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

“The raison d’être of macroprudential policy is to ensure the financial system supports the economy.” Mark Carney left out: “EFFICIENTLY”.

Mark Carney In his last speech as Governor of the Bank of England stated:

“The raison d’être of macroprudential policy is to ensure the financial system supports the economy.”

Yes, but absolutely not in the way of how a brochure at the Bank of England’s museum, explaining quantitative easing, states it, by: “Putting more money into our economy to boost spending”

Our financial system should support our economy by allocating financial resources as efficiently as possible… and that, with current risk weighted bank capital requirements is something it definitely does not achieve. For example:

Assigning a risk weight of 0% to the sovereign’s debt and one of 100% to the citizen’s debts de facto implies that a bureaucrat knows better what to do with a credit for which’s repayment he is not personally responsible for than for example and entrepreneur. And that sort of veiled communism has failed here, there and everywhere.

Assigning a risk weight of 0% to residential mortgages and one of 100% to debts of unrated entrepreneurs’, de facto implies that financing the purchase of a house is more important than financing those who could help create the jobs needed to be able to service utilities and repay mortgages… something which I hope everyone understands is not so. It caused houses to morph from being affordable homes into being risky investment assets.

Assigning a risk weight of 20% to corporate AAA rated debt and one of 150% to corporate debt rated below BB-, de facto implies that the former, besides being able to obtain much more credit and at much lower rates, also deserves even better terms… and that is plainly an immoral discrimination… and besides an utterly stupid one. Anyone who believes that the excessive bank exposures that could cause profound bank crises are built up more with assets rated below BB- than with assets rated AAA, has never ever left his desk and walked on Main-Street.

Soon the history on banking will include: Between 1988 and 202x, believe it or not, banks were regulated by experts using risk weighted bank capital requirements based on that what was perceived as risky, was more dangerous to our bank system than what was perceived as safe

http://subprimeregulations.blogspot.com/2019/03/my-letter-to-financial-stability-board.html

Central banks and regulators should not be allowed to discriminate in favor of asset owners or those perceived or decreed as safe.

Again, I visited the Bank of England’s museum.

The silence about what’s happening to our banks as a consequence of the introduction of risk weighted capital requirements was still total.

Into my hands came a brochure titled “Quantitative easing explained: Putting more money into our economy to boost spending” It reads:

A direct cash injection: The Bank creates new money to buy assets from private sector institution’

Purchases of financial assets push up their price, as demand for those assets increases and corporate credit markets unblocked

Total wealth increases when higher asset prices make some people wealthier either directly or, for example, through pension funds.

My comment: “some people” this is a clear recognition that quantitative easing helps more those who own assets than those who don’t. Central banks should not be allowed to carry out such under the table non transparent discrimination.

The cost of borrowing reduces as higher asset prices mean lower yields, making it cheaper for households and businesses to finance spending.

My comment: Because of risk weighted bank capital requirements the benefits of any “lower yields” are primarily transmitted to those perceived or decreed as safe, for example, the sovereign and the beneficiaries of residential mortgages. 

More money means private sector institutions receive cash which they can spend on goods and services or other financial assets. Banks end up with more reserves as well as the money deposited with them.

Increased reserves mean banks can increase their lending to households and businesses, making it easier to finance spending.

My comment: Again, because of risk weighted bank capital requirements, banks increases in lending will primarily benefit those perceived or decreed as safe, for example, the sovereign and the beneficiaries of residential mortgages. 

My conclusion: Central banks should not be allowed to carry out such here confessed under the table non transparent discrimination in favor of those who own assets and those who generate lower capital requirements for banks. The combination of quantitative easing with the main transmission channel for monetary policy, bank credit, being distorted by risk weighted bank capital requirements has de facto introduced communism/crony capitalism into the financial sector.

Here, there is good money to be earned, by just explaining the risk weighted capital requirements for banks to me.

I will pay a US$ cash bonus to the first who manage to extract clear answers from any regulator on two questions that have had me intrigued for a way too long time… so much that many tell me I am obsessive about… which of course I am.

I start with US$ 100 for each one of the answers and increase it by U$10 each month... for some time

US$100 to the first who gets a clear answer from a regulator on: Why do you want banks to hold more capital against what, by being perceived as risky has been made quite innocous, than against what, because it is perceived as safe, is much more dangerous? 

http://perkurowski.blogspot.com/2016/04/here-are-17-reasons-for-why-i-believe.html

And also US$100 to the first who gets a clear answer from a regulator on: Why are banks allowed to leverage much more when financing homes, than when financing the entrepreneurs who could help create jobs needed to pay utilities and service the mortgages?

https://perkurowski.blogspot.com/2018/01/many-of-our-young-will-be-without-jobs.html

Regulatory risk aversion distorts credit and causes dangerous bank exposures to what is perceived, decreed or concocted as safe.

Mark Carney, Governor of the Bank of England, and the Chair of the Financial Stability Board, on April 7, 2017 gave a speech titled: “The high road to a responsible, open financial system”. 

Carney said: “The pillars of responsible financial globalisation eroded prior to the global financial crisis. Regulation became light touch and ineffective…. few participants were exposed to the full consequences of their actions as governance and compensation arrangements focused on the short term.”

But to call regulations that as a pillar has risk weighted capital requirements for banks, which allow banks to leverage assets differently because of perceived or decreed risk, “light touch”, is pure nonsense. And if there is anything as focused on the short term, that must be regulations that give banks incentives not to lend to the “riskier” future, but to take refuge in refinancing the “safer” past and present.

Carney bragged: “The system is safer because banks are now much more resilient, with capital requirements for the largest global banks that are ten times higher than before the crisis and a new leverage ratio that guards against risks that may seem low but prove not.” 

Since that “ten times higher” refers to capital in relation to risk weighted assets, and he has no way to ascertain the ex ante risk perceptions will coincide with the ex post realities, that number may or may not be true. The improvement might come from banks shedding a lot of safe “risky” assets and taking on more exposures to potentially risky “safe” assets. Finally, mentioning “a new leverage ratio that guards against risks that may seem low but prove not”, amounts to admitting they had no idea what they were doing before.

Carney opined: “The financial system is simpler. As banks have become less complex and more focused, they are lending more to households and businesses and less to each other. A series of measures are eliminating toxic and fragile forms of shadow banking while reinforcing the best of resilient market-based finance. And more durable market infrastructure is simplifying the previously complex – and dangerous – web of exposures in derivative markets.”

He wishes!

But when I object the strongest is when Carney states “The financial system is fairer because of reforms that are ending the era of “too big to fail” banks and addressing the root causes of a torrent of misconduct.”

Fairer? With regulators favoring those who perceived as safe were already favored with easier access to bank credit, and increasing the obstacles for those who perceived as risky already found it harder to access bank credit, has nothing to do with fairness. It is just odious regulatory discrimination.

Bank regulators, de facto, decreed more inequality.

BoE: Regulations make banks value what’s “risky” riskier than what it is, and what’s “safe” safer than what it is.

I refer to “The art of the deal: what can Nobel-winning contract theory teach us about regulating banks?” by Caterina Lepore, Caspar Siegert, Quynh-Anh Vo published on BoE’s Bank Underground blog.

It states “Capital Structure: Banks can finance their assets via debt, equity, hybrid securities or a mix of them. Changes in banks’ capital structure may have big impacts on their market capitalisation and are usually under close watch of regulators.”

As many do, that recognizes that differences in capital structure impacts market capitalization and profits. But again, as most can’t, the authors cannot take that intellectual step to understand that different capital structures, ordained for different assets, by means of risk weighted capital requirements for banks, distort the allocation of credit to the real economy.

Since banks do look at perceived risks when deciding on size of exposures and risk premiums, to have regulators also make these ex ante perceived risks influence the capital requirements, one is effectively doubling down on whatever ‘information asymmetries’ might exist in the perception of risks.

That de facto means that current regulations make banks value what’s “risky” riskier than what it is, and what’s “safe” safer than what it is… and seemingly no one, not even BoE, cares a damn.

The author’s also write: “Because banks are better informed about their own risks, institutions allowed to determine risks using their own models, under the internal ratings-based (IRB) approach, may have incentives to under-estimate risks.”

Of course they have incentives to under-estimate risks, as that would generate lower capital requirements, as that would allow for higher leverage of equity, as that would increase the expected risk adjusted returns on equity. 

To understand how naïve regulators have behaved, let us just indicate that it is similar to allowing Volkswagen to do their own carbon emission testing in their own laboratories.

But, don’t get me wrong, this does not mean for a second bank regulators do it better with their standard risk weights. Just as an example those private sector assets rated AAA to AA and that could because of their perceived safety really cause a major bank crisis if those perceptions turn out to be wrong ex-post were assigned in Basel II a risk weight of 20%, while the totally innocuous below BB- rated carry a risk weight of 150%. 

The authors suggest: “In the real world where banks can both undertake excessive risks and underreport such risks, as recognized by the current capital framework, a combination of risk-weighted capital requirement and a non-risk-based leverage ratio might indeed be optimal.”

The fact is that the higher a “non-risk-based leverage ratio” might be, the more can the “risk-weighted capital requirement” distort on the margin. I invite you to think of the movie “The drowning pool”

Professors Oliver Hart’s and Bengt Holmström’s contributions to contract theory can indeed be “helpful in regulating banks!” But, let us not kid ourselves, current bank regulatory mistakes are so basic, these need no new theories in order to be corrected, just pure common sense.

Here are my most urgent questions on bank regulations. These seemingly belong to those that should not be asked, much less answered.

Economist Andrew Haldane. At least when acting as a bank regulator, you are admitting the wrong error you committed

Chief economist of Bank of England Andrew Haldane says “his profession must adapt to regain the trust of the public, claiming narrow models ignored ‘irrational behaviour’” “Chief economist of Bank of England admits errors in Brexit forecasting” The Guardian, January 5, 2017.

Hold it Mr Haldane! What you and other economists ignored. when acting as regulators, was that banks would, as always, behave perfectly rational, and lend to what they expected would yield them the highest risk adjusted returns on equity.

That is what you failed to understand when allowing banks to hold less capital against what was perceived, decreed or concocted as safe. That meant banks could leverage more, and so earn higher expected risk adjusted returns on equity, when lending to the “safe”. 

That distortion in the allocation of bank credit to the real economy, resulted in that banks end up lending too much at too low interest rates to the “safe”… which could be risky for the banks; and to little and too expensive to “risky” SMEs and entrepreneurs which is very dangerous for the economy.

Come on Mr. Haldane I dare you to answer the following verybasic questions.

FSB’s Mark Carney is no one to lecture us on inequality, lack of opportunities and intergenerational divide

Mark Carney, the Governor of the Bank of England, in a speech titled “The Spectre of Monetarism” December 5, 2016 said: 

“For both income and wealth, some of the most significant shifts have happened across generations. A typical millennial earned £8,000 less during their twenties than their predecessors. Since 2007, those over 60 have seen their incomes rise at five times the rate of the population as a whole. Moreover, rising real house prices between the mid-1990s and the late 2000s have created a growing disparity between older homeowners and younger renters...  At the same time as these intergenerational divides are emerging, evidence suggests that equality of opportunity in the UK remains disturbingly low, potentially reinforcing cultural and economic divides.”

But Mark Carney is also the current Chairman of G20’s Financial Stability Board and, as such, one of the primarily responsible for current bank regulations… the pillar of which is the risk weighted capital requirements for banks.

That piece of regulation decrees inequality resulting from negating “the risky”, like SMEs and entrepreneurs fair access to bank credit. 

That piece of regulation favors the financing of “safe” basements where jobless kids can stay with their parents over “riskier” ventures that could provide the kids in the future the jobs, so that they had a chance to become responsible parents too.

That piece of regulations is a violation of that holy intergenerational bond Edmund Burke spoke about.

Carney also said: “Higher uncertainty has contributed to what psychologists call an affect heuristic amongst households, businesses and investors. Put simply, long after the original trigger becomes remote, perceptions endure, affecting risk perceptions and economic behaviour. Just like those who lived through the Great Depression, people appear more cautious about the future and more reluctant to take irreversible decisions. That means less willingness to put capital to work and, ultimately, lower growth.”

If any have suffered form “affect heuristic” that is the bank regulators. Mixing up ex ante perceptions with ex post possibilities, these decided on “more risk more capital – less risk less capital”, without: defining the purpose of banks “A ship in harbor is safe, but that is not what ships are for.” John A Shedd; or looking at what has caused bank crises in the past “May God defend me from my friends, I can defend myself from my enemies” Voltaire

Mark Carney also said “For two-and-a-half centuries, the prices of government bonds and the prices of equities tended to move together: the typical bull market entails rising equity prices and falling bond yields, with the reverse in bear markets. Since the mid-2000s, however, this pattern has reversed and bond yields have tended to fall along with equity prices”.

He is not able to connect that to the fact the risk weight given to sovereign debt is 0%, as compared to one of 100% for We the People… and that capital scarce banks therefore shed “riskier” assets in favor of public debt. As statist, Carney also ignores the fact that regulation has subsidized public borrowings, paid of course by negating credit opportunities to SMEs and entrepreneurs.

Must one go on a hunger strike in order to get some contestability from the Basel Committee or the Financial Stability Board?

To lower the real real-interests in order to stimulate the real economy, take away the too costly subsidies of public debt.

Would any serious economist discuss gas prices at the pump ignoring taxes? No!

Would any serious economist discuss milk prices ignoring various subsidies? No!

Then why have almost all serious economists been discussing low real interest rates on public debt ignoring regulatory subsidies? I have no idea!

In 1988, the Basel Accord, Basel I, for the purpose of setting the capital requirements for banks, decided that the risk weight of the sovereign was 0% and that of We the People 100%. 

That would hence mean that banks would be able to leverage much more their equity, and the value of any explicit or implicit government guarantees they received, with loans to the public sector than with loans to the private sector. 

That would hence mean banks could obtain higher risk-adjusted returns on equity when lending to the public sector than when lending to the private sector.

That would hence mean that the interest rates of bank loans to the public sector included a regulatory subsidy.

That would hence mean that the subsidies for the access to bank credit by the public sector was to be paid by taxing the private sector with more restricted or more expensive access to bank credit.

And that should hence have meant that in order to know the real real-rate on public debt, to the nominal rates, we would have to add the cost of the regulatory taxes paid by the private sector.

That has not been done! All references to the interest rates of public debt have been limited to using the nominal rates. That has led experts like Lawrence Summers, Lord Adair Turner, Martin Wolf and many other, to argue that the public sector should take advantage of extraordinary low rates in order to finance public investments, like in infrastructure.

That is very wrong! If we include the economic cost of restricting the access to bank credit over the decade and around the world, for many millions of SMEs and entrepreneurs, the current real real-interests rates on public debt could in fact be the highest ever.

So, if the Fed, ECB, BoE or any other central bank, really wants to lower the interests in order to stimulate the real economy, then they should begin by asking bank regulators to take away those so very costly subsidies of public debt.

Central bankers might start doing this, in the name of equality, since making it harder than necessary for “the risky” to access bank credit, can only help to increase inequality. 

If bank regulators get too anxious and nervous about this, central bankers can (gently) remind them that there has never ever been a major bank crises caused by excessive exposures to what was ex ante perceived as risky. 

But what if the central banker also wears the hat of bank regulator? Then he has a problem he needs to solve… maybe with the help of some outside counseling assistance?

When and where did the last bank crisis resulting from excessive exposures to something ex ante believed risky occur?

I don't know. Ask the regulators in the Basel Committee on Banking Supervision and the Financial Stability Board. 

I mean they must have much data on this because, without it, why would they impose credit risk weighted capital requirements for banks, knowing that carried the huge cost of distorting the allocation of bank credit to the real economy?

I mean that if they use the theorem that what's perceived as risky is riskier to the bank system than what is perceived as safe, then they are indeed using a loony theorem.

Or did they not look for the data?  Or did they not understand it?

This September 2016, there will be 30 years since regulators, scared of the climb, declared our economies should peak

In Steven Solomon’s "The Confidence Game" (1995) we read: 

"On September 2, 1986, the fine cutlery was laid once again at the Bank of England governor’s official residence at New Change… The occasion was an impromptu visit from Paul Volcker… When the Fed chairman sat down with Governor Robin Leigh-Pemberton and three senior BoE officials, the topic he raised was bank capital…

At dinner the governor’s hopes had been modest: to find areas of sufficient convergence of goals and regulatory concepts to achieve separate but parallel upgrading moves… 

Yet the momentum it galvanized… produced an unanticipated breakthrough of a fully articulated, common bank capital adequacy regime for the United States and United Kingdom. This in turn catalyzed one of the 1980’s most remarkable achievements – the first worldwide protocol on the definitions, framework, and minimum standards for the capital adequacy of international active banks…

They literally wiped the blackboard clean, then explored designing a new risk-weighted capital adequacy for both countries… 

It included… a five-category framework of risk-weighted assets… It required banks to hold the full capital standard against against the highest-risk loans, half the standard for the second riskiest category, a quarter for the middle category, and so on to zero capital for assets, such as government securities, without meaningful risk of credit default.” End of quote.

And that suddenly meant that banks were able to leverage equity much more with what was perceived, or deemed by regulators, as safe, than with what was perceived as risky.

And that of course meant banks would earn higher expected risk-adjusted rates of return on equity on what was perceived as safe than on what was perceived as risky.

And that meant banks would stop lending to the risky future and just keep to refinancing the safer past.

The bank regulators, scared of more climbing, had then declared that the Western Civilization had reached its peak. No more risk-taking!

The Basel Committee for Banking Supervision, with the Basel Accord of 1988, concocted Basel I and in 2004 Basel II... and they are now in Basel III... and it has all been going down down ever since. The liquidity injected byTarps, QEs and fiscal deficits, and which generate temporary illusions of growth, obesity, cannot reach those who could best produce sturdy growth, the "risky" SMEs and entrepreneurs.

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!

September 2, 1986 was fatal for Western World’s economies. Its banks would be told not to finance the riskier future.

In Charles Goodhart’s “The Basel Committee on Banking Supervision: A History of the early years 1974-1997” 2012, Cambridge Press Goodman (p.167) refers to Steven Solomon’s The Confidence Game (1995), and we read:

On September 2, 1986, the fine cutlery was laid once again at the Bank of England governor’s official residence at New Change… The occasion was an impromptu visit from Paul Volcker… When the Fed chairman sat down with Governor Robin Leigh-Pemberton and three senior BoE officials, the topic he raised was bank capital…

At dinner the governor’s hopes had been modest: to find areas of sufficient convergence of goals and regulatory concepts to achieve separate but parallel upgrading moves… 

Yet the momentum it galvanized… produced an unanticipated breakthrough of a fully articulated, common bank capital adequacy regime for the United States and United Kingdom. This in turn catalyzed one of the 1980’s most remarkable achievements – the first worldwide protocol on the definitions, framework, and minimum standards for the capital adequacy of international active banks…

They literally wiped the blackboard clean, then explored designing a new risk-weighted capital adequacy for both countries… 

It included… a five-category framework of risk-weighted assets… It required banks to hold the full capital standard against against the highest-risk loans, half the standard for the second riskiest category, a quarter for the middle category, and so on to zero capital for assets, such as government securities, without meaningful risk of credit default.”

And that, as far as I am concerned, could be the opening scene for a Mission Impossible or Bond movie, describing the actions of terrorists wanting to destroy the world’s economies. 

Of course it was just dumb arrogant technocrats going abour their business of solely thinking about how banks could avoid failure, without giving even the slightest consideration to the possibility that when doing so they could dangerously distort the allocation of bank credit to the real economy.

The buckets with riskweights of 100%, 50% 25% 0%, and if the capital standard was set to 8 percent meant that a bank would be able to leverage its equity, and the implicit support of society, 12.5, 25, 50 and ∞ times to one respectively with the assets in each bucket.

That meant banks would earn higher risk adjusted returns on equity on assets in those buckets they could leverage more. And that meant that the net of risk margins offered by The Risky to the banks were worth less than the same margins offered by The Safe.

And what was also clear to these “statist conspirators”, was that the risk weight for the private sector would be 100% while that of their governments would be zero.

All in all that night the diners decided the Western World had had enough of risktaking and so the banks should stop giving credit to the riskier future and concentrate on refinancing the safer past.

You might argue that regulators did not force banks to do anything, but that would be to ignore that out there in the real world any bank that earns less risk adjusted returns on equity than other banks will, sooner or later, be eaten up.

And the baby conceived that night was born 21 months later in November 1988 and named the Basel Accord or Basel I. And that baby grew up to be a real monster in 2004, when it turned into Basel II.

And because of this financial terrorism act, millions of small loans to SMEs and entreprenuers that would otherwise have been awarded have now been denied. 

And with that the possibility of creating the new jobs that could substitute for the disappearing ones were greatly diminished.

And by so denying those in lack of capital the opportunities to access bank credit, inequality got a strong boost.

And, ridicously, all for nothing, since major bank crises never ever result from excessive exposures to what is ex ante perceived as risky.

Shame on you bank regulators… you even dared lie to your own Queen, to her face!

November 2008, Her Majesty, Queen Elizabeth asked: why did nobody notice the “awful" financial crisis earlier?

But now I see that in December 2012, four years later the “Queen finally finds out why no one saw the financial crisis coming”. Interested I went to read about it and, not really unsurprisingly, they are shamelessly lying to their own Queen, in her face.

It states: “As she toured the Bank of England's gold vault, Sujit Kapadia, an economist and one of the Bank's top financial policy experts, stopped the Queen to say he would like to answer the question she had posed. And Kapadia went on to explain that as the global economy boomed in the pre-crisis years, the City had got "complacent" and many thought regulation wasn't necessary.

Kapadia told Her Majesty that financial crises were a bit like earthquakes and flu pandemics in being rare and difficult to predict, and reassured her that the staff at the Bank were there to help prevent another one. "Is there another one coming?" the Duke of Edinburgh joked, before warning them: "Don't do it again."

When the Queen was leaving the governor of the Bank, Sir Mervyn King, said: "The people you met today are really the unsung heroes, the people that kept not just the banking system but the economy as a whole functioning in the most challenging of circumstances.”

Holy moly what bullshit! If it was my Queen, I would never have lied to her that way,I would have asked her instead for her pardon.

Of course financial crisis are difficult to predict but, in this case it was a crises fabricated by bad bank regulations.

Kapadia explained: “the City had got "complacent" and many thought regulation wasn't necessary”. 

Absolutely not! The regulators intervened perhaps more than ever and in doing so completely distorted the allocation of bank credit to the real economy.

With their risk adjusted capital requirements they allowed banks to leverage immensely more on assets ex ante perceived or deemed as "safe", like AAA rated securities or loans to Greece, than with assets perceived as "risky", like small loans wit high risk premiums to SMEs and entrepreneurs. 

And that meant they allowed bankers fulfill their wet dreams of earning the highest expected risk adjusted profits on what’s safe. And if, as a regulator, you do a thing like that, something is doomed , sooner or later, to go very bad.

In January 2003 I had already warned in a letter to the Financial Times: “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 worst of all is that basically the same regulators keep on regulating basically the same way, Basel I, II and III.

And all for nothing, since never ever have major bank crises resulted from excessive exposures to what was ex ante perceived as risky; these always resulted from excessive exposures to something ex ante perceived as risky, but that ex post turned out to be very risky.

The absolute truth is that had the regulators not regulated at all, banks would never have been leverage as much as they did.

You need not to be an Einstein to know that current bank regulations are procyclical.

Jon Cunliffe, Deputy Governor for Financial Stability of the Bank of England spoke on November 15, 2015 about “The outlook for countercyclical macro prudential policy”

He began with: “It is an interesting experiment to think what Einstein might have accomplished had he chosen the world of economics rather than physics. Would he have brought to our world the same brilliant simplicity and achieved the same lasting change in our understanding?”

I have no idea what Einstein would have done in such case but I am absolutely certain about what he would not have done.

He would not have set up pro-cyclical credit risk weighted capital requirements for banks, those which are lower for what is perceived as safe than for what is perceived as risky; those which allow banks to leverage more with what is perceived as safe than what is perceived as risky; those which therefore allow banks to earn higher risk-adjusted returns on what is perceived as safe than on what is perceived as risky; those which therefore in Mark Twain’s supposed words make bankers lend you the umbrella even faster than usual when the sun is out and take it away even faster than usual when it looks like it is going to rain.

When times are rosy and so much can seem safe, then banks need to hold little capital and so when times get bad, and so much seems risky, then banks, on top of their difficulties must also come up with additional capital or shed assets. No Mr Cunliffe Einstein would never have done a stupid thing like that.

Einstein would also have understood that the safer an asset is perceived the larger is its potential to deliver those unexpected losses that bank equity is to serve as a buffer against. To set capital requirements based on the ex ante expected credit losses is as dumb as it gets.

And Einstein would of course, before regulating the banks have asked: “What is the purpose of banks?” And when stress-testing banks, besides looking at what is on their balance sheets, Einstein would also have looked at what is not and perhaps should be.

But come to think of it… you should not be an Einstein to get all this!

With respect to developing countercyclical macro prudential policy Cunliffe expresses “I have some sympathy of the ‘don’t do it at all’ approach.

Yes Mr. Cunlifee. The regulators have done more than enough damage as is. Just eliminate the re-clearing in the capital of the perceived credit risk that has already been cleared for with interest rates and the size of the exposure. Don’t you understand that any risk, even though perfectly perceived, leads to the wrong actions if excessively considered?

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.

The Basel Committee for Banking Supervision flagrantly violates the precautionary principle by turning a blind eye to the dangers.

The precautionary principle states that if an action or policy has a suspected risk of causing harm to the public or to the environment, in the absence of scientific consensus that the action or policy is not harmful, the burden of proof that it is not harmful falls on those taking an action.

I have for years denounced that the credit-risk weighted capital requirements for banks adopted by the Basel Accord as the pillar of their regulations seriously distort the allocation of bank credit to the real economy.

The consequences of too much bank credit to what is perceived as “safe” and too little credit to what is perceived is that banks do not any longer finance the risky future, our children and grandchildren need to be financed, but only refinance the safer past. With this the world is slowly but surely coming to a grinding halt.

But the Basel Committee, the Financial Stability Board, the European Commission on Banking and Finance, IMF, BIS, ECB, Fed, FDIC, BoE and all other relevant institutions just look away and do not want that issue discussed.

It sure is a flagrant violation of the precautionary principle that will cause immense damage. 

Please… help me break the silence of that irresponsible mutual admiration club!

Overreacting to ex-ante perceived risks, whether credit or climate change related, is NOT in BoE’s remit.

Mark Carney, the Governor of the Bank of England, recently expressed some warnings on climate change, and specifically about the risks with “stranded fossil fuels”. 

I criticized that, considering the dangers that overreacting to perceived risks poses.

I got an official, very courteous and kind reply from the Public Enquiries Group of BoE. Unfortunately it is clear that they have not understood what I am referring to… it could be my fault... English is not my mother tongue.

And so here I will try to explain it again, briefly, with a reference to what is happening to banks.

Banks act on ex ante perceived credit risks, by means of setting risk premiums, the amounts of exposures and other contractual terms.

But bank regulators (Mark Carney is the current chair of the Financial Stability Board) decided to also act, on precisely the same ex ante perceived credit risks, by setting their capital requirements for banks.

And so we now have TWO bank reactions related to the same ex ante perceived credit risks. 

This results, of course, in that banks will hold more of assets perceived as “safe” than what those ex ante credit-risk perceptions would validate; and hold less of assets perceived as “risky”, than what those ex ante credit-risk perceptions would validate. 

In other words there is now a dangerous distortion in the allocation of bank credit to the real economy.

And I am sure that overreacting to ex-ante perceived risks, whether credit or climate change related, is NOT in BoE’s remit.

And I have seen no specific government policy approving of it. Would Winston Churchill have ever said: “We need twice the walls we need to keep out the ex ante risks we perceive"? Or, "We need to build one more Maginot Line on top of the other!"?

And so, back to my letter to BoE: The market is already worried, on its own, about “stranded fossils fuel assets” and so when big powerful BoE comes along and starts implicating that it also worries about those assets, and so it might conceivably do something about it, that again could provoke a dangerous overreaction to the ex ante perceived risks of stranded fossil fuels.

Do I make myself clearer now?

PS. When there is an overreaction then the only way ex ante perceived risks are correctly acted upon, is when these are adequately misperceived. That is how crazy all is.

PS. Of course, since climate change has much more long-term risk implications that are harder to clear for in the markets, allowing banks to hold less capital when financing sustainability, so that banks earn higher risk adjusted returns on equity when financing sustainability, could serve as a good stimulus that though distorting does so in the right direction.

Sir Jon Cunliffe. Tiberius would have regulated banks much better than the Basel Committee.

I hereby reference a speech titled “Macroprudential policy: from Tiberius to Crockett and beyond” given on July 28 by Sir Jon Cunliffe, Deputy Governor Financial Stability, Member of the Monetary Policy Committee, Member of the Financial Policy Committee and Member of the Prudential Regulation Authority Board 

Sir Cunliffe writes: “the underlying prudential standards – the reserves of capital and liquid assets that individual banks and other firms need to hold to enable them to withstand bad times – should be set not simply in relation to the risks in the individual firm, but also to reflect the importance of the firm to the financial system and the cost to the economy as a whole if the system fails”

Indeed but it was precisely there, when defining the risks of an individual firm, that regulators completely lost it:

Instead of considering the risks of unexpected losses, and the risk that banks would not be able to clear for the perceived risks, the regulators based “the reserves of capital and liquid assets that individual banks and other firms need to hold to enable them to withstand bad times” on the expected losses derived from the perceived credit risks… the only risks that were already being cleared for by banks by means of size of exposure and risk premiums…

And, as the regulator should have known, any risk even when perfectly perceived is wrongly managed if excessively considered. And that completely distorted the allocation of bank credit to the real economy.

If you’re a kid and your parents assign two nannies to care for you, you can still live a fairly ordinary childhood if the average of your two nannies’ risk aversion is applied. But, if their two risk aversions are added up, you stand no chance, then you better forget about having a childhood.

Sir Cunliffe writes: “The financial system does not simply respond to the economic cycle, growing as the economy grows and vice versa. It also feeds on its own exuberance in good times and on its fear in bad times which can in turn drive the real economy to extremes, as we have witnessed in recent years. The underlying causes of this phenomenon are interactions, feedback loops and amplifiers that exist within the financial system that can act as turbo chargers in both directions”

Precisely and perceived credit risks, credit ratings are main feedback loops and amplifiers that exist within the financial system. In January 2003 in a letter published in FT I wrote: “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds. Friends, please consider that the world is tough enough as it is.”

Sir Cunliffe writes: “recognition that what distinguishes ‘macroprudential’ from ‘microprudential’ and from ‘macroeconomic’ is its objective of financial system stability rather than the instruments it deploys.” 

Let me spell it out more directly: The best macro-prudential regulations is one of micro-prudential regulations that help banks to fail… fast… not the current micro-prudential regulation, which only helps to create too big to fail banks.

Sir Cunliffe so correctly writes: “The financial system plays a crucial role in a modern economy directing resources to where they can be most productive and can generate the greatest return. When the dynamics of the system itself distort incentives and judgments of risk and return, there can be a huge misallocation of resources in the economy. And when the bubble bursts and the economy has to adjust, a damaged financial system cannot guide the necessary reallocation of resources – indeed, as we have witnessed, it can slow it down.”

How unfortunate then that Sir Cunliffe, and his regulatory colleagues, cannot get themselves to understand that the pillar of their regulations, the portfolio invariant credit risk weighted capital requirements, is in fact the greatest source of distortion in the allocation of bank credit of them all. It guarantees the dangerous overpopulation of safe havens, as well as the equally dangerous lack of exploration of the riskier but perhaps much more productive bays.

Sir Cunliffe begins his speech by saying “Historians still argue about the exact causes of the financial crash of AD 33 that rocked the Roman Empire.” 

I guarantee him that historians will soon know perfectly well what caused the financial crash of 2008, and why it is taking so much time for the world to get out of it. And they will not be kind on the current batch of regulators. Without being clear about the crash of AD 33, they will have no doubt about that Tiberius would have known better than the Basel Committee.

Tiberius would have picked bank regulators who would have tried to understand why banks fail... not why bank clients fail. 

Tiberius would have picked bank regulators who would have known that the biggest risk for the banking system is that of not allocating bank credit efficiently to the real economy... as no bank can  remain safe while standing in the midst of the rubbles of a destroyed economy.

Mark Carney: Would the Magna Carta include risk-weights like these: King John 0%, AAA-risktocracy 20% and Englishmen 100%?

With the Basel Accord of 1988 (signed one year before the Berlin wall fall) bank regulators assigned a 0% risk weight for loans to the sovereign and 100% to the private sector. Some years later, 2004, with Basel II, they reduced the risk-weight for loans to those in the private sector rated AAA to AA to 20%, and leaving the unrated with their 100%.

That introduced a considerable regulatory subsidy for the bank borrowings of the infallible sovereign (government bureaucrats) and for those of the private sector deemed almost infallible. And that taxed severely the fair access to bank credit, of those deemed as risky, like SMEs and entrepreneurs.

Reading Mark Carney’s interesting: “From Lincoln to Lothbury - Magna Carta and the Bank of England” I felt like asking him what he would think the Magna Carta would have to say about these risk-weights.