruce Lee, whom many people regarded as immortal, died at the age of only 32 of a cerebral edema, or brain swelling, after taking some sort of aspirin. I have not the faintest idea whether that pill actually had anything to do with his death but I have frequently used (or misused) this sad death as an example of how an organism could be in such a highly tuned and perfect condition that it could not resist a small external shock.

And as a consultant I often used this metaphor to explain why companies nowadays, pressured by the stock market’s expectations for the next quarterly results; the latest theories in corporate finance as to how squeeze out the last drop in results; and, perhaps, even some bit of creative accounting, might be so well-tuned (no little reserve fat left) that they would not be able to withstand any minor recession. (Whenever I expose this theory, I can see in my wife’s eyes that she believes this is just my preparing an excuse for my growing—ok, grown—midline.)”

That and which I wrote in my book Voice and Noise (2006) should be more than enough evidence on how much I share and enjoy Nassim Nicolas Taleb’s discussions on fragility and the need for redundancy.

But where I have serious disagreements with NNT is when he relates his “black swan” to the financial crisis that occurred in 2007-08. And not because it was not a black swan event to most, it sure was, but because it provides bank regulators with the perfect excuse to avoid accountability. That Black Swan was not a natural black swan, it was a man made black swan… it was a Black Swan bred by the loony portfolio-invariant-credit-risk-equity-requirements for banks. 

For instance when NNT writes in “Thinking” 2013 “use of probabilistic methods for the estimation of risks did just blow up the banking system” I have to jump out of my chair to shout No! It was the use of the wrong risk factors that blew up the banking system. The Basel Committee used the risks of the banks assets when setting the equity requirements for banks, and not the risks banks would not be able to manage the risks of those assets.

Empirically, in terms of causing major bank crises, it is clear that banks are much worse managing “safe” assets than “risky” ones.

And when NNT, in the same chapter of “Thinking” writes about his four quadrants: Simple binary decisions in Mediocristan; Simple decisions in Extremistan; Complex decision in Mediocristan and; Complex decisions in Extremistan…no matter how much I agree and find that interesting, it has nothing to do with the bank 2007-08 bank crisis.

My more directly applicable to banks quadrangle, which explains the consequences for bank based on the ex ante perceptions of asset risks and ex post realities, IS THIS

Why is a forced debt reduction considered a “haircut”, while having to pay more taxes, accept inflation or negative interests is not?

Intro: If I am a European and have invested my savings in a bond issued by my sovereign, and then my sovereign cannot repay me without increasing the taxes on me, or printing the money that by means of inflation allows it to repay me with money worth less… is that not a slighted disguised but yet a very real haircut? 

Current bank regulators require banks to have much less equity when lending to the government than when lending to a small businesses or an entrepreneur. 

And we must presume that means regulators feel it is less risky to us citizens when banks lend to the government, and the use of that money is decided by bureaucrats, than when the spending of the money they are responsible for is decided by small businesses or entrepreneurs. 

I don’t get it. Do you?

Might that be because governments are less risky because they have the power to tax or to print money?

If so, why do regulators not explain to us how repaying by having to collect more taxes, or repaying through inflation, is de facto not quite similar to any regular “haircut”.

Really? Is a sovereign less risky because if it cannot repay its debt it can always tax some debt holders and other innocent bystanders more?

Really? Is a sovereign less risky because if it cannot repay its debt it can always print more money and repay you with money worth less?

Friends, are these bank regulators truly working for us citizens, or are they only working for government bureaucrats? Or is it only all about ideology?

PS. When credit rating agencies rate sovereigns, should they not realize that increased taxes and printing money inflation are de facto haircuts?

PS. If I purchase a 10-year US government bond paying 1.97%, and the Fed tells me it is pursuing a 2% inflation… is this a prepaid haircut?

PS. Should banks, insurance companies or pension funds be allowed to invest in bonds with negative interest.... meaning pre-announced prepaid minimum haircuts?

PS. Can somebody please raise some prices, so to make central bankers happy and get deflation out of their heads, and so that they allow us being paid at least some interest on our savings, when we , almost widows and orphans, save in something that is supposed to be safe?  

PS. And the above does not even touch on the haircuts provided by devaluations.

America, who do current bank regulators really regulate for?

Current regulators allow banks to hold much less equity when lending to sovereigns, the AAArisktocracy and the housing sector, than when lending to small businesses and entrepreneurs.

And that means banks can earn much higher risk-adjusted returns on equity when lending to sovereigns, the AAArisktocracy and the housing sector, than when lending to small businesses and entrepreneurs.

And that of course means that banks will lend too little and in relative terms too expensive to small businesses and entrepreneurs.

That must obviously be because regulators sincerely believe that when banks lend, for instance to the government, that is something much less risky for the citizens-society-tax-payers, than when banks lend to small businesses and entrepreneurs.

Where do they get it? Is it not a monstrous risk to distort bank lending in such a way that it might not  reach its most productive use, from which all could benefit, one way or another?

Today I heard an interesting conference about how the U.S. Small Business Administration (SBA) was doing so much lending to small businesses and entrepreneurs… because banks were not lending enough to these.

It blew my mind!

If so it must be because bank regulators think it is much less risky if government bureaucrats lend to small businesses and entrepreneurs than if bankers do. They are wrong. Bankers put at least some shareholder’s equity on the line, while regulators are lending out 100% in current or future anonymous tax receipts… or in future inflation if things go really bad.

So who do these bank regulators really regulate for?

As I see it the U.S. Small Business Administration should be up in arms against regulations that distort the allocation of bank credit, and so odiously discriminates against the fair access to bank credit of small businesses and entrepreneurs.

And before anyone screams at me about banks taking risks with small businesses and entrepreneurs, show me the first major bank crisis ever that has resulted from excessive bank exposures to what ex ante was perceived as risky... and I'll show you many resulting from lending to fallible sovereigns and members of the AAArisktocracy who, ex post, turned up as vulgar very risky.

All this is the result of a horrendous regulatory mistake committed by the Basel Committee for Banking Supervision and the Financial Stability Board. Those regulators concerned themselves with the risk of the assets of banks, instead of with the risks of how banks would manage the risk of those assets.

PS. How come they all can so blithely ignore the Equal Credit Opportunity Act (RegulationB)?

PS. Is the US Congress really aware of the regulatory risk aversion that has been introduced through the backdoor in the Home of the Brave?

  

PS.  Has Homeland Security looked into at what a threat distorting credit allocation could pose for the economy?

PS. And America, if it serves you as consolation...though it should not... in Europe it is even worse.

Only communists must believe it is safer for banks to lend to governments than to small businesses and entrepreneurs.

Since regulators allow banks to hold much much less equity when lending to the sovereigns, than when lending to small businesses and entrepreneurs, that must imply they think it is safer for the society to lend to the government, than to lend to the small businesses or entrepreneurs.

If you were not a communist, why the hell would you believe that?

And please don't tell me it is because sovereigns can print money!

Why do so many finance reporters and professors seemingly participate in the cover up of the greatest regulatory mistake of all times?

The risk of a bank to a regulator is that the credit risk of a bank client is not correctly perceived, or that the bank is not able to adequately manage that perceived credit risk, in the context of its portfolio. Even so regulators set the equity requirements for banks solely based on the ex ante perceived credit risks of the clients of the bank, and as if these perceptions were correct. Something really dumb!

But, if you use credit risks to set equity, then you should at least have been able to ascertain that it is what’s perceived as “safe” which has caused all major crises in the banking system, and never ever what has ex ante been perceived as “risky”. Even so regulators set much lower equity requirements for banks for what was perceived as safe than for what was perceived as risky. Doubling up on their dumbness! 

Regulators should also have known that the most important purpose of a bank is to allocate credit as efficiently as possible to the real economy. And even so, by allowing equity to be leveraged differently for different assets, and thereby skewing the risk-adjusted returns on equity, they caused that process to be distorted. Something really irresponsible!

And I have held for years that it all adds up to the mother of all regulatory mistakes. And the ones most responsible for it is the Basel Committee for Banking Supervision, the Financial Stability Board and the International Monetary Fund.

And it is very understandable that those regulators who are to be blamed for this monstrous mistake that not only caused the current crisis but also keeps our economies from finding the way out of it, want it to be ignored, forever and at whatever cost.

It is also easy to see why bankers do not comment on the mistake. To be allowed to earn the highest risk adjusted returns on equity when lending to something perceived as “absolutely safe”, must be a banker’s dream come true.

It is also easy to understand why politicians have not gotten involved. To begin with the “more-risk-more-capital and less-risk-less-capital” sounds so damn sensible. And to understand that when regulators speak of “risk-weighted capital requirements” they are actually speaking of “portfolio-invariant-ex-ante-perceived-credit-risk-weighted bank equity requirements” requires more reading than what they are used to in these PowerPoint days.

But that financial reporters and finance professors should keep mum about it all, effectively participating in the cover up, that to me is just plain incomprehensible.

And that those perceived as “risky” are not aware of how they are being so odiously discriminated against in their access to bank credit, that is just very sad.

I just pray some of the younger generation stands up and shouts out “That silly regulatory risk aversion is stopping our banks from financing that future we are supposed to live on!” 

PS. Look at poor Greece where greedy bankers and corrupt Greek governments are being blamed, with not a word about the fact that European regulators allowed banks to lend to Greece against no capital at all… which only could lead to Greece borrowing way too much.

Analysis of current equity requirements for banks in light of ex ante perceptions of risks and ex post realities

The Kurowski Matrix:

1st: ex ante Risky – ex post Safe; the results for banks (and the economy) are Positive

2nd: ex ante Risky – ex post Risky; the results for banks can be Moderately Negative. The riskier the ex ante perceptions the smaller the ex post consequences.

3rd: ex ante Safe – ex post Safe; the results for banks are basically Neutral.

4th: ex ante Safe – ex post Risky; here the results for banks are Potentially Extremely Negative as the distance between the initial ex ante perception and the ex post sad reality can be the largest. 

And now the horrible truth!

The Basel Committee set their portfolio-invariant-credit-risk-weighted-equity-requirements for banks by far the lowest, for what was perceived as the safest assets, the 4th quadrant, precisely where the potential size of disaster is by far the largest. 

The Basel Committee committed that horrible mistake because they used the risks of bank assets, instead of the risks that banks would not be able to manage the risks of those assets. 

In other words the capital requirements for banks are based solely on ex ante perceived risks of assets and not on ex post observed risks for banks.

And their mistake was compounded by the fact they did not understand, or did not care one iota about, the fact that different equity requirements for different assets seriously distorts the allocation of bank credit to the real economy. 

Conclusion: It is clear the Basel Committee, and the Financial Stability Board, had no idea about what they were doing… and that they still don't.

A 2010 homemade video on precisely this subject

And 2012, in the Financial Times, my warnings to Martin Wolf about all major crisis being built up with assets perceived as safe.

2003 at the World Bank: “Let us not forget that the other side of the Basel [Committee’s regulatory risk weighted capital requirements] coin might be many, many developing opportunities in credit foregone”

When will regulators ever learn? The risks to banks are not the same as the risks banks pose to us.

Banks need to perceive the risks of their assets, and to manage these correctly. And, if they are unable to do so, then it is good riddance.

We instead need for banks to perceive their risks and manage these sufficiently well, so that to avoid major overspills to us by having to pay for bailouts or other means; and also, primarily, we need them to allocate their credit efficiently to the real economy.

Unfortunately, current regulators, with their credit-risk weighted equity requirements for banks, focus mainly on the risks of the assets of banks, acting as if they were bankers, and are therefore not regulating on behalf of our needs and interests.

Bankers love it, no doubt about it. As a result they earn higher risk-adjusted returns on their equity on what is perceived as safe than on what is perceived as risky. It is banker’s dream come true.

And in this respect we can say the current score is “Banker’s needs 2 – Our needs 0”

When will we as a society show sufficient character and responsibility to stand up to the “experts" in the Basel Committee, and in the Financial Stability Board, so as to hold them really accountable?

Could the science of moral psychology help to explain the greatest regulatory mistake in history?

In Chapter 15 of “The New Science of Morality” by Jonathan Haidt in “Thinking”, 2013, edited by John Brockman we read:

“We need metaphors and analogies to think about difficult topics, such as morality… let’s think of… a perceptual analogy…

I think taste offers the closest, the richest, source domain for understanding morality. First, the links between taste, affect, and understanding behavior are as clear as could be. Tastes are either good or bad.

The good tastes, sweet and savory, and salt to some extent, these make us feel ‘I want more’. They make us want to approach. They say ‘this is good’. Whereas sour and bitter tells us, ‘Whoa, pull back, stop.’

Second, the taste metaphor fits with our intuitive morality so well that we often use it in our everyday moral language. We refer to acts as ‘tasteless’, as ‘leaving a bad taste in our mouths. We make disgust faces in response to certain violations.”

And I want to ask whether something of that could be helpful in explaining what is a great mystery to me, namely current bank regulations. Here a brief resume of my problem:

One of the pillars of current regulations is the risk-weighted capital requirements for banks;which in general terms requires banks to hold more equity against assets perceived as risky, than against assets perceived as safe. The justification of that is of course that what is perceived as risky carries more dangers for the banks than what is thought safe.

That could indeed occasionally be true for some individual banks but, for the bank system at large, I hold that what ex-ante is perceived as very safe, but that ex-post can turn out to be very risky, is what poses the real dangers.

And if my opinion were correct, then current regulations would, in principle, be 180 degrees off the target.

So here is the question to Professor Haidt, or to anyone else related to this field of “moral psychology”.

Does "risky" and "safe" play the same role as what tastes bad and what tastes good… and is there anything down this line of thought that could explain a mistake that I feel is endangering the economies of the Western world… as those regulations introduce a very serious distortion in the allocation of bank credit to the real economy.

Does this not represent an urgent, vital and fascinating research topic for you in the field? 

A proposal to the Office of Financial Research (OFR) about some urgent research needed on the causes of bank crises.

I extract the following from the webpage of the Office of Financial Research (OFR) established by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 in order to support the Financial Stability Oversight Council, the Council’s member organizations, and the public.

“OFR helps to promote financial stability by looking across the financial system to measure and analyze risks, perform essential research, and collect and standardize financial data.

Our job is to shine a light in the dark corners of the financial system to see where risks are going, assess how much of a threat they might pose, and provide policymakers with financial analysis, information, and evaluation of policy tools to mitigate them.”

I have a very important research that I would suggest the OFR to take on, as soon as possible. It is a follows:

One of the pillars of current capital requirements is portfolio invariant credit-risk-weighted equity requirements for banks, also less transparently known as “risk-weighted capital requirements for banks”.

And this regulation in general terms requires banks to hold more equity against assets perceived as risky than against assets perceived as safe.

And since that introduces a discriminatory distortion factor in the allocation of bank credit, something that could prove very dangerous to the real economy, the only possible justification is of course that what is perceived as risky carries more dangers for the system than what is thought safe.

I do not believe that. Of course that could be true for some individual banks but, for the bank system at large, I hold that it is what ex ante is perceived as very safe, but that ex post can turn out to be very risky that poses the real dangers.

And in this respect it would be very important for the US, as well as for the world, to research what perceived credit risks could be identified as having caused major bank crisis. Of course I do not mean an ex-post analysis, but an analysis of the perceptions on credit risk present at the moment banks incorporated the later troublesome assets on their balance sheets.

As you can understand, if my opinion is proven right, then current regulations would, in principle, be 180 degrees off target.

Thanks.

The most important behavioral, cognitive psychology, research program ever

Bank system crises never ever result from excessive exposures to what is perceived as risky, these always results from the buildup of excessive exposures to what was ex ante perceived as safe.

And yet bank regulators imposed on banks credit-risk-weighted equity requirements that are much higher for what is perceived as risky than for what is perceived as safe.

That is very clearly a monstrous mistake. It means that is something really bad happens to banks where that usually happens, regulators have made sure banks will stand there especially naked, with no equity to cover themselves up with. 

And my thesis is that the at-first-sight, Daniel Kahneman's “System 1: Fast, automatic, frequent, emotional, stereotypic, subconscious” standard basic intuition of “risky-is risky and safe-is safe”, is way too strong so as to permit opening a more reflective “System 2: Slow, effortful, infrequent, logical, calculating, conscious” analysis… and this most specially if that means questioning some other members of a mutual-admiration/ mutual-importance-reinforcement club. 

And that is the subject I would like to see researched by experts in behavioral finance and in cognitive psychology.

But why do I call this “the most important research program ever”?

Easy! Those regulations allow banks to leverage the back-stop supports that for instance central banks give more on assets perceived as safe than on assets perceived as risky; and that means banks will obtain higher risk-adjusted returns on their equity on assets perceived as safe than on assets perceived as risky.

That has introduced a regulatory risk aversion that seriously distorts the allocation of bank credit to the real economy.

And since risk-taking is the oxygen of any development, and what helped to bring the Western world to where it is, suspending it, de facto prohibiting banks from taking risks on the “risky”, our economies will first stall and then fall. And I hope you’d agree that’s not entirely unimportant.

Reading Daniel Kahneman's "Thinking Fast and Slow"
https://www.americanbanker.com/opinion/basel-iii-doubles-down-on-basel-iis-mistake

PS. Confirmation Bias

Are credit-risk weighted equity requirements for banks just regulators’ soothing blankets and teddy bears?

Bruce Hood, in “Essentialism” in “Thinking” edited by John Brockman, 2013, writes: “The reduction in funding in this country has impacted upon my field quite dramatically (behavioral sciences)… Now we have to justify with a view to application”.

Great! And do I have an application to suggest!

Bank regulators succumbed entirely to the intuition of if-more-risky-then-more-equity and if-less-risky-then-less-equity completely ignoring that for the banking system as such, what is ex ante perceived as risky poses little risks. It is what is perceived as “absolutely safe” but that later can pop up as very risky that which contains the true dangers.

And so regulators decided banks needed to hold much more equity against what is perceived as risky than against what is perceived as risky; and that resulted in that banks are now making much higher risk-adjusted returns on equity on what is perceived as safe than on what is perceived as risky.

And that leveraged the natural risk adverseness of banks into the skies; that one to which Mark Twain refers to as “they lend you the umbrella when the sun shines and what it back as soon it looks like it is going to rain”.

And, since our economies move forward thanks to for instance the risk-taking of banks on small businesses and entrepreneurs, the Western world is now stalling and falling.

Hood refers to among other to work he’s done with Paul Bloom about “bizarre behavior you find in children of the West [with their] emotional attachments to blankets and teddy bears [when] they need to self-soothe.” 

And it hit me that it could be an extraordinarily application if Hood and Bloom researched whether these bank regulations are the equivalent self-soothing instruments to regulators. Because if so then we would have some arguments in hands to go and tell the members of the Basel Committee for Banking Supervision and the Financial Stability Board that it is their role to regulate banks as society needs banks and not so to help them be calm when they suck their thumbs.

PS. The Western world was built upon a lot of risk-taking, among others by its banks... but in 1988 it got hit by the Basel Accord asteroid.

Unfortunately, with respect to believing the West decadent, it would seem Putin is right.

Edward Lucas of the Daily Mail suggests: “Putin believes the West is finished: overstretched, decadent and discredited. The truth is we are not losing this spate of arm-wrestles because we are weak, but because our willpower is weak.”

In terms of “decadent”, it seems Putin could unfortunately be right.

I say this because to impose larger equity requirements on banks when lending to “the risky” than when lending to “the safe” as the Basel Committee does; and thereby allow banks to earn higher risk-adjusted returns on equity when lending to the safe than when lending to the risky, is besides being something very dumb, a very clear sign of decadent risk aversion.

The Western world was built upon a lot of risk-taking, among others by its banks... but in 1988 it got hit by the Basel Accord asteroid.

En fråga till Herr Stefan Ingves av Sveriges Riksbank, som Ordförande i Baselkommittén

Just nu med Basel II och III, så kräver Baselkommittén att bankerna ska ha mycket mer eget kapital gentemot tillgångar som uppfattas som riskabla, än gentemot tillgångar som uppfattas som säkra. 

Detta leder naturligtvis till att bankerna kan tjäna mycket högre riskjusterade avkastningar på sitt kapital vid utlåning till "de säkra", än vid utlåning till "de riskabla". Och detta naturligtvis snedvrider utgivandet av bankkrediter till den reala ekonomin… och gör att bankerna lånar ut för mycket, på för lätta villkor, till de säkra, liksom till de ofelbara sovereigns och till AAArisktokratin; och för lite, på relativt alltför hårda villkor, till "de riskabla", som till småföretag.

Så låt oss fråga Stefan Ingves om detta. Som ordförande för Baselkommittén borde han kunna gynna oss med en förklaring.

Herr Stefan Ingves. 

Ni måste vara medveten om att även då vissa enskilda banker kan råka i bekymmer på grund av alla möjliga olika anledningar, så är banksystemet som sådant, aldrig riktigt hotat av vad som är på förhand uppfattas som riskfyllt, men bara av vad som på förhands upplevs vara helt säkert… och som senare överraskar oss alla genom att inte vara det.

I detta avseende borde ju bankregleringens första mål vara att säkerställa att bankerna har tillräckligt med kapital, framförallt visavi det som uppfattas som helt säkert. Tyvärr är detta precis motsatsen till vad som krävs nu.

Och ni Herr Ingves måste också vara medveten om att för den långsiktiga stabiliteten av bankerna, finns det inget så viktigt som en robust ekonomi; och för att en robust ekonomi ska kunna existera, är det mer än viktigt att bankkrediter sprids ut till den reala ekonomin så effektivt som möjligt.

Och så i detta avseende bör bankregleringens andra mål vara att säkerställa att man inte stör och hindrar bankerna från att fördela bankkrediter så bra som möjligt ... så att t.ex. de som mest behöver tillgång till bankkrediter, som små företag och entreprenörer, kan få det. Tyvärr är detta också precis motsatsen till vad som händer nu.

Nå Herr Ingves… förklara för oss varför de nuvarande kapitalkraven på bankerna är inte så dumma som de ser ut.

Ps. "Ett fartyg i hamn är tryggt, men det är inte vad fartyg är till för." John Augustus Shedd, 1850-1926

Gud gör oss djärva!

Per Kurowski

Ekonom, Lund 1971. fd Executive Director World Bank (2002-2004)

PS. http://subprimeregulations.blogspot.com/2019/03/my-letter-to-financial-stability-board.html

PS: Prioritera finansiering av bostadsfastigheter över finansieringen av sysselsättningen är inte det smartaste man kan göra