Bailouts, which could carry significant costs to taxpayers, to be justified, must have a great purpose.

Note: I’m simultaneously sending out this type of "J'accuse" letter to Financial Times, Washington Post, New York Times, Wall Street Journal, The Globe and Mail, and The Economist.

SVB was holding a high number of Treasury and other government bonds — amounting to more than half of its assets. When will one dare ask regulators: How much capital/equity/skin-in-the game, were SVB's shareholders required to hold against that?

Bailouts, which could carry significant costs to taxpayers, to be justified, must have a great purpose.

We do not need “tougher” rules for our banks, we need better rules. Risk weighted bank capital/equity requirements based on what’s perceived as risky being more dangerous to bank systems than what’s perceived as risky, make absolutely no sense. 

Not only, by feeding the creation of excessive exposures to what’s “safe”, these put the dangers to bank systems on steroids but also, by distorting the allocation of credit, make it much harder for the economy to reach its true potential.

By incentivizing banks to refinance much more the "safer present" than to finance the "riskier future" it effectively imposes a reverse mortgage on the economy that will be very costly for future generations.

 

Additionally, by de-facto declaring the more creditworthy more worthy of credit, and as a consequence the less creditworthy to be less worthy of credit, they hinder equality of opportunities.

And since banks are one if not the most important channel to transmit central banks’ monetary policies, these regulations impede those to work as expected. Just think about how these distort the risk-free interest rate.

To top it up, with decreed risk weights of 0% governments – 100% citizens, as if bureaucrats/apparatchiks know better what to do with credit, for which repayment they’re not personally responsible for than e.g., small businesses, that’s communism or fascism, that has empowered a Bureaucracy Autocracy.

And I could go on and on.

Therefore, assisting the banks in need during a conversion from risk weighted bank equity requirements to solely a strong leverage ratio, 10% equity against all assets, has a great purpose. Especially if it stimulates and democratizes new bank equity.

A Chilean styled bailout could do. Zero bonuses, dividends and buy-backs, until the bank’s shareholders have 10% of equity in it against all assets, and until all the financial assistance provided has been repaid with some interest.

In short: The world needs to rescue its banks from the hands of equity minimizing / leverage maximizing creative financial engineers, much empowered by regulators, and return these to old style “know your client” bank loan officers. Welcome back George Banks.

PS. I might not be a PhD, and I have never been a regulator, but I'm not a newcomer to these issues.

@PerKurowski

Zero dividends, buy-backs and big bonuses, before banks have ten percent in capital against all assets

We urgently need our banks to be banks again

Current bank capital requirements, with capital meaning equity, meaning the skin in the game bank shareholders should have, are mostly based on perceived credit risks; not on misperceived risks, or the unexpected, like a Covid-19.

That would be less of a problem, if those capital requirements were based on risks conditioned to how credit risks are perceived.

But they’re not! What’s perceived more creditworthy, meaning what’s preferred by banks, have much lower capital requirements than what’s perceived less creditworthy.

And lower capital requirements mean higher leverages, making it therefore easier to earn risk adjusted returns on equity with what’s perceived (or decreed by regulators) as safe, than with what’s perceived as risky.

The consequence? A procyclicality that fosters higher and higher exposures to what’s safe, against less and less capital.

And what’s defined as “safe”? Loans to sovereigns, residential mortgages and assets with very high credit ratings?

And what’s risky? E.g., loans to small businesses and entrepreneurs.

So precisely like in 2007-08, when banks were caught with their pants down because of huge exposures to mortgage-backed securities with misperceived AAA ratings, they’re now standing there naked because of the unforeseen economic consequences of Covid-19; especially those derived from lockdowns.

The procyclicality of it all; when times are rosy banks can hold little capital but when times get hard banks have a hard time raising capital, sets us up to the fact 

And so, just when we now most need banks to help us out, it’s the hardest for them to raise the capital that would allow them to do so. What a mess!

And on all that the Academia has for decades kept total silence.

So, what would I propose? In few words, the following: 

“Banks, you can now hold zero capital, but that comes with: zero dividends, zero buy-backs and zero bonuses until you have ten percent in capital against all assets; and until you’ve paid back, including a reasonable interest, all what central banks or taxpayers have assisted you with.”

To ease the transition one could allow all bank assets incorporated some months before the change, to be held, until its maturity, against the capital requirement valid when put on banks' balances.

And I would allow small investors to buy some of that bank equity that helps these meet that ten percent requirement on favorable conditions… so as to connect the banks with the citizens again

Fellow citizens, let’s rescue our banks from hands of those financial engineers concerned with “how much can we leverage this asset?”, so as to put these back into hands of loan officers whose first question to applicants is, “what are you going to use the money for?”

And let’s rescue banks from that statism/communism/fascism implied with risk weights of 0% the Government, 100% the citizens… all as if bureaucrats/politicians know better what to do with credit for which repayment they’re not personally responsible for, than e.g., entrepreneurs.

Let’s be clear. Risk taking is the oxygen of all development and so, in that vein, for the real economy what’s “safe” represents carbs, while what’s “risky”, proteins and vitamins.

God make us daring!

And finally let’s stop putting financial instability on steroids. The large dangerous exposures that could become dangerous for our bank systems are always built up with what’s perceived as safe, never ever with what’s perceived risky. 

For the record, most of the "zero-zero-zero-ten percent" idea is inspired in how Chile so intelligently managed their huge 1981-1983 bank crisis.

Give it a thought, the newspaper you read; would it dare to publish a Galileo-heliocentric opinion and risk being confronted by the Basel Inquisition?

More on Chile: https://ideas.repec.org/p/wbk/wbrwps/300.html

My 2019 letter to the Financial Stability Board

Thomas Hoenig of the FDIC, please indicate your colleagues, the right non-Taliban way of regulating banks.

In a speech of November 5, Thomas Hoenig, the Vice Chairman of the FDIC in a speech titled "Post-Crisis Risks and Bank Equity Capital", spelled out correctly and clearly the problem with current bank regulations.

Hoenig stated: “Global banks are not as well capitalized as some within the industry would have you believe. The fact is they remain highly leveraged and highly complicated, and should one fail, it would have systemic, destabilizing consequences. There are two different ways to address these concerns. One would require detailed rules to control firms' behaviors, structure their balance sheets, and direct their activities…

The other way to promote stability would be to simply demand more equity capital to enable banking firms to better withstand a crisis, while allowing them to run their businesses with less government direction.

The first option would require regulators to predict what activities and investments might cause future crises. It also would require them to calibrate rules in a manner that wouldn't give rise to subsequent crises. In other words, regulators would have to successfully anticipate the source of future crises, which as you know could arise from a number of activities, but mostly likely will come from something we fail to predict.

The second approach is based on equity capital and thus would not require such extraordinary insight from regulators. By design, it acknowledges that regulators cannot predict events and it ensures a safer system because well capitalized institutions are better able to withstand shocks and survive crises. Using simple leverage measures instead of risk-based capital measures eliminates relying on the best guesses of financial regulators to guide decisions.” End of quote.

Since the safer something is perceived the larger the potential for it to deliver an unexpected shock, it is of course only the second approach that can be the valid one… and the only thing we would pray for, is for that very careful attitude and steady hand required for getting us from here to there, without making it all so much worse.

Mr. Hoenig. Show your colleagues very carefully the right very careful way! There are more than enough regulatory Taliban out there.

Just asking for 20-30 percent capital requirements for banks is just playing for the galleries.

PS. Personally I would gladly settle for a goal of 8-12% of capital against all assets thereby getting rid of the worst part of current regulations, namely how the risk-weighing distorts the allocation of bank credit. How to get there? I have my ideas and the one I most like is inspired by how Chile capitalized their banks in 1985.