America "The Home of the Brave" is going down, because of bank regulators' silly/sissy credit risk aversion.

Banks use to decide whom to lend to, based on who offered them the highest risk adjusted interest rates. 

Not any more. Now banks have to calculate what those risk adjusted interest rates signify in terms of risk-adjusted rates of return on their equity. That is because with their risk weighted capital requirements, regulators now allow banks to hold less capital, and therefore be able to leverage more their equity, when engaging with The Safe than with The Risky.

And those perceived, decreed or concocted as belonging to The Safe, include sovereigns (governments), members of the AAArisktocracy and the financing of houses.

And those belonging to The Risky are SMEs, entrepreneurs, the unrated or the not-so good rated, and citizens in general.

And that of course has introduced a regulatory risk aversion that distorts the allocation of credit to the real economy. By guaranteeing “The Risky” will now have too little access to credit, that dooms the economy and the banks to slowly fade away.

But the banks and the economy could also disappear with a Big Bang. That because by giving banks incentives to go too much for The Safe, sooner or later, some safe havens will be dangerously overpopulated, and we will all suddenly find ourselves there gasping for oxygen.

In essence, because of this regulation, banks no longer finance the riskier future; they just refinance the (for the time being) safer past.

How did this happen? There are many explanations but the most important one is that regulators never defined the purpose of the banks before regulating these.

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

PS. That also goes for the rest of the world. For instance the Eurozone was done in with it.

PS. Should this not be an issue for Homeland Security?

PS. Is that regulatory discrimination legally allowed?

PS. Risk-taking is the oxygen of all development

God make us daring!

Here is a fuller explanation of why the Basel Committee's bank regulators are idiots... or something much worse! 

There are risks and risks. Bank regulators promote the worst and avoid the best.

We now read “US federal regulators this week proposed new pay rules intended to limit excessive risk-taking”

And so its time again to understand there are different “excessive risk-taking”.

One “excessive risk-taking”, is that of creating dangerously large exposures to what is perceived, decreed or concocted as safe. Those exposures currently require very little bank capital. That was the “excessive risk taking” that caused the 2007-08 crisis; AAA rated securities, residential housing finance and sovereigns like Greece.

Another different “excessive risk-taking” is taking risks on the risky, like on SMEs and entrepreneurs. These risks, because they currently generate much higher capital requirements, are risks not sufficiently taken by the banks, and the economy suffers from that.

Do regulators really know what “excessive risk-taking” they want to limit? I seriously doubt it. The “more-risk less-pay” and the “less-risk more-pay” is just the typical kind of intervention that brings on unexpected consequences.

More-risk more-capital less-pay. Less-risk less-capital more-pay. Friends with these regulations we will soon all end up suffocating because of lack of oxygen in some over-populated safe haven!

And our children, they will be without jobs. Because with this regulatory silliness banks do not finance the riskier future any longer, they just refinance the for the short time being safer past.

In short, any senseless risk aversion, whether in bank regulations or elsewhere, condemn our economies and nations to fizzle out.

The Vasa and the Basel I, II and III disasters

Stefan Ingves, the chair of the Basel Committee, in a speech titled "From the Vasa to the Basel framework: The dangers of instability" last November, said the following:

“In 1625, King Gustav II Adolf of Sweden ordered the construction of…the mighty Vasa. 

It took three years and 300 men to build the Vasa. And 40 acres of timber were consumed. 

The final result was impressive. The Vasa had two gun decks, 64 bronze cannons, and its tallest mast soared to 57 metres. The ship was the result of a quest for perfection. 

This perfection was, alas, short-lived. Tragically, the Vasa sank on its maiden voyage, after sailing only 1,300 metres, on 10 August 1628. 

After so much planning, so many resources and so much time and effort, why did the Vasa sink? According to the King, it was the result of ‘foolishness and incompetence’ 

But historians generally agree that a key factor in the Vasa's fate was the lack of stability and the hull's excessive rigidity… the Vasa was well constructed but incorrectly proportioned” 

As I read that, if the historians are right, then clearly so is the King.

And bank regulations designed by the Basel Committee, especially the risk weighing of the capital requirements, was absolutely “incorrectly proportioned”, and so to me the regulators have been foolish and utterly incompetent.

And with respect to Basel III Stefan Ingves said: “The framework has remained unchanged from Basel II across two broad dimensions: first, the way in which risk is measured - and in particular, the reliance on banks' own estimates of risk - has remained the same following the crisis; and second, the risk-weighted approaches are essentially the same as they were before the crisis"

But, in order to “address the fault lines that emerge from these two dimensions” Ingves now tells us that the regulators are working to fix that with "(i) enhancing the risk sensitivity and robustness of standardized approaches; (ii) reviewing the role of internal models in the capital framework; and (iii) finalizing the design and calibration of the leverage ratio and capital floors."

As I see it, in Vasa terms, the hull of Basel III still lacks stability, but the Basel Committee just keeps on loading more “bronze cannons” on its deck.

“Enhancing the risk sensitivity”? For God’s sake, they are still looking at the risk of the assets and not at the risk those assets pose to the banks… and so they still do not understand that the safer an asset might be perceived, the riskier it could be for the banking system.

And they still have not defined the purpose of the banks, and so they still do not care one iota about if their risk weighing distorts the allocation of credit to the real economy.

I ask, would, King Gustav II Adolf of Sweden have given the constructors of Vasa the resources to build another boat, like we allow the same regulators who designed Basel I and Basel II to now work on Basel III? I don’t think so!

And in wikipedia we read “An inquiry was organized by the Swedish Privy Council to find those responsible for the Vasa disaster, but in the end no one was punished for the fiasco.”

Lucky Stefan Ingves... in the case of the monumental failings of Basel II there has not even been an inquiry!

“A ship in harbor is safe, but that is not what ships are for.” said John Augustus Shedd, 1850-1926. Well, if built by something like the Basel Committee, it is not even safe in the harbor J

PS. Had the Vasa and the Titanic been perceived as "risky" would the outcomes have been the same? No! The outcomes were much conditioned on the ships being ex ante perceived as safe.

PS. 2015 En fråga till Herr Stefan Ingves av Sveriges Riksbank, som Ordförande i Baselkommittén

Let us tell the story of the Basel Committee’s risk weighted capital requirements for banks this way:

This happened during a meeting in the Basel Committee for Banking Supervision

Q. Colleagues, how on earth can we stop banks from failing? 

A. Well they must avoid taking risks?

Q. Absolutely! But how do we stop them from taking risks?

A. Perhaps by giving them great incentives to make their profits where it is safe?

Q. Sounds great! Any idea how?

A. Well we could allow them to leverage much more when lending to what is safe than when lending to what is risky.

Q. How would that help?

A. Well then the banks could obtain higher risk adjusted rates of return on lending to what is safe than on lending to what is risky.

Q. But, could that not distort the allocation of credit to the real economy?

A. Oh that is not our problem. We are just here to make banks safe. 

Q. But, what if something perceived as safe turns out to be risky?

A. Don’t be so negative. We will deal with that later if it ever happens.

Q. But could not someone argue we are introducing a regulatory discrimination against The Risky?

A. Who cares? The sovereign will be more than happy if we give it a zero percent risk weighting. The banks, making their best profits on what is safe, will only have their wettest wet dreams realized. And the risky, the SMEs and entrepreneurs, they have no voice… hey they are not even invited to the World Economic Forum at Davos… there we only meet the AAArisktocracy.

Q. Dear colleague, you have convinced all of us… let us go for it. By the way, what is your name?

A. Chauncey Gardiner Sir

Current bank regulators are a serious threat to economic growth and financial stability; and they promote inequality.

Risk weighted capital requirements for banks, more perceived risk more capital; less risk less capital, results in the following: 

It allows banks to leverage more their equity with what is perceived as safe than with what is perceived as risky; and banks will therefore be able to earn higher expected risk adjusted return on equity on what is perceived as safe than on what is perceived as risky. 

And so banks will therefore lend too much and in too easy conditions to The Safe, like to sovereigns, residential housing and the AAArisktocracy; and too little in too harsh terms to The Risky, like SMEs and entrepreneurs.

That has negative consequences for:

Economic growth: It is affected negatively by hindering the access to bank credit of those most likely to open new paths of growth. Now banks are not financing the riskier future, thet are just refinancing the, for the short time being, safer past

Risk of financial instability: It grows since bank crisis never ever result from excessive exposures to something perceived as risky, they always result from excessive exposures to something erroneously perceived as safe. And in this case all is made worse by the fact that when an explosion occurs, the banks will stand there with specially little capital to cover themselves up with.

Inequality: Is promoted by denying “The Risky” a fair access to the opportunities that bank credit can provide. 

The regulators have gone mad! You want proof? Here are four of many:

1. The bank regulators are regulating the banks without having defined the purpose of these. Anyone trying to regulate anything without asking what he regulates is for, is as crazy as can be. “A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926

2. In Basel II, June 2004, regulators assigned a 35 percent risk weight to residential mortgages; AAA-rated securities backed with mortgages to the subprime sector carried a 20 percent risk weight; the risk weight for sovereigns rated like Greece, hovered between 0 and 20 percent… but assets rated below BB- carried a 150 percent risk weight.

Who in his sane mind can believe that assets rated below BB- pose a bigger risk to our banking system than those assets believed to be safe?

3. Bank capital is primarily to cover for unexpected losses. Who in his sane mind would estimate unexpected losses based on expected credit losses? If anything what is perceived as safe has greater potential to deliver unexpected losses than what is perceived as risky.

4. Regulators ignored that any risk, even if perfectly perceived, leads to the wrong actions if excessively considered. Credit risk are already cleared for by banks by means of interest rates and size of exposure, so that to also order the same risks to be cleared for again in the capital, completely distorted the allocation of bank credit to the real economy. Who in his sane mind could think that, as a regulator, he was authorized to do a thing like that?

God make us daring!

IMF & World Bank Spring Meetings: Time again for finance ministers not daring to ask bank regulators THE QUESTION

Dear regulator

Because of your risk weighted capital requirements, banks are allowed to hold less capital against assets that are perceived as safe than against assets perceived as risky.

That means of course that banks can leverage equity more with assets perceived as safe than with assets perceived as risky.

That means of course that banks can obtain higher expected risk adjusted returns on equity with assets perceived as safe than with assets perceived as risky.

So here is THE QUESTION:

Does that not distort the allocation of bank credit to the real economy, causing banks to lend way too much to those perceived, decreed or even concocted as safe, and way too little to those perceived as risky, like SMEs and entrepreneurs?

PS. Where did all our current bank regulators, those who are writing up Basel I, Basel II, Basel 2.5, Basel III or what have you, study their Bank Regulations 101? Who checks the CVs of these appointees, or do they appoint themselves? Might they just have dropped in like any Chauncey Gardiner?

The way governments are cooking it perhaps we should all run to Panama, for our children and grandchildren’s sake.

Look at what government’s are doing.

The regulators set risk weights for public debt at zero percent, which means that the banks need to hold the least capital when lending to those who sort of appoint them, talk about a conflict of interest… talk about lobbying.

The central banks, with their QEs, buy mostly sovereign debt.

And the central banks with their negative interest rates benefit mostly governments, since who in his sane mind would lend to his neighbor at a negative rate?

So really, what do they need our taxes for?

But those who will surely have to pay for all this madness, will be our children and grandchildren, and so perhaps we, responsible fathers and grandfathers, should all be running to Panama and similar places to see what we can safeguard for them.

William C Dudley, Fed New York, does still not understand how risk-weighted capital requirements for banks distort

On March 31, 2016 William C Dudley of the Federal Reserve Bank of New York, gave a speech titled “The role of the Federal Reserve – lessons from financial crises” 

There are many issues I do not agree with in that discourse but let me here concentrate on “lessons from financial crisis”. 

Mr Dudley stated: “The crisis showed that the regulatory community did not fully grasp the vulnerability of the financial system. In particular, critical financial institutions were not resilient enough to cope with large scale disruptions without assistance, and problems in one institution quickly spread to others.”

Not a word about how the risk-weighted capital requirements for banks; which permit banks to leverage more on what is perceived, or has been decreed, or has been concocted as safe, than with what is perceived as risky; which means banks earn higher risk adjusted returns on equity on what is "safe" than on what is “risky”; which means banks will lend too much to what is “safe”, like sovereigns and the AAArisktocracy, and too little to what is “risky”, like SMEs and entrepreneurs.

And anyone who has still not understood the dangers that distortion of the allocation of bank credit poses to the banks, and to the real economy, doest not have what it takes to work on bank regulations.

The main lesson here is: It was the regulators who, by allowing banks to hold less capital against precisely the stuff that all major bank crisis are made of, namely what is ex ante perceived as safe, made the banking sector more vulnerable.

The regulatory powers of our bank regulators need to be urgently regulated, at least those of the Basel Committee.

What do you think the world would have said if the Basel Committee had informed it that it would regulate the banks, without considering the purpose of the banks? 

What do you think the world had said if the Basel Committee had informed that in order to make the banks safer, they were going to distort the allocation of credit to the real economy?

What do you think the world would have said if the Basel Committee had informed it that even though all major bank crises have always resulted from excessive exposures to something ex ante erroneously perceived as safe, they would allow for especially low capital requirements against bank exposures to what ex ante was perceived as safe.

What do you think the world would have said if the Basel Committee had informed it that even though the society considered that banks giving credit to SMEs and entrepreneurs was very important, they would saddle the banks with especially large capital requirements on account of those “risky” being risky.

What do you think the world would have said if the Basel Committee had informed it that it was going to assign a zero risk weight to sovereigns and a 100 percent risk weight to the citizens, and which indicated their belief that government employees could make better use of other people’s money than private citizens could use theirs. 

What do you think the world would have said if the Basel Committee had informed it that even though banks already cleared for credit risks with interest rates and size of exposure they would also require banks to clear for that same risk in the capital; and that even though any risk that is excessively considered leads to the wrong actions even if perfectly perceived.

What do you think the world would have said if the Basel Committee had informed it that because they could not estimate the unexpected losses that bank capital is primarily to cover for, they would use expected credit risks as a proxy for the unexpected.

What do we think about that even when the 2007-08 clearly evidenced the failure of the regulators, they go on as if nothing, using the same regulatory principles? I just know that neither Hollywood nor Bollywood would ever have permitted those creating the box-office flop of Basel II, to go on working on Basel III.

Sincerely, are we really sure all these regulators in the Basel Committee, and in the Financial Stability Board, are just not some Chauncey Gardiner characters?

Again the Basel Committee for Banking Supervision evidences it is a clueless producer of systemic risks.

I refer to a speech by William Coen the Secretary General of the Basel Committee, given in Sydney on 5 April 2016 and titled “The global policy reform agenda: completing the job” Coen said: 

“A bridge is an apt metaphor for the Basel framework. Bridges must be safe and sound. A safe and sound banking system is exactly what the Basel framework aims to support. Bridges facilitate movement, commerce and trade. The financial system plays a crucial role in directing investment and funds between individuals and businesses…

For the past 25 years, the foundation of the international approach to the prudential regulation of banks has been a risk-based capital ratio.

The level of capital is a difficult question. There are many views on what the "right amount" should be”

So it is clear that the Basel Committee still does not understand the distortion they cause. Its risk-based capital ratios, which allows banks to leverage equity differently with different assets depending on their ex ante perceived risk, amounts to building some very wide bridges where banks and “the safe” can interact a lot with ease, and then some very narrow bridges that make the relations between banks and “the risky” much harder than they already were.

Coen confesses: “We have spent several years developing a framework to make sure that banks' capital and liquidity buffers are strong enough to keep the system safe and sound.” And that is precisely the problem; they only cared about the condition of the banks and not one iota about the fundamental social purpose of banks, which is allocating credit efficiently to the real economy.

And Coen also quoted the Dutch central bank with: "today's undesirable behavior in financial institutions is at the root of tomorrow's solvency and liquidity problems".

That is correct but I would also add: Today’s undesirable regulatory failure is and will be at the root of tomorrows problems with the real economy… and in the long run no bank system cam be safe and sound, if the underlying real economy is not safe and sound.

And by the way, the root of 2007-08’s solvency and liquidity problems, laid in those authorized leverages of over 60 to 1 for AAA rated securities and sovereigns like Greece.

What are we to do with this bunch of not accountable to any technocrats that have never walked on Main Street, and are incapable of understanding that risk-taking is the oxygen of all development? 

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

Please, give our banks one sole equal capital requirement for all assets, to protect banks not against expected credit risks already cleared for, but against unforeseen risks, such as the Basel Committee falling into the hands of clueless regulators.

Let us never forget that the most dangerous systemic risks can easily be introduced by the regulators.

God make us daring!