Task Force on Climate Related Financial Disclosures is clueless about the allocation of resources to the economy.

The Task Force on Climate Related Financial Disclosures begins the summary of its “Final TCFD Recommendations Report” with: 

“One of the essential functions of financial markets is to price risk to support informed, efficient capital-allocation decisions. Accurate and timely disclosure of current and past operating and financial results is fundamental to this function, but it is increasingly important to understand the governance and risk management context in which financial results are achieved. The financial crisis of 2007-2008 was an important reminder of the repercussions that weak corporate governance and risk management practices can have on asset values. This has resulted in increased demand for transparency from organizations on their governance structures, strategies, and risk management practices. Without the right information, investors and others may incorrectly price or value assets, leading to a misallocation of capital.”

Efficient credit and capital allocation to the real economy is indeed the most essential function of financial markets, but let me here inform TCFD that bank regulators, like the Basel Committee and the Financial Stability Board gave zero importance to that. Had they done so, they would never ever have come up with the risk weighted capital requirements for banks, which make that impossible. 

“The financial crisis of 2007-2008 was an important reminder of the repercussions that weak corporate governance and risk management practices can have on asset values”

No! It was an important but ignored reminder of what dangers lie in allowing regulators to regulate within a mutual admiration club breeding intellectual incest. 

When you allow banks to leverage more their equity with what is ex ante perceived, decreed or concocted as safe, so that banks can earn higher risk adjusted returns on equity on what’s “safe”, then you will end up, sooner or later, with dangerous excessive bank exposures, against little capital, to what’s “safe”, like AAA rated securities backed with mortgages to the subprime sector and loans to sovereigns like Greece, but that ex post can turn out to be very risky.

Who the hell authorized regulators to direct (distort) the allocation of bank credit that way?

Listen up Mark Carney, Michael Bloomberg and you other! Any risk, even if perfectly perceived, if excessively considered, causes the wrong actions. Let banks be banks!

Let me end this comment by just asking: How many profiteering climate-change consultants will now banks have to employ in order to fulfill what is requested by this report?

Want some more detailed objections to the idiotic current bank regulations? Here!

A challenge: Can you spot the lunacy in the Basel Committee’s risk weighted capital requirements for banks?

These are the facts established by Basel II in 2004.

1. Very safe AAA to AA rated = 20% risk weight = 1.6% capital requirement = 62.5 times to 1 allowed leverage.

2. Very risky below BB- rated = 150% risk weight = 12% capital requirement = 8.3 times to 1 allowed leverage.

So what’s crazy with that?

Let me give you a clue! 

What can create those kinds of excessive bank exposures that could bring down a bank system?

Mr Watson IBM, besides helping wine growers, when are you going to tell bank regulators they’re so wrong?

Bank regulators, thinking they are so smart, assigned a meager 20% risk weight for what is rated AAA to AA, and a whopping 150% to what is rated below BB-.

That allows banks to hold much less capital against assets rated AAA to AA than against assets rated below BB-.

Now you tell me Watson, what is more dangerous to our banking system, that rated AAA to AA, that because is perceived as so safe could lead to the dangerous build-up of excessive bank exposures, or that which because it is rated below BB- bankers wont touch with a ten feet pole?

So, when are you going to offer to help the bank regulators? They sure need it! We sure need it!

Sadly the Basel Committee did not perform a Gedankenexperimente before regulating banks.

I just read about "Gedankenexperimente" in The Economist of June 10, 2017 "Quantum mechanics and relativity theory: Does one thing lead to another?" 

So, if the Basel Committee had done a Gedankenexperimente before regulating banks, then, if also applying Werner Heisenberg's uncertainty principle, they would have understood that the better current risks are perceived and the more you want banks to go for what is now safe, the riskier the future becomes.

First, because risk taking is the oxygen of development and a better future is built at least as much upon failures than upon successes. 

Second because what would be perceived as safe in the present would then get too much access to bank credit and thereby at one point in the future become very risky.

And so the regulators would have realized that with their risk weighted capital requirements for banks, they would be setting up the bank system for the worst kind of explosion imaginable, namely huge exposures to something very safe, turning very risky, against little capital, and with a real economy that has gone soft. 

PS. July 2011 I wrote twice to the Financial Times about Basel Committee’s regulations and Heisenberg’s uncertainty principle but, since I have been censored by FT, the editor was not interested. 

http://teawithft.blogspot.com/2011/07/bank-regulators-should-read-up-on.html

http://teawithft.blogspot.com/2011/07/arbiters-under-fire-should-be-bank.html

What causes the “motivated reasoning” that keeps Basel bank regulators from admitting their mother of all mistakes?

The Basel Committee for Banking Supervision developed, as a pillar of their regulations, the risk-weighted capital requirements for banks. 

They should never have done that because that completely ignored the fact that these would distort the allocation of credit to the real economy. 

But, when doing so, they also committed the mother of all regulatory mistakes, namely the following:

They set the risk weights based on the risk of the assets and not on the risks the assets represented for the bank system.

That for instance is why, in their standardized risk weights of Basel II, regulators assigned a meager 20% risk weight to what is AAA to AA rated, something which precisely because of such good rating, could lead to the build-up of dangerously large exposures; and a whopping 150% risk weight, to what is rated below BB-, and which is therefore of course rarely touched by bankers, not even with a ten-feet pole.

In other words regulators took the ex-ante risks to be the ex-post risks.

But it has been absolutely impossible to get anyone related to those regulations to admit such thing. And many of those who should have no reason to not divulge that mistake, like specialized journalists and finance professors, have also kept mum on it.

The Economist, June 10, 2017 writes on: “How to be wrong: To err is human. Society is suffering from an inability to acknowledge as much”. It refers there to a “framework for thinking about…[why] people frequently disregard information that conflicts with their view of the world”, elaborated by Roland Benabou and Jean Tirole.

The framework holds that: “Because beliefs… are treasured in their own right, new information that challenges them is unwelcome. People often engage in “motivated reasoning”. [This can be caused by]: “‘Strategic ignorance’… when a believer avoids information offering conflicting evidence.” or “In ‘reality denial’ troubling evidence is rationalized away”, or “in ‘self-signaling’, the believer creates his own tools to interpret the facts in the way he wants”

So Mr Roland Benabou and Mr Jean Tirole, I here ask you. Was, is, any of the three causes for “motivated ignorance” you mention, absent in this case of the Basel Committee’s so mistaken risk-weighted capital requirements for banks?

And also when illustrious Martin Wolf publicly acknowledges, without doubting the correctness of it, that “As Per Kurowski, a former executive director of the World Bank, reminds me regularly, crises occur when what was thought to be low risk turns out to be very high risk", Why is Wolf still not capable to understand how 180 degrees-off the risk weighted capital requirements are?

And about that society is suffering from this mistake there can be no doubt.

It caused the AAA rated securities backed with mortgages to the subprime sector mess.

It caused the mess of several sovereigns, like Greece.

It has hindered millions of SMEs and entrepreneurs a fair opportunity to access bank credit.

It has fostered inequality

If you want even a more detailed explanation on The Mistake go here.

And if Econ Journal Watch wants to attract some confessions then help me ask these questions 

A safer banking system compared to our current dangerously misregulated one with so many systemic risks on steroids

What is a safer banking system?

One in which thousand banks compete and those not able to do so fail as fast as possible, before some major damage has been done, while even, as John Kenneth Galbraith explained, often leaving something good in their wake. 

What is a dangerous banking system?

One were all banks are explicitly or implicitly supported, by taxpayers, as long as they follow one standard mode that includes living wills, stress tests, risk models, credit ratings, standardized risk weights... all potential sources of dangerous systemic risks.

A bank system in which whenever there is a major problem, the can gets kicked down the road with QEs and there is no cleaning up, and banks just get bigger and bigger.

One that make it more plausible that the banks will all come crashing down on us, at the same time, with excessive exposures to something ex ante perceived safe that ex-post turned out risky, and therefore the banks holding especially little capital.

But you don’t worry; the regulators have it all under control with their Dodd-Frank’s Orderly Liquidation Authority (OLA). “Orderly”? Really?

So that is why when I hear about banks “cheating” with their risk models I am not too upset, since that at least introduces some diversity. 

Also that cheating stops, at least for a while, the Basel Committee regulators from imposing their loony standardized risk weights of 20% for what has an AAA rating, and so therefore could be utterly dangerous to the system; and one of 150% for the innocuous below BB- rated that bankers don’t like to touch with a ten feet pole.

How did we end up here? That is where you are bound to end up if you allow some statist technocrats, full of hubris, to gather in a mutual admiration club, and there engage into some intellectually degenerating incestuous groupthink.

Statist? What would you otherwise call those who assign a 0% risk weight to the Sovereign and one of 100% to the citizen?

And it is all so purposeless and useless!

Purposeless? “A ship in harbor is safe, but that is not what ships are for”, John A Shedd

Useless? “May God defend me from my friends, I can defend myself from my enemies”, Voltaire

In essence it means that while waiting for all banks to succumb because of lack of oxygen in the last overpopulated safe-haven available, banks will no longer finance the "riskier" future our grandchildren need is financed, but only refinance the "safer" present and past.

In April 2003, as an Executive Director of the World Bank I argued: "A mixture of thousand solutions, many of them inadequate, may lead to a flexible world that can bend with the storms. A world obsessed with Best Practices may calcify its structure and break with any small wind."

PS. FDIC... please don't go there!

Note: For your info, before 1988, we had about 600 years of banking without risk weighted capital requirements for banks distorting the allocation of bank credit to the real economy.

PS. The best of the Financial Choice Act is a not distorting, not systemic risks creating, 10% capital requirement for all assets. Its worst? That this is not applied to all banks.

PS. If I were a regulator: Bank capital requirements = 3% for bankers' ineptitude + 7% for unexpected events = 10% on all assets = Financial Choice Act
 

FDIC, don’t go there! The more similar living wills, stress tests & risk models are, the greater the systemic risks

I just received the FDICs “Supervisory Guidance on Model Risk Management"

It really scares me to read how concerned FDIC still is with how bankers’ develop and use their risk models, among these those for determining capital and reserve adequacy.

I just don’t get it! Let bankers do their job, which is to develop all the models they can that will facilitate their job as bankers, the best they can. And the more crazily diverse these risk models are, the better, as the less is their systemic risk.

FDIC should concern itself exclusively with the what if the bankers of some banks are not good enough when modeling.

And the same goes for living wills and stress tests. Force each bank to present what they think about that, and leave it like that.

In January 2003, while an ED of the World Bank, in a letter published by the Financial Times I argued: “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”

And in April 2003, commenting on the World Bank's Strategic Framework 04-06 I wrote: "A mixture of thousand solutions, many of them inadequate, may lead to a flexible world that can bend with the storms. A world obsessed with Best Practices may calcify its structure and break with any small wind."

I still hold all that to be true… now more than ever!

FDIC, please, they are the bankers and you are the regulator (and insurer), don’t confuse the roles!

FDIC, please, don't insist on being a better banker than the bankers, just be their regulator!