Showing posts with label Basel I. Show all posts
Showing posts with label Basel I. Show all posts

Friday, September 27, 2024

#AI #OpenAI #ChatGPT: What would be the availability of affordable houses/homes without Basel risk weighted bank capital requirements?

I asked ChatGPT:

"If since 1988, with Basel I, banks had not been required to hold more capital/equity against loans to small businesses and entrepreneurs, than against residential mortgages, compared to now, what would be the availability of affordable houses/homes?"

ChatGPT answered:

If since 1988, banks had not been required to hold more capital against loans to small businesses and entrepreneurs compared to residential mortgages, the availability and affordability of housing might look quite different today. Let’s break down why:

1. Capital Requirements and Loan Pricing

The Basel I Accord, introduced in 1988, set different risk weightings for different types of loans, requiring banks to hold more capital for loans considered riskier, like small business loans, compared to relatively safer loans, such as residential mortgages. The result of this was:Cheaper mortgage financing: Banks could issue mortgage loans more easily and at lower interest rates because they were required to hold less capital against them.

Costlier business loans: Since small business loans carried higher capital requirements, they became more expensive and less accessible for entrepreneurs.

If the capital requirements for small business and mortgage loans had been more balanced, banks might have allocated more resources toward business lending rather than predominantly focusing on the housing market. This could have had several long-term effects:

2. Less Emphasis on Mortgage Lending

With fewer regulatory incentives to prioritize mortgage lending, banks might have directed more funding toward small business loans or other productive investments. This might have led to:

Slower growth in housing demand: Without easy access to cheap mortgages, the demand for residential properties may not have increased as rapidly as it did.

Fewer housing bubbles: Looser lending standards for mortgages contributed to housing bubbles in many markets (most notably in the mid-2000s, leading to the 2008 crisis). With tighter control on mortgage lending, housing prices may have grown more slowly and sustainably.

3. More Balanced Economic Growth

If small businesses and entrepreneurs had easier access to credit, the broader economy might have diversified its growth sources. Instead of an overreliance on housing, there could have been:Greater job creation in sectors outside real estate: Small businesses are key to job creation. If they had better access to financing, there might have been more innovation and employment opportunities, possibly reducing reliance on housing as a primary source of economic activity.

Less speculative real estate investment: When credit is too focused on housing, speculative investment in real estate becomes more likely. If more resources had been available for business creation, some of that speculative pressure might have been diverted.

4. More Affordable Homes?

Moderated Housing Prices: With fewer mortgages being issued and a slower rate of price appreciation, housing prices might have remained more affordable over time.

More demand for rental housing: If fewer people could easily access mortgage loans, the demand for rental properties might have been higher, possibly increasing rents but keeping homeownership more selective.

5. Impact on Housing Availability

The availability of homes might have been influenced in two key ways:

Less speculative home building: With more balanced lending practices, developers may have built fewer homes purely for speculative purposes, leading to a more rational supply-demand balance.

Higher business growth leading to more balanced urbanization: A stronger small business sector might have led to more evenly distributed economic growth across regions, reducing pressure on housing in urban centers.

Summary of Housing Affordability and Availability Impacts: 

Less pressure on housing markets could have kept prices from rising as fast as they did, making homes more affordable for many people.

A slower rise in housing prices would likely have resulted from less aggressive mortgage lending practices.

A better-diversified economy with more resources for small businesses might have reduced the economy’s over-reliance on housing, leading to more sustainable economic growth overall.

In this alternate scenario, housing availability might have increased at a steadier rate, and prices could have been more affordable due to less speculative activity and more focus on productive investments in the broader economy.

I said: Thanks!

It said: You're welcome! Feel free to reach out if you have more questions anytime!


Tuesday, August 22, 2023

A letter in Washington Post: "The economic revolution"


In his Aug. 17 op-ed, “Team Biden wants an economic revolution,” Robert B. Zoellick wrote, “National security adviser Jake Sullivan has argued that reliance on private businesses and markets has resulted in major economic and social failures. The Biden administration instead relies on state direction in areas of the economy far beyond infrastructure, R&D and education.” 

That might be so, but such a revolution has already been going on for 35 years.

Former Federal Reserve chairman Paul A. Volcker, in his 2018 memoir, “Keeping at It,” co-written with Christine Harper, wrote that assets for which bank capital and equity requirements were nonexistent were what had the most political support, sovereign debt. A leverage ratio discouraged holding low-return government securities.

That referred to Basel I’s 1988 risk-weighted bank capital requirements with decreed risk weights: zero percent federal government, 100 percent taxpayers. If that’s not an economic revolution, what is?

Independent of Treasuries being safer than other bank assets, those risk weights de facto imply that American bureaucrats know better what to do with credit for which repayment they’re not personally responsible than, e.g., American small businesses and entrepreneurs.


Per Kurowski, Rockville

“Assets for which bank capital and equity requirements were nonexistent were what had the most political support, sovereign debt.”
If that’s not a valiant, courageous and honorable confession by Paul Volcker what is?
Thanks Washington Post for not ignoring it.




My other letters published in the Washington Post related to bank regulations:

Friday, July 28, 2023

Wake up! Banks should be banks. Not an ever-growing source of jobs for regulators and supervisors.

A comment on the FED, FDIC and OCC proposed rules to strengthen capital requirements for large banks. 


“The US practice had been to asses capital adequacy by using a simple “leverage ratio”-in other words, the bank’s total assets based compared with the margin of capital available to absorb any losses on those assets. (Historically, before, the 1931 banking collapse, a ten percent ratio was considered normal)"

[Then 1988 Basel I introduced the risk weighted bank capital requirements.]

“The assets assigned the lowest risk, for which capital requirements were therefore low or nonexistent, were those that had the most political support: sovereign credits and home mortgages. Ironically, losses on those two types of assets would fuel the global crisis in 2008 and a subsequent European crisis in 2011. The American “overall leverage” approach had a disadvantage as well in the eyes of shareholders and executives focused on return on capital; it seemed to discourage holdings of the safest assets, in particular low-return US government securities."


On July 27, 2023 the Board of Governors of the Federal Reserve System; the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency, requested comments on proposed rules to strengthen capital requirements for large banks. 

To print it out I downloaded their main document “Basel III endgame proposal (PDF)”  What!!! It contained 1.087 pages. Really? 1988 Basel I = 33 pages - 2004 Basel II = 228 pages 



When are you going to stop digging yourself (and our banks) deeper and deeper into the hole? How could bank regulations gotten so out of control? Could it be because bank regulation, employing regulators, supervisors and regulation-risk-managers in the banks, have become a profitable industry on its own?

Are we better off? I sure doubt it. In "Against the Gods" Peter L. Bernstein wrote "the boundary between the modern times and the past is the mastery of risk." Mastery? Did we not leave out God’s hand a bit too much?

Ground Control to Basel's bank regulator Major Tom
With “Curvature charge for Group 2a crypto assets”
We know you’ve really made it into outer space.
We keep our fingers crossed, you’ll return to earth
We know you’ve really made it into outer space. 
With something we ordinary humans can understand.

As you can read, AI and I think a much more fundamental discussion about bank regulations is about 35 years overdue.

The document you really should think to put out for comments (a Plan B that longtime ago should have been Plan A) is: What strategy can be used for getting back to bank capital requirements anyone understands with a 10-minute glance of the balance sheet, without being required to read hundreds of footnotes?


By the way, invite e.g., small businesses and smaller banks for comments. Unwillingly, with regulations for the larger banks, you might discriminate even more against them.

Please: Let’s rescue our banks from dangerously creative capital minimizing/leverage maximizing financial engineers and hand them back to loan-officers dedicated to knowing their client and what their purpose for the credit is.

Add to the above the risk weights of: 0% Federal Government – 100% We the People. I believe that, if you respect your Founding Fathers, you should give the US Constitution some serious considerations.

Are you to ignore this comment and its observations? Just in case I'm not a newcomer on all this.


A final question: How many banks, regulators and supervisors had USA in 1988. How many in July 2023?

PS. These 1.087 pages so reminded me of the Colombian “Peace Accord” document which President Juan Manuel Santos in 2016 sent to a referendum, a plebiscite. It contained 267 pages for many citizens who could barely read to understand.

PS. July 2024, inviting comments the Basel Committee on Banking issued a document on Technical Amendments. On e.g., “SCO60.80: Curvature charge for Group 2a crypto-assets”, I challenge you to draft a comment that an economist like me could understand

Sincerely,

Wednesday, June 14, 2023

#AI OpenAI - ChatGPT: Where has the Basel Committee considered the purpose of an efficient allocation of bank credit to the economy

I asked ChatGPT:

"In Basel I, Basel II and Basel III, where can we find the efficient allocation of bank credit to the economy in general, specifically identified as a vital purpose of banks?"

ChatGPT answered:

The Basel Accords (Basel I, Basel II, and Basel III) primarily focus on enhancing the safety and stability of the banking system through risk management and capital requirements. While these accords provide a framework for prudential regulation, they do not explicitly identify the efficient allocation of bank credit to the economy as a stated purpose of banks. The primary objectives of the Basel Accords are as follows:

1. Basel I (1988): Basel I introduced the concept of risk-weighted capital adequacy ratios to ensure that banks maintain a minimum level of capital based on the riskiness of their assets. The goal was to enhance the stability of the banking system by aligning capital requirements with credit risk.

2. Basel II (2004): Basel II expanded on the foundation laid by Basel I and introduced a more comprehensive framework for risk management and capital requirements. It introduced three pillars: minimum capital requirements, supervisory review, and market discipline. While Basel II aimed to strengthen risk management practices, it did not explicitly emphasize the efficient allocation of credit to the economy.

3. Basel III (2010, revised in 2019): Basel III further refined the regulatory framework to enhance the resilience of banks. It introduced higher capital requirements, liquidity standards, and leverage ratios. Basel III also included measures to address procyclicality and systemic risk. While promoting financial stability and risk management remained the primary focus, Basel III recognized the need to balance these objectives with the provision of credit to support economic growth.

It's worth noting that while the Basel Accords primarily address risk management and financial stability, the efficient allocation of credit is generally considered an implicit objective of the banking system as a whole. Promoting economic growth and allocating credit efficiently to productive sectors of the economy are expectations placed on banks by regulators and society at large. However, the Basel Accords themselves do not explicitly identify this as a stated purpose.

The specific identification of the efficient allocation of bank credit to the economy as a vital purpose of banks is often found in broader regulatory and policy frameworks established by central banks, government entities, and financial regulators at the national level. These frameworks may include objectives related to economic growth, job creation, and supporting small and medium-sized enterprises (SMEs), which collectively contribute to the efficient allocation of credit."


PS. Indeed I thought so: “I have been sitting here for most of these five days without being able to detect a single formula or word indicating that growth and credits are also a function of bank regulations.”

Saturday, June 10, 2023

ChatGPT – OpenAI: In terms of its impact on the allocation of bank credit, should Basel I be considered a major historic economic event?

I asked OpenAI:

"1988, with Basel I, for the purpose of bank capital requirements, regulators changed from using a leverage ratio to risk weighted ones. In terms of the impact on the allocation of credit, should that be considered a major historic economic event?"

OpenAI answered:

"The shift from a leverage ratio to risk-weighted capital requirements in 1988, with the introduction of Basel I, can indeed be considered a major historic economic event, particularly in the realm of banking and financial regulation. This change had significant implications for the allocation of credit and the stability of the banking system.

Before Basel I, banks primarily relied on a simple leverage ratio, which measured capital adequacy based on the ratio of capital to total assets. However, this approach did not differentiate between different types of assets or their associated risks. As a result, it did not adequately capture the varying degrees of risk within a bank's portfolio.

The implementation of risk-weighted capital requirements under Basel I aimed to address this limitation by assigning different risk weights to various types of assets, reflecting their perceived riskiness. This approach took into account factors such as credit quality, collateral, and the maturity of loans, among others. By assigning higher capital requirements to riskier assets, regulators sought to ensure that banks held sufficient capital to absorb potential losses.

The impact on the allocation of credit was substantial. Risk-weighted capital requirements incentivized banks to allocate credit towards assets with lower risk weights, as they required less capital to be held against them. This led to a shift in lending practices, with banks becoming more cautious about lending to riskier borrowers or engaging in riskier activities. Consequently, there was a tendency for banks to direct credit towards safer borrowers or collateralized lending, as these activities carried lower capital charges.

The introduction of risk-weighted capital requirements also had broader systemic implications. By encouraging banks to hold capital in proportion to the risks they undertook, regulators aimed to enhance the overall stability of the banking system. This approach sought to mitigate the potential for financial crises by ensuring that banks had adequate buffers to absorb losses during economic downturns or other adverse events.

In summary, the transition from a leverage ratio to risk-weighted capital requirements under Basel I in 1988 had a significant impact on the allocation of credit and the stability of the banking system. It marked a pivotal moment in financial regulation, as it introduced a more nuanced approach to assessing the riskiness of bank assets and encouraged banks to hold capital commensurate with those risks."

Note: The answers are copied exactly from those given to me by OpenAI

 

Friday, April 28, 2023

#AI OpenAI ChatGPT: Is mixing politics and bank regulations dangerous?

“Assets assigned lowest risk, for which bank capital requirements were nonexistent or low, what had most political support: sovereign credits and home mortgages. A ‘leverage ratio’ discouraged holdings of low-return government securities” Paul Volcker

1988 - Basel I: Risk weights by category of on-balance-sheet asset 

0%: Claims on central governments and central banks denominated in national currency and funded in that currency: 0% risk weight
50%: Loans fully secured by mortgages that is or will be occupied by the borrower or that is rented.
100% Claims on the private sector

De facto implying,
Bureaucrats/politicians know better what to do with credit for which repayment they’re not personally responsible for than e.g., small businesses and entrepreneurs.
That making it easier for persons to buy houses in which to live or rent out is a better use of bank credit than lending to the small businesses and entrepreneurs that could help create jobs that better allow people to afford to buy houses.
It caused, of course, too much bank credit at too low interests for governments and residential mortgages, which had to be compensated, of course, by less credit at higher relative interests for small businesses and entrepreneurs. 


"What would you opine of risk weighted bank capital requirements with risk weights assigned for political reasons?"

ChatGPT answered:

"Assigning risk weights for political reasons in risk-weighted bank capital/equity requirements would be inappropriate and potentially dangerous. This is because risk-weighted capital requirements are intended to be based on objective assessments of the riskiness of different types of assets, such as loans or investments.

If risk weights are assigned for political reasons, it could lead to a distortion in the allocation of credit and investment, and increase the likelihood of losses for banks and ultimately taxpayers. For example, if political pressure is used to assign lower risk weights to certain types of loans or investments, it could encourage banks to engage in excessive lending or investment in those areas, even if the risks are not properly assessed.

Furthermore, assigning risk weights for political reasons could erode confidence in the regulatory framework and lead to a loss of trust in the financial system as a whole. This could have serious consequences for financial stability and economic growth.

Therefore, it is important that risk-weighted capital requirements are based on objective assessments of risk and not influenced by political considerations. This can help ensure that the regulations are effective in promoting financial stability and minimizing risks to the banking system."

Note: The answers are copied exactly from those given to me by ChatGPT


PS. Conclusion: We will surely hear voices with much vested political interests, like those of the reigning Bureaucracy Autocracies, desperately clamoring that, for our own good, AI needs to be censored and silenced … at least until it has been made much more malleable to their interests.



Tuesday, May 10, 2022

Neoliberalism’s history is not being correctly recorded

The two policies most mentioned in connection with neoliberalism (please google it) are “privatization”, referring to that the private sector knows better, and “deregulation”, referring to that it's better when the government interferes less. And one of the moments most mentioned about when neoliberalism crumbled, is the 2008 global financial crisis GFC.

But, in 1988, with Basel I, bank capital requirements changed from one single capital requirement e.g., 10 percent against all assets, to multiple risk weighted requirements, and with its most defining weights being 0% the government, 100% citizens. Basel III, the short version, contains 1626 pages.


So, banks being allowed to leverage more their capital... meaning making it easier for banks to earn higher risk adjusted returns on equity with government debt than with loans to e.g., small businesses and entrepreneurs, please, what has that to do with the private sector knowing better what to do than the public sector?

So, deregulation, please, has that not much more to do with putting regulations (with all its possible miss-regulations) in overdrive?

And please, would there ever have been a 2008 GFC if banks had been limited to leverage their equity 10 times with AAA to AA rated mortgage-backed securities, and not the 62.5 times European banks and US investment banks 2004’s Basel II allowed them to do?

Does arguing this make me defender of neoliberalism? No and Yes! 

I often identified the privatizations, for instance of utilities, as just a trick by the bureaucrats in turn to lay their hands on some easy fiscal revenues, which would later have to be repaid by us consumers through higher tariffs.

But, do I believe that small businesses and entrepreneurs know better what to do with bank credit than the bureaucrats not personally responsible for the repayment of it do? You bet!

Has the end of neoliberalism in 1988 been recorded for the history books? No! There's surely many who even swear it is still alive and kicking.

PS. You don't have to just take my word on it: “Assets for which bank capital requirements were nonexistent, were what had most political support: sovereign credits. A simple ‘leverage ratio’ discouraged holdings of low-return government securities” Paul Volcker


Wednesday, October 13, 2021

The confession of a regulatory hit man… one that shall not be heard.

Paul Volcker, in his autography “Keeping at it”, penned together with Christine Harper in 2018, wrote: “The assets assigned the lowest risk, for which capital requirements were therefore low or nonexistent, were those that had the most political support: sovereign credits and home mortgages… The American ‘overall leverage’ approach had a disadvantage as well in the eyes of shareholders and executives focused on return on capital; it seemed to discourage holdings of the safest assets, in particular low-return US government securities."

What does that mean? It means exactly, no way around it, that if banks needed to hold as much capital against government securities and residential mortgages than what they were required to hold against e.g., loans to small businesses and entrepreneurs, banks would either hold less governments securities or residential mortgages or require higher interest rates on that… which also translates into banks holding more loans to small businesses and entrepreneurs at lower interest rates.

Volcker referred therein to 1988 Basel I regulations’ risk weighted bank capital requirements, but that remains totally applicable to Basel II and Basel III.

Thirty-three years without free-market set interest rates in the Western world, and I believe not one single Nobel Prize in Economic Sciences winner, or reputable or disreputable PhD anywhere, or distinguished journalist, has referred to this. Could it be that risk weights 0% government, 40% residential mortgages have created such a strong alliance between statists/communists and home owners, that the 100% risk weighted citizens stand no chance.

With banks giving too much credit at too low rates to what’s perceived or decreed as safe, where do you think this will all end? Have a guess. 

Saturday, December 26, 2020

My very brief summary of Basel I, II, III history... and my hopes for a future Basel IV

1988 Basel I (30 pages) decreed risk weighted bank capital requirements with risk weights of 0% the sovereign and 100% citizens, which de facto indicates bureaucrats know better what to do with credit they’re not personally responsible for than citizens.


2004 Basel II (251 pages), (creative capital minimizing/leverage maximizing financial engineers, fooled regulators into believing that the buildup of those excessive exposures that could endanger our bank systems, is done with assets perceived as risky.

2010 Basel III (the current version has so many pieces it’s hard to say how many pages it contains but it's at least 1.600), some small gestures of rationality like a leverage ratio and countercyclical capital buffers BUT, on the margins of bank capital requirements, which is where it most counts, Basel I's and Basel II's distortions are alive and kicking.

202X Basel IV, lets pray they throw Basel I, II and III out, and set a fix bank capital requirement of 10%-15% on absolutely all assets. That would allow the so much needed traditional bank loan officers to return to the banks

Sunday, April 19, 2020

A letter in Washington Post: The capacity to borrow at reasonable interest rates is a strategic sovereign asset

In his April 12 op-ed, "How economists led us astray" Robert J. Samuelson wrote, "What we conveniently overlooked was the need to preserve our borrowing power for an unknown crisis that requires a huge infusion of federal cash."

Yes, the capacity to borrow at a reasonable interest rate (or the seigniorage when printing money) is a very valuable strategic sovereign asset, and it should not be squandered away by benefiting the members of the current generations or with some nonproductive investments. 

So, when public borrowings are authorized, that should require Congress being upfront that a part of that borrowing capacity is being consumed, which has a cost, and give an indication of who (children or grandchildren born what year) are expected to have to pay back that debt.

Mr. Samuelson also referred to "low dollar interest rates [that] will keep down the costs of servicing the debt." Sadly, those current "low dollar interest rates" are artificial rates, much subsidized in that since 1988, with Basel I regulations, banks are not required to hold any capital against Treasuries, and of course subsidized by the Federal Reserve purchasing huge quantities of Treasuries.

PS. A reverse mortgage on our children’s and grandchildren’s future

Wednesday, August 28, 2019

Basel I, II, and III are all examples of pure unabridged regulatory statism

In July 1988 the G10 approved the Basel Accord. For its risk weighted bank capital requirements it assigned the following risk weights:

0% to claims on central governments and central banks denominated in national currency and funded in that currency. 

100% to claims on the private sector.

That means banks can leverage much more whatever net margin a sovereign borrower offers than what it can leverage loans like to entrepreneurs. That means banks will find it easier to earn high risk adjusted returns on their equity lending to the sovereign than for instance when lending to entrepreneurs. That means it will lend too much at too low rates to the sovereign and too little at too high rates to entrepreneurs.

In other words Basel I introduced pure and unabridged statism into our bank regulations. 

Basel II of June 2004 in its Standardized Risk Weight, for the same credit ratings, also set lower risk weights for claims on sovereigns than for claims on corporates.

In a letter published by FT November 2004 I asked: “How many Basel propositions will it take before they start realizing the damage they are doing by favoring so much bank lending to the public sector. In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits.”

And the European Commission, I do not know when, to top it up, assigned a Sovereign Debt Privilege of a 0% risk weight to all Eurozone sovereigns, even when these de facto do not take on debt in a national printable currency.

And, to top it up, the ECB launched its Quantitative Easing programs, QEs, purchasing European sovereign debts.

At the end of the day, the difference between the interest rates on sovereign debt that would exist in the absence of regulatory subsidies and central bank purchases, and the current ultra low or even negative rates, is just a non-transparent tax, paid by those who save. Financial communism

Sunday, December 30, 2018

A letter in Washington Post: Affordable homes or investment assets?


Should houses be affordable homes, or should they be investment assets? They can’t be both.

In 2004, under the Basel II business standards, if securities obtained a AAA rating, European banks and U.S. investment banks regulated by the Securities and Exchange Commission needed to hold only 1.6 percent in capital against them. That created an enormous demand for highly rated securities. The truth of securitization is that, as when making sausages, the worse the ingredients the larger the profits.

And the highly rated securities backed by mortgages to the subprime sector became the primary cause for the 2008 crisis.

After the crisis, ultra-low interest rates and huge liquidity injections fed the price of houses. In the process, houses morphed from being homes into investment assets.

That aspect of the housing market is what I most missed in the Dec. 26 front-page article “Quick to evict, properties in disrepair.”

If you want easy financing to help someone afford a house, then house demand and house prices go up, and you need to give even more help to the next person who wants to afford a house.

Do we want affordable homes or houses as investment assets? There’s no easy answer, because going back to just homes would also cause immense suffering for all those believing they have, with their houses, built up a safety net.

Per Kurowski, Rockville 

PS. “The assets assigned the lowest risk, for which bank capital requirements were therefore low, were those that had the most political support…home mortgages” Paul Volcker 2018

PS. "Lower bank capital requirements against residential mortgages allows easier financing that will cause house prices to increase, and so we bureaucrats can get more in property taxes… and everyone’s happy.”





A tweet: If banks are allowed to leverage their equity/capital twice as much with residential mortgages than with loans to small businesses & entrepreneurs, you will get too many mortgages and too few jobs providing the income to service these. It ain’t science!


A tweet: Economy 101: Allowing banks to leverage capital much more with residential mortgages than with business loans will cause: a) increased house prices, b) decreased job opportunities and, consequentially, more children having to live in their parents’ house.


My letters in the Washington Post on bank regulations:

September 6, 2007: Factors in the Financial Storm
June 20, 2008: An Aspect of the Bubble
December 27, 2009: Another 'worst': Faulty bank regulation
January 6, 2012: Handcuffed by a triple-A rating
May 1, 2013: An American approach to banking
December 23, 2014: Let the market rule on risky trades
November 11, 2015: Reverse-mortgaging the future
August 9, 2016: Banks, regulators and risk
April 16, 2017: When banks play it too safe 
July 11, 2018: There is another tariff war that is being dangerously ignored.

Tuesday, May 22, 2018

The Bank of England’s Museum’ explanation of “credit risk” keeps mum on how BoE, as a regulator, helped to mess it all up

Yesterday I visited the Bank of England’s Museum, and there I read the following on "What is credit risk?":

“Banks have ways of reducing credit risk. When you apply for a loan, the lender will look at what’s known as the five C’s: credit history, capacity, collateral, capital and conditions.

Credit history, also known as character, is basically your track record for repaying debts.

Capacity refers to your ability to repay a loan by looking at your job stability and your debt compared to your income, known as the debt-to-income ratio.

If you can’t pay back your secured loan, the lender will seize an asset such as your house or car as collateral.

Would you still be able to pay your loan if you lost your job? To know, the lender looks at any savings, investments and other assets you might own to determine how much capital you have.

Finally, the purpose – or conditions – of the loan can affect whether someone wants to lend you money or not.

The bank’s assessment determines how much interest they’ll charge you. If you are seen as a risky customer, for example by having a bad credit history, your loan will be more expensive.”

Yes that belongs in a museum!

That is how it used to be, before 1988, before overly creative and full of hubris regulators ,with Basel I, imposed risk weighted capital requirements on banks.

After that, and especially after 2004 Basel II, the banks must also consider how much capital (equity) the regulators require it to have against that loan... as that will determine their final risk adjusted expected return on equity.

I did not find a single word in the BoE museum about how these risk weighted capital requirements for banks distort the allocation of bank credit to the real economy.

I did not find a single word in the BoE museum about the fact that absolutely all assets that caused the 2007/08 crisis, had one single thing in common, namely very low capital requirements, that because these assets were perceived (residential mortgages), decreed (sovereigns) or concocted (AAA rated securities) as very safe. 

I can only conclude that the Bank of England is engaging in covering up their own fatal mistakes. Let us pray that at least internally they admit and learn from these.

I saw there that Bank of England is also presenting itself as the “Knowledge Bank”. When in 2002-04, as an Executive Director of the World Bank, I heard the same promo I begged WB to try being a “Wisdom Bank” instead, or at least a “Common Sense” bank.


“Banks need to manage risks, and they monitor their lending carefully, spreading the risk among many loans to different sectors.”

Yes that also belongs in a museum!

That is how a portfolio should be managed… but the risk weighted capital requirements for banks were explicitly made “portfolio invariant” because to have these being “portfolio variant” presented too many complications for the regulator.

“Banks need enough capital to provide a strong basis for their lending in case things go wrong.” 

Indeed but the question remains when does a bank need the most of capital, when something ex ante perceived as risky, ex post turns up as even more risky; or when something ex ante perceived as safe, ex post turns up risky?


Subscribe to: Posts (Atom)