The Basel Committee for Banking Supervision’s bank regulations vs. mine.

A tweet to: @IMFNews, @WorldBank, @BIS_org @federalreserve, @ecb @bankofengland @riksbanken @bankofcanada

"Should you allow the Basel Committee to keep on regulating banks as it seems fit, or should you not at least listen to other proposals?

Bank capital requirements used to be set as a percentage of all assets, something which to some extent covered both EXPECTED credit risks, AND UNEXPECTED risks like major sudden downgrading of credit ratings, or a coronavirus.

BUT: Basel Committee introduced risk weighted bank capital requirements SOLELY BASED ON the EXPECTED credit risk. It also assumes that what is perceived as risky will cause larger credit losses than what regulators perceive or decreed as safe, or bankers perceive or concoct as safe. 

The different capital requirements, which allows banks to leverage their equity differently with different assets, dangerously distort the allocation of bank credit, endangering our financial system and weakening the real economy.

The Basel Committee also decreed a statist 0% risk weight for sovereign debts denominated in its domestic currency, based on the notion that sovereigns can always print itself out of any problem, something which clearly ignores the possibility of inflation, but, de facto, also implies that bureaucrats/politicians know better what to do with bank credit they are not personally responsible for, than for instance entrepreneurs, something which is more than doubtful.

Basel Committee's motto: Prepare for the best, for what's expected, and, since we do not know anything about it, ignore the unexpected 

I propose we go back to how banks were regulated before the Basel Committee, with an immense display of hubris, thought they knew all about risks; which means one single capital requirements against all assets; 10%-15%, to cover for the EXPECTED credit risk losses and for the UNEXPECTED losses resulting from wrong perceptions of credit risk, like 2008’s AAA rated securities or from any other unexpected risk, like COVID-19.

My one the same for all assets' capital requirement, would not distort the allocation of credit to the real economy.

My motto: Prepare for the worst, the unexpected, because the expected has always a way to take care of itself.


PS. My letter to the Financial Stability Board
PS. A continuously growing list of the risk weighted bank capital requirements mistakes

PS. Risk-weights are to access to credit what protectionist tariffs are to trade, only more pernicious.

PS. I am no newcomer to this issue

J’Accuse[d] the Basel Committee for Banking Supervision (BCBS) a thousands times, but I am no Émile Zola and there’s no L’Aurore

J’Accuse the Basel Committee of setting up our bank systems to especially large crises, caused by especially large exposures to something perceived as especially safe, which later turns into being especially risky, while held against especially little capital.

My letter to the Financial Stability Board

J’Accuse the Basel Committee for distorting the allocation of bank credit to the real economy by favoring the sovereign and the safer present, AAA rated and residential mortgages, while discriminating against the riskier future, SMEs and entrepreneurs.

My letter to the International Monetary Fund

A question to the Fed: When in 1988 bank regulators assigned America’s public debt a 0.00% risk weight, its debt was about $2.6 trillion, now it is around $22 trillion and still has a 0.00% risk weight. When do you think it should increase to 0.01%?

Had there been a Basel Committee on Tennis Supervision, Roger Federer would be history by now.

The Basel Committee for Banking Supervision (BCBS) in order to make bank systems safer imposed risk weighted bank capital requirements. The lower the perceived risk the lower the capital the higher the leverage allowed. The higher the perceived risk the more capital the lower leverage allowed. 

For example, in Basel II of June 2004 they held that against any private sector asset that was rated AAA to AA banks needed to hold 1.6% in capital, meaning they were allowed to leverage 62.5 times. Against any private sector asset that was rated below BB- banks needed to hold 12% in capital, meaning they were allowed to leverage 8.3 times. 

In terms of tennis that would mean that those players ranked the highest would be able to play with the best rackets, and be allowed many more serves than those player ranked lower. Someone not only unranked but also lousy player like me would be happy to have one serve and at least be allowed a to uses a ping-pong racket if playing against Roger Federer. 

But what would have happened if there had been a Basel Committee on Tennis Supervision that implemented these regulations?

To make a long story short, the best tennis players would have it easier and easier to win, and would have less and less need to practice. Those betting on them would bet ever-larger amounts at ever-lower odds… until “Boom!” (2008 Crisis) suddenly the best player was discovered to completely have lost his ability to play and lost in three blank sets to a newcomer.

PS. Here is somewhat more extensive aide memoire on the mistakes in the risk weighted capital requirements for banks.

Here is one mystery in current bank regulations that regulators refuse to reveal to us.

That which has an AAA rating, meaning it is perceived as very safe, will of course have much access to bank credit, and be required to pay very low risk premiums. If those ratings then turn out to be wrong, sometimes precisely because since it was considered very safe too much credit was given to it, individual banks, and the bank system, face a very serious problem.

That which has a below a BB- rating, meaning it is perceived as extremely risky, has access to much less credit and, when it gets it, will be by paying much higher risk premiums. If those ratings turn out to be even worse, some individual bank might have a smaller problem, but the bank system as such, would face no problems at all.

But, an here is the mystery, bank regulators, with their Basel II, in June 2004, for the purpose of setting the capital requirements for banks, set a 20% risk weight for the AAA rated and 150% for what is below BB-.

Why so? If "safe" could be dangerous and "risky" is innocuous, could it not really be the other way around?

And that, since regulators refuse to explain it, is now, soon 13 years later, still a mystery to us

PS. Questions regulators refuse to answer

Dear Mr Kurowski, here is our answer to your doubts. Sincerely, the experts in Basel Committee, FSB and affiliates

(I dreamt I got this letter from our bank regulators in response to my questions.)

Dear Mr Kurowski

It does not matter whether the risky already get less credit and pay higher interest rates, they must get even less credit and pay even higher interests… because they are risky. Don’t you get that!

It does not matter whether the safe already get more credit and pay lower interest rates, they must get even more credit and pay even lower interests… because they are safe. Don’t you get that!

It does not matter that the risky have never caused a major bank crisis. Risky is risky and that’s that! 

It does not matter that there could be too large exposures to what’s perceived safe but could in act not be; which could cause a huge crisis. Safe is safe and that’s that.

Yes, yes we understand, (we think) that our risk weighted capital requirements might introduce some serious credit austerity for the risky, like SMEs and entrepreneurs, and that this could affect the economic growth of the real economy. But that’s not our problem. Our sole concern is to keep banks safe. 

For economic growth there are infrastructure projects, like bridges, to be undertaken by the Sovereign taking advantage of the exceptionally low rates it is awarded, because it is really and truly safe. If we can’t trust the Sovereign who are we to trust? The citizens?

Oh, that the 2007-08 crisis was caused primarily because of too much investment in securities rated AAA that was supposed to be super-safe? Yes, but now we are imposing huge fines on those credit rating agencies, so they should have learned their lessons, and all will be fine and dandy. Trust us Mr Kurowski. We are after all, as you know, the experts. 

PS. For your own good stop writing those letters about us to the Financial Times. How many now, around 2500? You’re crazy! Don’t you see FT doesn’t care?

Yours sincerely,

Names withheld (by me)… out of delicacy

PS. Friends, as you can see, our bank regulators remain as captured as ever in their cognitive bias, poor us.

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!

Wake up! Our banks are regulated by highly unprofessional technocrats; all members of a small mutual admiration club

Could there be something more dangerous to the real economy, and to banks, than distorting the allocation of credit? Not really.

And yet that is what the current batch of bank regulators did, without even considering that possibility a factor. They did not even care about it.

They imposed risk weighted capital (equity) requirements for banks. More ex ante perceived risk more capital – less risk less capital.

With that they allowed banks to leverage their equity more when lending to ”the safe” than when lending to ”the risky”.

With that they caused banks to be able to earn higher risk adjusted returns on equity on assets perceived as safe than on assets perceived as risky.

And so of course the banks are lending more than normal to those who already had easier and cheaper access to bank credit, ”The Safe”, like the sovereigns (governments) and members of the AAArisktocracy.

And so of course banks are lending less and relatively more expensive than usual to those who already found it harder and more expensive to access bank credit, ”The Risky”, like the SMEs and entrepreneurs.

And you ask how the hell did this happen? There are many explanations but the most important one was that they regulated without even asking themselves what was the purpose of those banks they were regulating.

And if that is not unprofessional what is?

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

And to top it up they have not made our banks safer, since never ever do major bank crises result from excessive exposures to something perceived risky, these always result from excessive exposures to something perceived or deemed to be safe when booked... you see even the safest harbor can become dangerously overpopulated.

We must rid ourselves from these lousy and already very proven failed bank regulators. Urgently!

Global Association of Risk Professionals (GARP) Have you no comments on bank regulators’ risk management?

One of the few and perhaps even only risks that banks clear for, with risk premiums and size of exposures, is the ex ante perceived credit risks, that quite often expressed in credit ratings.

But regulators did not find that sufficient and decided that banks should also clear for the same ex ante perceived credit risk, in their capital.

And as far as I understand any perceived risk, even if it is perfectly perceived leads to the wrong action if it is excessively considered. Would you agree GARP?

And if I was a bank regulator I would be much more interested in why banks fail than in why their borrowers fail. Wouldn’t you be too GARP?

And knowing that bank capital is to be there to cover for unexpected losses, then the last thing I would do would be to base the capital requirements on some expected losses… especially when we know that the safer something is perceived the larger its potential to deliver some truly nasty unexpected losses. Would you not agree with that GARP?

And, if I was a bank regulator, managing risks, the first thing I would do is to be certain about the purpose of banks. That would indicate me that probably the risk we least can afford banks to take, is that of not allocating bank credit efficiently to the real economy. And that is something that becomes impossible when allowing banks to leverage differently with different assets, and thereby earning different and not market based expected risk adjusted returns on equity. Would you not agree with that GARP?

Right now the world is becoming a sad place, especially for coming generations, since regulators having given banks the incentives to stop financing the riskier future, and to make their profits by concentrating on refinancing the safer past. 

GARP do you not have a responsibility is speaking up against the Basel Committee’s and the Financial Stability Board’s particularly harmful and lousy way of managing risks?

I ask because your stated mission is: “As the leading professional association for risk managers, the Global Association of Risk Professional's mission is to advance the risk profession through education, training, and the promotion of best practices globally.”

And also because in “What we do” you state: “GARP enables the risk community to make better informed risk decisions through “creating a culture of risk awareness®”. We do this by educating and informing at all levels, from those beginning their careers in risk, to those leading risk programs at the largest financial institutions across the globe, as well as, the regulators that govern them.”

“delta, vega and curvature risk” Basel Committee’s member understand less and less what they are doing, by the minute

To read the Basel Committee’s “Minimum capital requirements for market risk” of January 2016 is truly mindboggling. Do yourself a favor and just look at the index.

Do those really responsible for what is coming out of the Basel Committee truly understand what is said there?

I am sure that John Kenneth Galbraith’s “If one is pretending to knowledge one does not have, one cannot ask for explanations to support possible objections”, applies to most of them.

And it is not like the Basel Committee has shown itself to be a good regulatory body. It has actually been one of the most failed ones… so failed that they should have been prohibited from having anything to do with bank regulations… forever.

Do you really think its current Chair, Stefan Ingves, could provide you with a lucid explanation of it?

I know enough about finance to know when our banks are being dug even deeper in the hole in which they should not be.

The regulators wrote that the bank capital requirements are portfolio invariant because … otherwise it “would have been a too complex task for most banks and supervisors alike”... and now they come with "delta, vega and curvature risk"?

Banks regulators believe what’s rated AAA, is more dangerous to the banking system than what’s rated below BB-… Really?

Bank regulators, when trying to make our banks safe, decided that the risk weight for AAA rated assets, a rating described as “prime”, was to be 20%. That, since the basic capital requirement in Basel II was 8 percent, meant that banks needed to hold 1.6 percent in capital (equity) against those assets; and could leverage their equity 62.5 times to 1 with these assets. 

For assets rated below BB_ though, ratings described as moving from “highly speculative”, through “extremely speculative” and up to “default imminent”, the risk weight was set at 150 percent. And that, with Basel II’s basic 8 percent, meant that banks needed to hold 12 percent in capital against such assets, and which allowed banks to only leverage about 8.4 times to 1.

But let me ask all of you. What do you think can create those kind of excessive exposures that could endanger the stability of our banking system; exposures to what ex ante was thought to be AAA but that ex post surprised banks by being very risky, or exposures to what was rated below BB- and actually turned out to be very risky?

I hear you… so what did we do to deserve such bad bank regulators?

The Basel Committee insists in not caring one iota about whether its risk-weighted capital requirements distort the allocation of bank credit to the real economy.

In December 2015 The Basel Committee on Banking Supervision has now released its “Second consultative document: Standards: Revisions to the Standardised Approach for credit risk”. It is issued for comments by March 11, 2016.

The introduction states: “This is the Committee’s second consultation on Revisions to the Standardised Approach for credit risk. The Committee wishes to thank all respondents for their extensive feedback on its first consultative document, which was published in in this second consultative document aim to address the issues raised by respondents with respect to the initial proposals. These revised proposals also seek to achieve the objectives set out in the first consultative document to balance simplicity and risk sensitivity, to promote comparability by reducing variability in risk-weighted assets across banks and jurisdictions, and to ensure that the standardised approach (SA) constitutes a suitable alternative and complement to the Internal Ratings-Based (IRB) approach.”

I was one of very few citizens who responded to their first consultative document, and my objections have not been even remotely considered much less responded to. I ended then my comments with:

“Regulators, please, before you keep on regulating, go back and define the purpose of banks. It has to be more than to just be safe mattresses. It has to at least include not distorting the allocation of bank credit. 

With these credit risk adverse regulations, banks are financing less and less the risky future; and only refinancing more and more the safer past. That has to stop, for the good of our children and grandchildren. “A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926 

In 1999, in a Op-Ed in 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'. 

We have already seen too many low-risk-weights AAA bombs detonate with disastrous consequences. So when are you bank regulators going to stop trying being the self appointed risk managers for the world? You’re doing a lousy job at it, and not being held accountable for it.”

And so with this 2nd consultative document it is clear that the Basel Committee still does not care one iota about whether their risk-weighted capital requirements distorts the allocation of bank credit to the real economy.

And it is clear that the Basel Committee is still utterly fixated on the risks of bank assets and ignore the much more important risk of whether banks can adequately manage those perceived risks. In day-to-day terms they find motorcycles to be much more dangerous than cars for the system, even though many more die in car accidents than in motorcycle accidents.

And it is clear that they are still trying to base the capital banks should primarily hold against unexpected losses, on estimates about the expected credit losses. And it is clear they cannot understand that the safer something is perceived the larger the potential of it to deliver unexpected bad news.

And since expected credit risks are already cleared for by banks with interest rates and size of exposures, the Basel Committees insistence on also clearing for those risks in the capital requirements, evidences they have no understanding of that any risk, even if perfectly perceived, will cause the wrong actions if excessively considered.

The way the Basel Committee has seemingly circled its wagons against any outside real criticism, I am not too optimistic about my chances to influence them. Nevertheless I have to try doing so, and so I will send them these comments and perhaps some others before March 11, 2016.

PS. Since they also refer to the use of credit rating agencies, let me quote a letter I wrote and that was published in the Financial Times January 2003. It included: “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. Friends, as it is, the world is tough enough.”

And so, if anything, it would be much more logical to make the capital requirements for banks based not on the credit ratings being correct, in which case there is no problem, but based on the possibilities of credit ratings being wrong… let us say about 8 percent on all assets.

PS. Do I have any credential to be opining here? I think so. As an Executive Director of the World Bank 2002-2004, in October 2004, in a formal statement I wrote: "We (I) believe that much of the world’s financial markets are currently being dangerously overstretched through an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions"

Professors around the world, please, we are urged you teach our bank regulators a good Statistics 101.

Please, professors in statistics, explain to our bank regulators in the Basel Committee and the Financial Stability Board that when you try to make banks safe, you should be interested in what has made banks fail, and not in whether bank clients have failed.

As is, regulators have set higher credit risk weighted capital requirements for banks when lending to those perceived as being risky from a credit point of view; namely to those poor unlucky ones who anyhow have to pay more for credit and get smaller loans. And of course that means that “The Risky” receive even less credit and have to pay even more for it.

While those ex ante perceived as safe, but who are always those who detonate all major bank crises when they suddenly ex post turn out to be risky, their access to bank credit has been subsidized by the fact banks need to hold much less equity when lending to them. And of course that means banks might lend too much and at too low risk premiums to “The Safe”, and that, when disaster strikes, we find our banks standing naked there with little or no capital to cover themselves up with.

In fact, empirically, any statistic research could conclude in out that banks should in fact hold more capital when lending to The Safe than when lending to The Risky.

Professors, as you can see our bank regulators can’t seem to understand that the safer an asset is perceived ex ante, the bigger its potential to deliver ex post those unexpected losses that the bank capital is supposed to help cover. The banks themselves should, of course manage any expected credit losses.

So you see current bank regulators need a good Statistics 101. Can we count on you to lend us a hand? Please?

Current bank regulators have no moral right to address the misconduct of other in the financial sector.

The Financial Stability Board (FSB) published November 6 a progress report for the G20 on the FSB’s work on addressing misconduct in the financial sector. The progress report on the Measures to reduce misconduct risk sets out details about the FSB-coordinated work to address misconduct in the financial sector and the timeline for the actions.

For many years argued that the bank regulators themselves carried out the most serious misconduct in the financial sector.

With their portfolio invariant credit-risk weighted capital requirements for banks, imposed without the slightest evidence of having empirically studied why bank crises occur, and without defining what is the purpose of banks, they manipulated the world’s bank credit markets with serious consequences for millions.

Compared to that, the manipulation of of example the Libor rate, although clearly not to be excused in any way, is simply peanuts.

When we consider the millions of SMEs and entrepreneurs who have been impeded fair access to bank credit, and the loss of job creation for the coming generations that must have resulted from that; and the trillions of public bailout/stimulus debts hanging over us, the regulators should better retire in shame than preach about the misconduct of others.

The mother of all regulatory stupidities!

This data is found on the web:

The fatality rate per 100 million vehicle miles traveled in motorcycles is 21.45

The fatality rate per 100 million vehicle miles traveled in cars is 1.14

In 2011 in the US, 4,612 persons died in motorcycle accidents 

In 2011 in the US, 32,479 persons died in vehicle accidents

And so, even though travelling by motorcycle is about 20 times riskier than cars, cars cause about 7 times more deaths than motorcyclists. That is of course because the riskier something is perceived, the more care is taken to avoid the risk. And because the safer something is perceived, the higher its potential for delivering unexpected tragedies/losses.

And yet the Basel Committee of Banking Supervision decided on higher capital requirements for banks when lending “the risky” motorcyclist of the economy, the SMEs and entrepreneurs, than when lending to “the safe” car drivers, sovereigns and corporations with high credit ratings… even though clearly dangerous excessive bank lending to the latter is much more likely to occur.

And that even though serious misallocations of bank credit to the real economy had to result.

The regulatory loonies did not even care to look at what had caused the major bank crises in the past.

The regulatory loonies did not even care to define the purpose of banks, like that of allocating bank credit efficiently, before regulating the banks.

Shame on them!

And to top it up, in 1988, the Basel Accord introduced a risk weight of zero percent for sovereigns and 100 percent for the private sector. Rarely has statism been able to advance its agenda faster and more than with that.

And IMF, Financial Stability Board, Federal Reserve Bank, Bank of England, European Central Bank, World Bank, Financial Times... and many more, they just don't see it, or keep mum about this, the mother of all regulatory stupidities.

Who helps me getting bank regulators to even acknowledge the biggest systemic error in Basel I, II and III?

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 its collapse”

A Big Bang happened. I know what that systemic error is, but embarrassed regulators don’t want to even acknowledge the problem… and so they keep us traveling down the same crazy road... on route to the next Big Bang.

The most fundamental systemic error, is the credit risk weighted capital requirements.

To estimate the unexpected losses for which banks should have capital, the dummkopfs used expected credit risk. 

Banks consider credit risks when setting the interest rates, the amounts of exposures and other contractual terms.

So when regulators decided that the capital banks should hold against unexpected losses was to be based on ex ante expected credit losses, then they force-fed the banks to consider credit risk twice.

And any risk, even when perfectly perceived, produces a wrong decision if excessively considered.

And so here are our bank lending too much to The Safe, like the governments (sovereigns) and the AAArisktocracy, and too little, or nothing to The Risky, the SMEs and entrepreneurs… those tough we need to get going, especially when the going gets tough.

And you can find in my blogs and in several publications innumerable occasions when I have presented this argument… and most other “experts”, or media like the Financial Times, have not yet even acknowledged the existence of the problem in clear terms.

Friends, can you help me stop these besserwisser busybody hubristic bank regulators from interfering with the allocation of bank credit to the real economy?

What important institution dares to set up a conference on the theme “Do credit-risk weighted capital requirements dangerously distort the allocation of bank credit to the real economy? World Bank? IMF?

PS. Perhaps I should refer to the Basel regulators as just another bunch of statists? I say this because, believe it or not, in the Basel Accord of 1988, they assigned a zero percent risk weight to the sovereign, and a 100 percent risk weight to the private sector. 

PS. There was of course another systemic error. The exaggerated use of the credit ratings On that, in January 2003, in a letter to FT I wrote: “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. Friends, as it is, the world is tough enough.”

PS. While I was an Executive Director of the World Bank, 2002-04, the following were my totally ignored comments on bank regulations.

The Basel Accord was an important turning point for the bad for the whole Western civilization...and it has sadly been ignored

In 1988, the G10 countries, signed up on the Basel Accord. With it, with Basel I, the regulators imposed on banks capital requirements based on ex-ante perceived credit risks.

And the risk weight assigned to the private sector was 100 percent, while the risk weight assigned to their governments was zero percent.

That meant banks needed to hold NO capital when lending to their governments, but 8 percent when lending to the private sector (the basic Basel 8 percent standard capital requirement, multiplied by the risk weight).

That meant that banks could leverage their equity and the support they explicitly and implicitly received from taxpayers infinitely, when lending to their governments, but only about 12 to 1, when lending to the citizens.

That meant in essence, that the regulators decreed that government bureaucrats would be able to use bank credit much more efficiently than the private sector.

That meant in essence, that the free Western world signed up to communistic precepts.

Is that not a historic turning point for our Western World? Tell me, how many times have you heard this being discussed?

And then, in 2004, with Basel II, regulators decided that the risk weight for those private sector borrowers rated AAA to AA was to be 20 percent, while for the unrated ordinary citizens and their SMEs, it remained 100 percent.

And that meant that regulatory risk aversion was also introduced with respect to bank credit to the private sector in the Western world... making it impossible for SMEs and entrepreneurs to have fair access to bank credit.

And since that its been going down down down and these two sad historical event are still being ignored.

Any civilization unwilling to take risks will stall and fall.

God make us daring again!

Mark Twain vs. The Basel Committee for Banking Supervision… Who do you think is right?

Mark Twain is supposed to have said: “A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain” 

The Basel Committee though, with its credit risk weighted capital requirements for banks, evidently argues: A banker lends you the umbrella when it rains but want it back when the sun shines”. 

I mean, otherwise, as regulators wanting banks to hold capital against unexpected losses, would it require banks to hold much more capital when lending to “the risky”, those in the rain, than when lending to “the safe”, those enjoying the sun? 

I side a hundred percent with Mark Twain… because I have never ever seen a major bank crisis that has resulted from bankers lending too much to those they perceive as being in the rain, these have always resulted from lending too much to those they believe find themselves in the sun.

If you think that would seem to mean I believe those in the Basel Committee have no idea of what they are doing… you are absolutely right… I don’t.

It is tragic. The direct consequences of what the Basel Committee is doing, is that banks will now earn much higher risk adjusted returns on what is in the sun than on what is in the rain, and therefore only lend the umbrella to those they see in the sun, and stay away entirely from lending to those they see in the rain... like to all the "risky" SMEs and entrepreneurs, those  who could create the future jobs our grandchildren will need.

Dumb bank regulators clearly evidence we need artificial intelligence, at least as a backup

Banks fail because: they cannot perceive the risks correctly, they cannot manage the correctly perceived risks correctly, or suddenly something truly bad an unexpected happens… like the economy falling to pieces.

So if banks should be required to hold equity, in order to build up a buffer before they need help from taxpayers, those equity requirements should be based on: the credit risks not being correctly perceived, the bankers not being able to manage perceived risks, and something truly not expected happening, like an asteroid hitting their borrowers.

But, the Basel Committee for Banking Supervision, based its equity requirements for banks on the ex ante credit risks being correctly perceived… and that is nothing but loony... seemingly they all missed the lecture on conditional probabilities.

Besides they regulate banks in thousand of pages, without defining what the purpose of banks is… and that is nothing but absolutely irresponsible.

Any artificial intelligence worthy of its name would have made two simple questions.

What is the purpose of banks?

What has caused major bank crisis?

And how different and better the world would then have been. We could surely have had other type of problems, but definitively not the current crisis, caused by excessive lending to what was ex ante perceived as safe; nor the current lousy economy, caused by the lack of lending to those perceived as “risky”, like the SMEs, precisely the tough we need to get going when the going gets tough.

Our grandchildren will damn current bank regulators, for not allowing banks to take the risks their future needs.

PS. Here is an updated list on the many mistakes with risk weighted capital requirements

Would the Basel Committee or the Financial Stability Board approve the following exam question?

Suppose they ask you to calculate the risks of accidents in crossroads, and you based it on how drivers suffer accidents in general. Would you pass the exam? I don’t think so.

I ask this because the Basel Committee, when setting their equity requirements for banks, based it on the risks that bank borrowers would fail, and not on the risks that banks would fail.

And based on that they allow banks to hold less equity when lending to "the safe" than when lending to "the risky.

Something like allowing drivers with good driving records to speed faster through the crossroad than more accident prone drivers… even though records would show that it is precisely when drivers drive too fast through a crossroad, or the lights are malfunctioning, that the worst accidents occur. 

Scary eh!

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.