It takes two to tango, and it takes two to play the game of bank capital requirements
Sir, I refer to “On Wall Street Truth must be told about bank capital rules plans” Sheila Bair, FT September 2, 2023.
Way back, before 1988, when there was one bank capital/equity requirement against all assets, a leverage ratio, the game bankers played was easier than Ludo. It was all about hiding some assets away from their balance sheet, and of finding more capital on it than what they really had.
After 1988, with the introduction of the Basel Committee’s risk weighted bank capital requirements, Basel I, and especially with Basel II which assigned so much importance to credit rating agencies, the game became dramatically more complicated. Out went the type of old time basically loan officer bankers, and in came the dangerously creative banking financial engineers. A game much more like chess has ensued.
The steps in this Bank Capital Requirements are becoming ever more complicated. If you doubt it just consider that though Basel I had 30 pages, the recent Fed FDIC OCC July 2023 request for just comments on proposed rules to strengthen capital requirements for large banks has 1.087 pages.
Sheila Bair, expressing a concern about the complexity of current proposals ends with “Hopefully, regulators will find ways to simplify the rules and make them more understandable to the public.”
Sir, from my thousands of letters to you over the last two decades, you know I would like the bank capital requirements to become a game of Ludo again. I might have given you hundred arguments for scrapping the risk weighted capital requirement, Please let me just list here the most fundamental ones.
Lower risk weights for government debt de facto imply that bureaucrats and politicians know better what to do with credit for which repayment they’re not personally responsible for than e.g., small businesses and entrepreneurs. (Long term US treasuries still have a 0% risk weight) I strongly object to that. Sir, don’t you?
Lower capital requirements against residential mortgages de facto imply that financing houses is more important for the economy than lending to small businesses and entrepreneurs. I object to that. Sir, don’t you?
Basing the risk weights on perceived risk and not conditioned to how bankers perceive risks; and on that what’s perceived as risky is more dangerous to bank systems than what’s perceived as safe is clear evidence that the regulators work from their desk and have never walked on main-street. Just think of Mark Twain supposedly saying: “A banker is a fellow who wants to lend you the umbrella when the sun shines and wants it back when it rains”, and then consider the risk weights of 20% for AAA to AA rated assets and 150% for the below BB- rated ones. It’s sheer hubristic lunacy. Sir, don’t you agree?
And honestly, in an uncertain world where so many unexpected events can become dangerous, how on earth, even with “a thoughtful multi year process” can regulators still base their capital requirements so much on the certainty of perceived risk? In “Against the Gods” Peter L. Bernstein writes that the boundary between the modern times and the past is the mastery of risk, since for those who believe that everything was in God’s hands, risk management, probability, and statistics, must have seemed quite irrelevant. Sir, today, I cannot but speculate on whether we, when managing risk, have not left out God’s hand just a little bit too much.
Finally, as I have tweeted or X-ed repeatedly: “When times are good, and bank capital buffers should be built-up, regulators allow banks to hold little equity, pay dividends and do buybacks so, when times turn bad, banks stand naked, when we need them the most, when the hardest to raise new bank equity.”
PS. Sheila Bair writes about “massive mortgage defaults during the financial crisis”. Let’s not ignore that crisis was caused not really by mortgages but by the AAA to AA rated securities backed with mortgages to the subprime sector and which therefore were assigned a mind-blowing low 20% risk weight.
@PerKurowski
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