Stop the risk aversion and pro-government bias of bank regulations. Deceitfully it plunders our young's future.

A friend told me I had to read Mark R. Levin´s “Plunder and Deceit”, and when I saw it was subtitled “Big governments exploitation of young people and the future” I immediately ordered a copy. 

And in its first chapter I read about the intergenerational continuum of the past, the living and the unborn… and I knew the author and I, at least in this respect, shared very similar concerns.

And just looking through the index, I knew I had to add a chapter to this book titled: “God make us daring!”

Why? Because the most important driving force on the intergenerational continuum is the willingness of those of us here now, to take the risks needed today in order for the tomorrows of our descendants to be brighter and brighter.

But, unfortunately, tragically, our most important societal financiers of risk-taking, the banks, have been instructed not to attend to the credit needs of The Risky, but to keep financing solely The Safe. How come? 

Regulators imposed capital requirements on banks that are much higher for what is perceived a risky, from a credit risk point of view, than for what is perceived as safe. That allows banks to leverage their equity and the support these receive from the society much more when lending to The Safe than when lending to The Risky. And that of course allows banks to earn much higher risk adjusted returns on equity when lending to The Safe, than when lending to The Risky.

And so regulators have impeded the fair access to bank credit of those perceived as risky, like SMEs and entrepreneurs, and therefore banks are no longer helping out financing the future of our young people, they are only refinancing the past.

And, to top it up, with that so amazingly unnoticed historical event of the Basel Accord of 1988, regulators decided the risk-weight for sovereigns was zero percent, while the risk-weight of citizen 100 percent. And with that these statist/communists de facto made our banks to operate under the assumption that government bureaucrats use bank credit more efficiently than the private sector.

And the credit-risk-aversion and pro-government bias introduced in our bank regulations, has our western civilization going down and down

In April 2013 the Washington Post published the following letter I wrote:

“It suffices to remember the saying about “a banker being that chap who lends you the umbrella when the sun shines but wants it back as soon as it looks like it is going to rain” to know that those assets perceived as safe are already much favored over those perceived as risky. The risk weights applied by the Basel regulations and based on exactly those same perceived risks only increase the gap between “The Infallible” and “The Risky.” 

And that is why I very much salute the bill by Sens. Sherrod Brown (D-Ohio) and David Vitter (R-La.) that looks to “require more capital and better capital but also limit the ‘risk-weighting’ of assets.” More capital is a perfectly legitimate requirement, but the imposition of risk weights is fundamentally incompatible with “a land of the brave.” The United States did not become what it is by avoiding risks.”

Unfortunately, in the Home of the Brave, the interests of bankers making their dreams of very high returns with very little risks come true, seems to trump the needs of its younger. 

America: Why do you saddle your young and brightest with huge education loans, if you’re not willing to allow banks financing those who might generate the jobs your young need in order to service that debt?

US Congressmen and Governors: How come you allow your banks to hold less capital when financing sovereigns and members of the AAArisktocracy, than when financing your own small unrated local businesses?

US bank regulators: Have you never heard of the Equal Credit Opportunity Act (Regulation B)?

A verse of a Swedish Psalm 288 reads: 

“God, from your house, our refuge, you call us 

out to a world where many risks await us.
As one with your world, you want us to live.
God make us daring!”

PS. And all this risk adverse and pro-sovereign regulations for nothing! Major bank crisis do not result from excessive exposures to what was perceived as risky, these always result, no exceptions, from excessive exposures to what was erroneously perceived as very safe. Just look at the AAA rated securities backed with mortgages to the subprime sector... and Greece.

Why does IMF never mention that credit-risk-weighted capital requirements for banks, is a potent inequality driver?

I refer to an IMF Staff-Discussion-Note titled “Causes and Consequences of Income Inequality: A Global Perspective”. It includes among other “Factors Driving Higher Income Inequality” the following:

“Financial globalization. Financial globalization can facilitate efficient international allocation of capital and promote international risk sharing. At the same time, increased financial flows, particularly foreign direct investment (FDI) and portfolio flows have been shown to increase income inequality in both advanced and emerging market economies… Financial deregulation and globalization have also been cited as factors underlying the increase in financial wealth, relative skill intensity, and wages in the finance industry, one of the fastest growing sectors in advanced.

Financial deepening. Financial deepening can provide households and firms with greater access to resources to meet their financial needs, such as saving for retirement, investing in education, capitalizing on business opportunities, and confronting shocks. Financial deepening accompanied by more inclusive financial systems can thus lower income inequality, while improving the allocation of resources… Theory, however, suggests that … inequality can increase as those with higher incomes and assets have a disproportionately larger share of access to finance, serving to further increase the skill premium, and potentially the return to capital.”

And again I must ask: Why does IMF insist on keeping mum on that huge financial inequality driver that is the risk-weighted capital requirements for banks?

Society lends bank much support, not only directly, by entrusting it with its deposits, but also indirectly, by offering deposit guarantees that if called upon will be paid by taxpayers.

And the Basel Committee thought it could make banks safer by making the capital requirements for banks to be dependent on perceptions of credit risk… while entirely ignoring that those perceptions of risk were already cleared for, by means of risk premiums and size of exposure.

And so, for instance with Basel II, regulators decided that banks were allowed to leverage the societal support over 60 times to 1 when lending to the AAArisktocracy, namely those rated AAA to AA, but only about 12 times to 1, when lending to unrated SMEs and entrepreneurs. That, which allows banks to earn much higher risk-adjusted returns on equity when lending to “The Safe”, blocks the opportunities of “the risky” to obtain fair access to bank credit. It therefore constitutes a huge driver of inequality.

And since the document refers to “Financial deregulation” I must also ask, for the umpteenth time…what financial deregulation? That where a small number of regulators redirect the allocation of bank credit all over the world… de facto imposing global capital controls? You’ve got to be kidding!

No! The Basel Committee is just a nest of irresponsible populist technocrats, who frankly have no idea of what they are doing. For instance they derive those capital requirements, that they themselves declare should be there to cover for unexpected losses, from the perceptions of expected losses. How loony is not that? Clearly the safer something is perceived, the bigger its potential to deliver truly disastrous unexpected losses.

I have often complained about these regulations on the IMF blog… you can Google it on “blog-imfdirect.imf.org Kurowski”. But I have never received an answer from IMF, seemingly the automatic solidarity among technocrats is very strong.

PS.That regulatory protectionism can both keep our banks safe and allocate credit well, is pure and unabridged technocratic populism

PS. My 2019 letter to the Financial Stability Board (FSB)

One of Basel Committee’s many monstrous regulatory mistakes made easy. The expected and the unexpected mix up.

As regulators have explicitly stated, banks should be required to have capital (equity) as a cushion against unexpected losses. 

In Basel II, the risk weight applied to assets of private corporations rated AAA to AA, was 20%. This weight, applied to a base capital of 8%, signified banks had to hold 1.6% in capital against these “safe” assets. And the correspondent risk-weight for assets rated BB- and below, was 150%, which meant banks had to hold 12% in capital against these “risky” assets.

Let me ask anyone of you… what carries a larger potential of dangerously high-unexpected losses, what is rated AAA to AA, or what is rated below BB- and for which therefore the expected losses are huge? 

Do you get the drift?

Also, the moment a risk is generated for a bank is not when an asset is down-rated, but when that asset is put on the bank’s balance sheet. But currently it is when a credit gets down-rated that regulators, much too late, jack up the capital requirements; something which makes it even more difficult for banks to manage the problem assets.

PS. This is one of the many observations regulators have steadfastly refuse to comment on. If anyone of you is able to extract something of an answer from these not accountable to anyone regulators, I would be grateful to know about it.

World Bank, before Public Credit Guarantee Schemes (CGSs) help removing the obstacles to bank lending to SMEs

“The World Bank Group and FIRST Initiative are inviting stakeholders -- governments, credit guarantee schemes (CGSs) and lenders -- to provide input on how to improve access to finance for SMEs through an effective design, implementation and evaluation of Public Credit Guarantee Schemes CGSs.”

As a justification the document states something we can all surely agree on: “Financial inclusion, particularly for small and medium enterprises (SMEs), is widely recognized as one of the key drivers of economic growth and job creation in all economies. SME credit markets are notoriously characterized by market failures and imperfections including information asymmetries, inadequacy or lack of recognized collateral, high transaction costs of small-scale lending and perception of high risk.”

We also read: “In order to address these market failures and imperfections, many governments intervene in SME credit markets in various forms. A common form of intervention is represented by credit guarantee schemes (CGSs). A CGS provides third-party credit risk mitigation to lenders with the objective of increasing access to credit for SMEs. This is through the absorption of a portion of the lender’s losses on the loans made to SMEs in case of default, in return for a fee. The popularity of CGSs is partly due to the fact that they typically combine a subsidy element with market-based arrangements for credit allocation, therefore involving less room for distortions in credit markets than more direct forms of intervention such as state-owned banks.”

And I would want to draw your attention specifically to: “they typically combine a subsidy element with market-based arrangements for credit allocation, therefore involving less room for distortions in credit markets.”

That because the World Bank Group and the FIRST Initiative, are aware of the existence of risk-weighted capital requirements for banks which allow banks to leverage much less their equity when lending to “The Risky”, like SMEs than when lending to “The Safe” like sovereigns and the AAArisktocracy.

And they must also be aware that these regulations impede “market-based credit allocation, and cause huge distortions in credit markets”. We know that because already in the World Banks' The Global Development Finance 2003 (GDF-2003), “Striving for Stability in Development Finance” it had this to say on Basel II, pages 50-52

“The new method of assessing the minimum-capital requirement [proposed by the Basel Committee for Banking Supervision (BCBS)]… will be explicitly linked to indicators of credit quality… The regulatory capital requirements would be significantly higher in the case of non-investment-grade emerging-market borrowers than under Basel I. At the same time, borrowers with a higher credit rating would benefit from a lower cost of capital under Basel II….”

And so, though welcoming very much this initiative of the World Bank and the FIRST Initiative, I pray that it is not in substitution of getting rid of the portfolio invariant credit-risk weighted capital requirements for banks, which blocks SMEs from having fair access to bank credit. If it is, then let me assure you the “Public Credit Guarantee Schemes (CGSs) for SMEs” discussed amounts to a petty consolation prize for the SMEs, and could even increase the existing regulatory distortions.

We read the consultation invites “stakeholders -- governments, credit guarantee schemes (CGSs) and lenders” should not SMEs, or those who speak up for the borrowers’ rights of not being discriminated against by regulators, be specifically invited?

The Basel Committee is a pitiful bunch of bank regulators incapable of expressing even the smallest “We’re sorry Greece”

There is no doubt whatsoever that had regulators not allowed to leverage their equity over 60 times to 1 when lending to Greece, Greece not matter what accounting shenanigans it could come up with, would not have been able to borrow as much as it did. 

And now, as a consequence, we read about Greece having to hand over 16 of its airports to those who  in order for the creditors to be paid, have paid for the right of charging a toll on much of the future tourism to Greece.

And yet not even the slightest hint of the Basel Committee telling Greece, and its creditors, they're sorry. What a sad bunch of technocrats.

Who did the Eurozone in?

How to blow up the banking system

Q. What is the most dangerous for banks?

A. That they build up excessive dangerous exposures to something that turns out much riskier than they expected

Q. When do banks usually build up such exposures?

A. Obviously when they perceive something as very safe and they expect to make very good returns on it.

Q. And what else can make those excessive bank exposures especially dangerous, for instance for the taxpayers?

A. That the banks, if something goes wrong, stand there almost naked with very little equity to cover the losses.

Q. So hypothetically, mind you, what would you think of credit-risk weighted capital requirements for banks that are especially low for what is perceived as safe?

A. Well, since that would allow banks to earn the highest risk adjusted returns on what is perceived as safe, it would therefore, sooner or later, cause banks to build up dangerously excessive exposures to what is perceived as safe against very little capital, and so it sure sounds like the perfect way to blow up the banking system..... Sir, excuse me, why do you ask all this?

PS. 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 it collapse”

Note: My January 2009 AAA-Bomb blog

Pension funds, widows and orphans have been told to keep out of what’s perceived safe, that’s now the banks’ domain

Bank regulators, with their credit-risk-weighted capital requirements, allow banks to leverage their equity and the support received by deposit guarantees and similar, immensely, as long as they stick to lending to “The Safe”... in their mind the infallible sovereigns, the AAArisktocracy and housing.

Consequentially the more regulators favor and therefore subsidize bank lending to “The Safe”, the lower will be the interest rates paid by “The Safe”... sometimes even down to zero interests, and, of course, in relative terms the higher the rates “The Risky” need to pay. 

Ergo… non-banks who have to evaluate the increased spreads between The Safe and The Risky, without counting with the regulatory bank-subsidies, are more tempted by, or are in more need of the higher rates paid by The Risky.

Pension funds, widows and orphans who were the one investing in “The Safe”, have now been told to get out of there… “That’s for the banks!”

"The Risky", like the SMEs and the entrepreneurs they used to have access to the banks… now they are left out in the cold… desperately looking for some crowd-funding.

Why has not a proper independent autopsy of the financial crisis 2007-08 been done? The answer: What would be found!

When we see with how much care and dedication investigators perform the autopsy of the causes of an accident whenever a plane crashes, one can truly be surprised about how little autopsy has been performed on the 2007-08 financial crash.

But of course those performing the autopsy of a plane crash are not the designers of the plane, nor those responsible for its maintenance, nor air-traffic controllers nor, of course, those who were flying it… and so there are no conflicts of interests present in the investigation (I presume).

In the case of the Financial Crisis 2007-08 crisis any outside completely independent investigator would have determined its principal cause to be:

The very low capital requirements for banks when holding assets perceived as “safe”, and which created unmanageable perverse incentives for banks to lend or invest excessively in what was ex ante perceived as safe.

Evidences?: Just look at the debris: a) AAA rated securities and credit default swaps issued by AAA rated AIG that, at least US investment banks and European banks were allowed to leverage 62.5 times with; b) loans to sovereigns like Greece to which EU authorities had assigned a 0% risk weight, meaning no capital requirements at all; and c) loans to real estate like in Spain. Nowhere is something ex ante perceived as "risky" found to have caused any problem. What more can you need for a prosecutor to rest his case?

But since those investigating the Financial Crash 2007-08 were, by commission or omission, directly responsible for those risk weighted capital requirements, they all found it in their best interest to classify these as truths that shall not be named.

Until now their strategy has worked splendidly for them... even deregulation is denounced a thousand times more as the source of the problem than their misregulation... and some of the regulators have even been promoted, like to BIS and ECB... and other have found job working on Basel III.

PS. At least I managed to get through with some comments to the Financial Stability Board.

  

What were (are) regulators in the Basel Committee smoking when they set their capital requirements for banks?

The capital requirements for banks are primarily, almost exclusively, to cover for Unexpected Losses (UL), since the Expected Losses (EL) are covered by means of risk premiums, size of exposures and other terms.

And this the bank regulators know as we read in “An Explanatory Note on the Basel II IRB Risk Weight Functions”.

It states: “Banks are expected in general to cover their EL on an ongoing basis, e.g. by provisions and write-offs, because it represents another cost component of the lending business. The UL, on the contrary, relates to potentially large losses that occur rather seldom. According to this concept, capital would only be needed for absorbing UL… [and so] it was decided to follow the UL concept and to require banks to hold capital against UL only.”

But then the strangest thing happened! The regulators, when calculating those UL decided to do this all with formulas that used the EL, and so, inexplicably, they came up with capital requirements that indicate the potential of higher UL for higher EL.

And that just cannot be. It is clear that the safer an asset is perceived, the larger its potential to deliver UL. It is also clear that many of UL in a bank can derive from causes completely unrelated to the intrinsic riskiness of assets… like for instance a cyber-attack.

And, as a result of the confusion, the current capital requirements for banks are much higher for assets perceived as “risky” than for assets perceived as “safe”, with the following consequences:

Banks are able to create huge exposures, against very little capital, to what is ex ante perceived as safe but that ex post could turn out risky, and that is precisely the stuff major bank crises are made of.

The allocation of bank credit is much distorted since using Mark Twain’s analogy bankers will now lend out the umbrella even more than usual when the sun is out and want it back faster than ever as soon as it looks like it is going to rain.

Just look at how much those in the sun, like AAA rated securities, real estate and governments (like Greece) have been able to borrow, when compared to the much tightened borrowing conditions for SMEs and entrepreneurs.

And so nowadays, thanks to our regulators, banks are not financing the riskier future but are mainly busy refinancing the safer past… Friends, where are the jobs for our grandchildren come from?