Explaining to World Bank and IMF the horrific mistakes of Basel’s bank regulations, has not been an easy journey

http://live.worldbank.org/civil-society-townhall-2017

28:30, I am Per Kurowski, of New Rules for Global Finance

This is a question for the umpteenth time to the World Bank:

As the world’s premier development bank the World Bank must know that risk-taking is the oxygen of any development. So why is it still not speaking out against the risk-weighted capital requirements for banks that put a brake on risk-taking, like on the lending to SMEs small and medium sized enterprises…even though never ever has a major bank crisis erupted because of excessive exposures to something ex ante perceived as risky.

30:50, World Bank, Jim Yong Kim

On risk taking I am not sure I understood the question correctly, but there is, because of in many ways I think very much necessary prudential rules, the Basel process, one of the side effects of it is that it has been a systematic de-banking of many developing countries, especially in Africa. 

And so many banks Standard Chartered and others that had very strong presence in the developing world have for the most part left. And so we have a terrible time in terms of accessing capital markets in the way that they did before.

So it’s a huge concern for us, and we are continuing to engage with the Basel process and we are continuing to try to talk about some of the side effects. For example it is much more difficult and expensive to send remittances back now because these institutions don’t exist. 

And so the problem of insuring that the poorest countries have access to capital markets is very-very high on our agenda, and is really at the core of the major issue we talked about in spring meetings which is our cascade; and the cascade is essentially recognition that on the one hand it is very difficult for very good emerging markets infrastructure projects to get capital, and on the other hand there is more than 10 trillion dollars in negative interest bond, and 25 plus trillions in very low earning bonds and another 8 trillion in cash sitting in peoples safes, and they would like to get a higher return, but the perception of risk in the emerging market is so high, that the capital is just not moving.

So we are putting so much of our effort into mitigating this situation where you have great projects, great potential for building infrastructure that would lead to growth but that are not being financed; we are really focusing on filling that void on the problem I think you are pointing to.

My comment: It was not answering my real question but it was still a very valid answer. If given a chance my re-question would have been: Do you think Standard Chartered would have left those development markets had it had to hold the same capital against all its assets than what it is required to hold on loans to these markets? The answer to that is surely “No!”

35:25, IMF, Mme Christine Lagarde.

I am actually tempted to address also this question, is that okay?

Because I think it is an important point and one that has very complex ramifications. It has complex ramifications in the banking regulations business, in the banking supervision business, and in the accounting business.

And then it is at the very junction of between sort of self-established model by the banks versus models established by the supervisors. 

I think we both would agree that methods that would actually encourage the lending by banks and by insurance companies and by pension fund to SMEs, you know with the risk associated with it, should actually be very much in order.

At the moment the risk weighing methods and the models that are being used are discouraging from actually investing and taking risk to benefit the small and medium sized enterprises 

And that’s not necessarily the best avenue to support the economy and to support entrepreneurs who want to have access to financing.

My comment: Many thanks, but Mme Lagarde, it really behooves the IMF, and the World Bank, to understand why it took them about 15 years, Basel II, to see this problem.

30:50 World Bank, Jim Yong Kim

Just to add to that, we are now trying to come up with lots of different innovative approaches to de-risking those investments, taking first loss, using political risk insurance credit enhancements, lot of tools that we are using now to try to respond to the situation

My comment: That is good to hear, but beware, de-risking credits, against distorted and inadequate bank regulations, could have very bad unexpected consequences.

PS. Very much inspired by John Kenneth Galbraith’s “Money: Whence it came, where it went” (1975), I started my fight against Basel Committee’s regulations in 1997, in my very first Op-Ed “Puritanism in Banking”.

And in 2003, as an Executive Director or the World Bank, in a workshop for bank regulators I warned: “The other side of the coin of a credit that was never granted, in order to reduce the vulnerability of the financial system, could very well be the loss of a unique opportunity for growth. In this sense, I put forward the possibility that the developed countries might not have developed as fast, or even at all, had they been regulated by a Basel.”

In 2007, ten years ago, at the High-level Dialogue on Financing for Developing at the United Nations, as civil society, I presented the document: “Are the Basel bank regulations good for development?”

And since then I do not know how many times, I have tried and failed to draw IMF’s and World Bank’s attention to the many very serious mistakes that are imbedded in Basel’s risk-weighted capital requirements for banks.

Have I arrived at the end of my journey? I am not 100% sure, but I do see some light J

Mme Lagarde. I don’t agree with that IMF is “Building a More Resilient and Inclusive Global Economy”.

On April 12, Christine Lagarde, Managing Director of IMF gave a speech titled “Building a More Resilient and Inclusive Global Economy”

Mme Lagarde stated: “We have found that technology has been the major factor behind the relative decline of lower- and middle-skilled workers’ incomes in recent years, with trade contributing to a much lesser extent” So where was IMF with this argument during the recent walls against foreign workers debate? Jobs are of course important but is it not also time to start thinking about the need for decent and worthy unemployments?

Mme Lagarde also stated: “Financial stability requires that we complete the reform of global financial regulations. These rules—especially on bank capital, liquidity, and leverage” Hah! With capital requirements for banks that are especially low for what can cause bank crises, namely what’s perceived as safe? Like the ultra low risk weighted assets of the AAA rated securities and a sovereign like Greece? IMF has to be joking.

Mme Lagarde spoke about IMF’s efforts for “avoiding protectionist measures as well as distortive policies that give rise to competitive advantage.” So why then does IMF keep silence on capital requirements for banks that make it harder than it already is for those perceived as risky, to access bank credit, like the SMEs and entrepreneurs?

Mme Lagarde holds that “today’s policies should not disadvantage future generations, who would be left to pay for the imprudent actions of today’s generation.” Hold it there! The current imprudent risk adverse bank regulations that give banks incentives to stay away from financing the riskier future and just keep to refinancing the safer present, does precisely disadvantage future generations.

Mme Lagarde, let me assure you that the current Basel Committee’s bank regulations do not live up to any of the three principles proposed by the great Roman architect Vitruvius:

Durability: No! “May God defend me from my friends, I can defend myself from my enemies” Voltaire”.

Utility: No! “A ship in harbor is safe, but that is not what ships are for” John A Shedd.

Beauty: No! Besides perhaps delighting some anxious nannies that regulation raises no one’s spirits. God make us daring!

@PerKurowski

Excuse me Mme. Lagarde, but you and the IMF, are so astonishingly wrong

Christine Lagarde, the Managing Director of the International Monetary Fund, in a speech titled Three “Rosetta Moments” for the Global Economy in 2015 delivered January 15, 2015 stated:

“If there is one lesson from the Great Recession, it is that you cannot have sustainable economic growth without a sustainable financial sector.”

Sincerely, excuse me Mme. Lagarde, but you are so astonishingly 180 degrees wrong.

Current difficulties derive directly from the fact that bank regulators, trying to bring stability, sustainability, to the banks, concocted portfolio invariant credit risk weighted equity requirements. And these allowed banks to earn much much higher risk adjusted returns on equity when lending to the “infallible sovereigns”, the housing sector and to members of the AAArisktocracy than when lending to “the risky”.

And so, as should have been expected, because it is always excessive exposures to what is perceived ex ante as absolutely safe that causes bank crises, we ended up with excessive banks exposures, against much too little bank equity, to AAA rated securities, to the real estate sector (Spain) and to sovereigns like Greece.

And so, as should also have been expected, because banks naturally search to maximize their risk-adjusted returns on equity, the banks abandoned those who are most in need of credit, those same our real economy most need to have access to bank credit, namely “the risky” small businesses and entrepreneurs.

And all this simply because regulators obnoxiously regulated our banks without defining a purpose for these any different from just being safe and convenient mattresses in which to stash away our money.

Mme Lagarde: If there is one lesson from the Great Recession, it is that you cannot have a sustainable financial sector without sustainable economic growth.

We hear all the time about the need to save taxpayer, but to save taxpayers by reducing even more their taxable earnings, sounds about as silly as can be.

Mme Lagarde states: “we must complete the agenda on financial sector reform”. Absolutely, but not by having the same regulators, taking us with their Basel III on even more shady and curvy roads, in the same dumb direction.

PS. Mme Lagarde, this is not the first time I comment on this to you... for example:

http://subprimeregulations.blogspot.com/2013/10/my-question-for-umpteenth-time-to-world.html

Yes Mme. Lagarde. It matters much where banks are going, and they’re being directed in the wrong direction.

Yes Mme. Lagarde. It matters much where banks are going, and they’re heading the wrong way.

Christine Lagarde Managing Director, International Monetary Fund in “The IMF at 70: Making the Right Choices—Yesterday, Today, and Tomorrow” during The IMF/World Bank Annual Meetings, Washington, D.C. October 10, 2014, states: “It matters where we want to go in order to decide which way we go.”

Indeed it matters. And that is why I ask Christine Lagarde to use her influence to ask bank regulators: where do they want our banks to go.

I say this because in all their regulations there is not on single word about the destiny of the banks, in terms of the purpose of our banks. 

And that is of course why they have allowed themselves to impose on banks “credit-risk weighted capital requirements for banks”, which introduces a sissy silly risk aversion in the banking system and which completely distorts the allocation of bank credit to the real economy.

When Mme. Lagarde presents to us a choice between stability and fragility, that is a perfect opportunity to remind all of you that the search for stability can itself produce that stiffness, brittleness and lack of flexibility, that can lead to real monstrous fragility.

When Mme. Lagarde presents to us a choice between acceleration and stagnation that is not really a choice, since the lack of acceleration, moving forward, taking risks, will make the economy stall and fall, sooner or later.

And finally when Mme. Lagarde presents to us the choice between solidarity and seclusion, I would just note that, though there is a saying that goes “better alone than in bad company”, whenever you build a wall, you cannot be absolutely sure you end up on the right side of it.

IMF, and World Bank you have an important and urgent role to perform in holding bank regulators accountable for what they have done and are doing… please do not shy away from it.

And also never forget that secular stagnation, deflation, mediocre economy, unemployment, underemployment, managed depression and all similar obnoxious creatures, are all direct descendants of risk aversion.

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

IMF, Christine Lagarde, “the new mediocre” was ordained by risk adverse bank regulators.

Christine Lagarde speaks about “the new mediocre the state of the global economy—and the risk that the world could get stuck for some time with a ‘mediocre’ level of growth”; and of that we need a mix of bolder policies to inject a ‘new momentum that can overcome this ‘new mediocre’ that clouds the future.

The “New Mediocre” is the direct result of a growing risk adversity, most clearly illustrated by the credit-risk-weighted capital (equity) requirements for banks that for no good reason at all, distorts the allocation of bank credit, by allowing banks to earn much much higher risk-adjusted returns on equity on exposures ex ante perceived as “absolutely safe” than on exposures perceived as “risky”… since risk-taking is the oxygen of any development such risk-aversion can only lead to our economies stalling and falling, and where “mediocrity” is only a benign intermediate point.

How the IMF and others have allowed bank regulators to regulate banks without even defining the purpose of the banks, and caring exclusively about the banks and not about the allocation of bank credit to the real economy, is just incomprehensible to me.

Two times during civil society round-tables (do not ask me what civil society means) I have asked Christine Lagarde about the odious discriminatory regulations that impedes “the risky” to have fair access to bank credit, two times she has answered as she could be understanding, two times she has clearly not.

1. http://subprimeregulations.blogspot.fr/2011/09/my-question-at-civil-society-townhall.html

2. http://subprimeregulations.blogspot.fr/2013/10/my-question-for-umpteenth-time-to-world.html

This year I will not be present at the IMF/World Bank annual meetings in Washington... (I have better things to do in her Paris :-))... but I sure hope, and pray for, that when she speaks of the “need of bolder policies”, she will understand that for that it might very well suffice with getting rid of silly and dangerous credit-risk-adverse bank regulations.

PS. Christine Lagarde, let me be even clearer still. Secular stagnation, deflation, mediocre economy, unemployment and all similar creatures, are direct descendants of silly risk aversion.

PS. Comments on IMF Global Financial Stability Report October 2014 Chapter III: Risk Taking by Banks: The role of Governance and Executive Pay

No Mme Lagarde… you are wrong! Bank regulators are more to blame than bankers.

Christine Lagarde, the Managing Director of the International Monetary Fund, at the Economic Club of New York on April 10, 2013, with respect to the financial sector reform said: 

“The bottom line is that we need a global financial system that supports stability and growth” 

Yes! Absolutely! No doubt! And that is why during a Civil Society Town Hall meeting in 2011 I asked Mme Lagarde: 

“If bank regulators had defined a purpose for banks before regulating this, we might have had a very different bank crisis, but not as large, systemic, and dangerous as this one. IMF, World Bank, when are you, as our global development agents, going to require from the regulators in the Basel Committee to openly and explicitly define the purpose of our banks… to see if we all agree? 

And Mme Lagarde answered: 

“On the purpose of banks, it is a very good debate to have, and it is one that I think the Vickers Commission Report is actually helping to build--what are banks for, and what are the state guarantees or general deposit guarantees intended for? Is it to actually guarantee the savers and the depositors, or is it something that is intended to fuel and benefit other activities that are really within a completely different realm of activities? 

My sense is that the most critical mission for the banks--and that is what we are trying to say when say that banks have to rebuild their capital buffers--is to actually finance the economy, first and foremost, and that should be really the critical mission” 

But Mme Lagarde, unfortunately, as you know, that debate and the definition of the purpose of banks have not happened yet, and the Basel III producers keep on working as if that is not necessary. 

And so when Mme Lagarde now says: “we have seen what happens when a banking sector chooses the quick buck over the lasting benefit, backing a business model that ultimately destabilizes the economy” I must object, because much more that a wrong business model it was a wrong regulatory model that destabilized the economy and the banks. 

It was bank regulators that while for instance requiring German and Cyprus banks to hold 8 percent when lending to German and Cypriot small business and entrepreneurs, which implies a 12.5 to 1 authorized bank equity leverage, allowed German and Cypriot banks to lend to a sovereign like Greece, or buy triple-A rated securities in the US, holding only 1.6 percent in capital, and which implies a mindboggling 62.5 to 1 authorized bank equity leverage. 

Though banks clear for perceived risk in the numerator, by means of interest rates, amounts of loans and other terms, bank regulators required the banks to also clear for the same risks, in the denominator, with capital requirements based on the same perceived risk. 

And the consequence of that is that banks earn much higher expected risk-adjusted returns on equity when lending to “The Infallible” than when lending to “The Risky” and that has of course fully distorted out common sense from our banking system 

And this has been one of the greatest regulatory stupidities ever, and neither the IMF nor Christine Lagarde should help to cover it up. 

PS. Here is how Mr. Zoellick as the President of the World Bank answered my question during that same Town Hall Meeting: 

“Your point about the Bank regulators is a particularly intriguing one, and let me share with you a little anecdote. 

Bank regulators come out of the world of central banks, and central banks will be the last bastion to fall in openness and transparency. When Pascal Lamy, who is head of the WTO, who has dealt with civil society groups for many years, as I did, starting in the trade area--and I met with Mario Draghi at that time, head of the Financial Stability Board--we shared with him a story that some union groups had come to Basel and tried to get in the door and talk to people, and they were met with screams of uncertainty. And we have suggested--and I'll just pass this along--that they also have to build some outreach mechanism through the Financial Stability Board and openness and transparency. And I will just share this from my own learned experience. Some institutions--central banks in particular because of the sensitive market information--build in cultures of this, and it is understandable, but then, on the policy level, as you suggest, people need to get used to being more open about it. And I just think that that is something, again, that we can try to work with you with as a general principle. I think the world will move more in this direction, but it will take some time on it. 

And I agree with Christine's response to you about the fact that the good news is, as the discussion in Britain showed, that people are starting to debate the exact purpose of banks.” 

PS. Here is my letter to the Ministers gathering in Washington for Spring Meetings 2013 on the issue of subprime banking regulations and their odious discrimination of "The Risky".

PS. Here my 2019 letter to the Financial Stability Board