Bank regulators… dare to answer this single question

There are literally thousand of risks, especially many unexpected risks, which could bring our banking system down.

And so why on earth did you regulators base your capital requirements for banks, those which are to cover especially for unexpected risks, solely on the ex ante perceived credit risk, that which is basically the only risk already cleared for by banks, by means of interests risk premiums and the size of their exposures?

And, to top it up, you made those capital requirements portfolio invariant… as if diversification has no meaning?

If anything, should you not have based it on the risks that bankers were not able to clear for those perceived risks?

Since that dangerously distorts the allocation of bank credit to the real economy, do we not deserve a clear-cut answer on that?

I have been asking this for over a decade, and you have not even wanted to acknowledge my question. Does that not tell you something?

I don’t know whether to laugh or cry, but current bank regulations are just as loony as they can be

With Basel II, the regulators decreed for instance that the risk-weight of a private corporation rated AAA to AA, was 20%, while the risk weight of a corporation rated below BB-, was 150%.

Since their basic bank equity requirement was 8 percent, that meant that banks needed to hold only 1.6 percent in equity against any loan to an AAA to AA rated corporation, while having to hold 12 percent in equity when lending to a corporation rated below BB-. 

And that meant that banks were allowed to leverage their equity over 60 times to 1 when lending to an AAA to AA rated corporation, but limited to a 8 to 1 leverage in the case of lending to BB- rated private corporations. 

And all that… in the name of bank safety! 

As if there was any sort of danger that many banks in the banking system would dangerously overexpose themselves to BB- rated private corporations? 

As if the danger does not lie in the possibility that an AAA to AA rated corporation, those which bankers love to lend to, could suddenly turn up to be worse than a BB-rated private corporation. 

Regulators, like Jaime Caruana, Mario Draghi, Mark Carney, Stefan Ingves and some other are just like telling kids…

If you go into that dark forest that looks horrible to you...

then we will force you to eat broccoli and spinach...

But, if you stay out on the fields where everything looks safe and beautiful...

then we will allow you to eat as much chocolate cake and ice cream you want.

This even though you could become dangerously obese (or too big to fail)

It can also be rephrased as if you eat broccoli you must eat spinach too but, if you eat chocolate cake you can have as much ice cream as you want.

How naïve and infantile can it be to believe that what’s perceived risky is what’s really risky?

And worse, much worse, some banks, the biggies, the TBTF, those would hurt the most if they failed, they are allowed to run their own internal models to decide on how much broccoli or spinach (not) to eat

“May God defend me from my friends: I can defend myself from my enemies” Voltaire

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

“One has to belong to the intelligentsia to believe things like that: no ordinary man could be such a fool.” George Orwell

“There are some mistakes it takes a Ph.D. to make”. Patrick Moynihan?

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

MY CONCLUSION: Without bank regulations, especially the credit risk weighted capital (equity) requirements, there would not have been a financial crisis like the current, nor would there have been any reason for the IMF to write this chapter. And IMF should have the guts to rise to the occasion and state that truth... the world needs it.

Here: Chapter III: Risk Taking by Banks: The role of Governance and Executive Pay

General comments:

Though I have naturally no objections to the call for better governance of banks, or for more constrain and rationality on their executive pay, I object to the relative importance assigned to those issues in terms of causing the current financial crisis… as this will help to divert the attention from those who most need to be held accountable… namely bank regulators.

And that because I am totally convinced that the distorting regulatory incentives present in the risk-weighted capital requirements for banks were the most important cause of the crisis and for the difficulties of our economies to be placed on the road of finding sturdy growth. 

And also, specifically relevant to this chapter, because those regulations dramatically eroded the importance of bank capital (equity) and bank shareholders, and thereby left the road open for bank management to appropriate for itself, much more of the financial results.

Comments on the Summary:

Text: “There is broad consensus that excessive risk taking by banks contributed to the global financial crisis.”

Comment: A broad consensus does not necessarily represent the truth. In this case it is important to remember that absolutely all of the excessive risk taking that showed up on the balance sheets of banks, were related to excessive exposures against which regulators allowed minimum capital requirements, as a consequence of these assets being ex ante perceived as absolutely safe from a credit point of view.

Text: “Equally important were lapses in the regulatory framework that failed to prevent such risk taking. Reforms are under way to further strengthen the regulatory framework, realign incentives, and foster prudent behavior by bankers.”

Comment: To be effective and avoid unintended consequences, such reforms must be based on a thorough understanding of what drives risk taking in banks. The distortions in the bank’s portfolios, and in the allocation of credit to the real economy produced by the risk-weighted capital requirements, have not been sufficiently acknowledged and discussed so as to expect these will be eliminated in a rational way. I hold this because even though there are many calls for more bank equity, and some who correctly suggest the full elimination of risk-weighting, the transition of the banks from here to there implies serious risks, for the banks and for the real economy.

Comments on: Box 3.5. Regulation and Risk-Taking Incentives: Basel I to III 

Text: “Basel I (1988) introduced uniform, risk- sensitive minimum capital standards at the international level… credit risk was divided into five buckets, ranging from zero percent to 100 percent depending on the riskiness of the underlying asset.”

Comment: “depending on the riskiness of the underlying asset” is not a correct way to phrase it. More precisely it depended on the ex ante risk preferences of regulators and general ex ante credit risk perceptions, both which does not necessarily have anything to do with the ex post realities.

Text: "Although Basel I was hailed for incorporating risk into the calculation of capital requirements and was regarded as a big step forward, it was also criticized for not taking into account hedging, diversification, and differences in risk-management techniques. It also did not take into account other types of risk, particularly market risk."

Comment: Basel II (and Basel III) are still essentially “portfolio invariant” and has therefore not corrected for not taking into account diversification. One loan of $1 billion to one “absolutely safe” borrower requires the bank to hold only a fraction of the capital needed against 1.000 $1 million loans to “the risky”. And though coverage for liquidity risk has been included in Basel III, as it also build on ex ante perceptions, it could also be aggravating the distortions.

Text: "Advances in technology and risk-management techniques allowed banks to develop their own internal capital allocation models in the 1990s, which enabled them to align the amount of risk they undertook on a loan with the overall goals of the bank (internal risk tolerance). 

For example, Basel I placed all commercial loans into the 8 percent capital category. In contrast, internal model calculations led to capital allocations on commercial loans that varied from 1 to 30 percent, depending on the loan’s estimated risk. It was hence argued that although Basel I was a step in the right direction, it was not sufficiently risk sensitive and could result in arbitrage: if capital regulation was binding, a lack of risk sensitivity encouraged banks to shift toward the riskiest activity within each category.

The Market Risk Amendment (1996) and Basel II (2005) were introduced to address these shortcomings, allowing internal models for market and credit risk, respectively. These measures allowed banks to use internal models to more finely differentiate risks of individual loans. Risk could now be differentiated not only between but also within loan categories."

Comment: And the consequence of that, which should have been expected by the regulators, was that instead of taking diversified risks on what was perceived as “risky”, banks took on extreme and dangerously leveraged exposures to what was and is ex ante perceived as “absolutely safe”

Text: “The regulations were designed to induce banks to invest more in risk-management and modeling technology by providing capital relief— the standardized approaches were calibrated to be more conservative than risk-sensitive internal models.”

Comment: “the standardized approach” calibrations were the result of a complete absurdity that in my opinion no one understood but no one dared to question. I dare anyone to read the explanation provided by the Basel Committee and then he might understand better the horrible truth behind the “risk-weighing” which sounds so comforting and rational. 

Specifically I strongly suggest all development and finance ministers to query their regulators on the Explanatory Note on the Basel II IRB Risk-Weight Functions issued by the Basel Committee.

Text: “Before these changes were introduced, banks’ internal risk models (and other risk-management functions) were designed to measure risk accurately. However, after the Market Risk Amendment and Basel II, subject to regulatory approval, models became a key input in determining capital requirements, generating a competing objective of using models to minimize measured risk to minimize capital requirements.”

Comment: Is not minimizing capital requirements a natural and essential way for banks to compete in capital markets, especially when risk-weighing of assets made everything less transparent to the market? That regulators did not foresee that risk-weighted capital requirements would lead to overall much lower bank capital is mind-blowing.

Text: “These incentives may have contributed to the global financial crisis, during which banks, particularly large banks, were found to hold insufficient capital. Since the crisis, Basel III has raised the capital requirements for banks, and work is ongoing to better capture risk.”

Comment: “These incentives may have contributed to the global financial crisis”, may count as one of the understatements of the century. Those incentives caused the global financial crisis… suffice to see the total correlation between “bank assets in trouble” and “low capital requirements”.

Final comments: 

The regulators never defined what is the purpose of the banks, and therefore they never cared, nor care, one iota about how banks allocated credit to the real economy. “A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926.

The regulators fixated on the expected ex ante perceived risk of the assets of the banks, something which is already clear for by means of interest rates and exposures, instead of focusing on the unexpected risks of the banks… pas le meme chose. Amazingly, by their own confession, they substituted expected risks for unexpected risks.

And the above allows banks to earn much higher risk adjusted returns on equity on assets perceived as "absolutely safe" than on assets perceived as "risky", something which introduces a monstrous distortion in the allocation of bank credit to the real economy.

And because of this regulatory distortion much or even perhaps most of current fiscal and monetary support systems of the real economy is wasted, only because regulations do not allow bank credit to go to where it is needed the most.

As a grandfather, extremely concerned about the future of my grandchildren, I hold that the current regulators, and whose extreme hubris made them believe they could be risk managers for all our banks, deserve to be sent home... in shame. Were we to regulate for climate change the way banks have been and are regulated, our planet will be toast!

PS. In 1999 in an Op-Ed I wrote “The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause the collapse of our banks” And the Big Bang happened! And yet seven years after the explosion, the world seems not to have noticed the Basel Bomb... and the IMF has a lot of responsibility for that.

PS. As the IMF is now taking up the issue of inequality, it should be reminded that the odious discrimination  against fair access to bank credit of "the risky", is one prime driver of inequality.

And the Guinness Book of Records’ nomination for the most outlandish case of hubris should go to…

The Basel Committee and the Financial Stability Board... who with their credit-risk weighted capital requirements for banks thought they could act as risk managers for the banks of the whole world.

In 1999 I was afraid of something like that… and so in an Op-Ed then I wrote: “The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause the collapse of our banks”

Why regulators picked as the number one and sole objective for banks that of avoiding risks, ignoring entirely that of allocating bank credit efficiently in the real economy beats me… I guess it might be the result of that kind of incestuous intellectual craziness that can affect the not accountable to anyone members of a small mutual admiration club.

How crazy did they get? Well consider that while the regulators limited the banks to leverage their capital (equity) 12.5 times to 1 when giving small loans to SMEs, they allowed banks to leverage a mindboggling 62.5 times to 1 when investing huge amounts in AAA-rated securities or in lending to Greece… and so you tell me!

At the kindergarten questions to regulator X about bank lending to Mr. Safe and Mr. Risky

If a bank perceives Mr. Safe as an absolutely safe credit risk, it will probably be willing to lend him much money at a low interest rate. And regulators, sort of just for good measure are currently also willing to allow the bank to lend to Mr. Safe against very little capital (equity), meaning the bank will be able to leverage its capital a lot.

If on the contrary a bank perceives Mr. Risky as a bad credit risk, if it anyhow lends to him, it will be little money, at high interest rates. And regulators, also sort of just for good measure, then currently requires the bank to hold more capital, meaning the bank will be able to leverage much less its capital.

Q. Why on earth should a lot of money lent at low rates to Mr. Safe be safer, or less risky for the bank, than little money lent at high rates to Mr. Risky?

Q. Is the truth not that the risk of banks have nothing to do with the credit risks of Mr. Safe or Mr. Risky, and all to do with how banks lend to Mr. Safe or Mr. Risky which, as they say in French, is pas la meme chose?

Q. Why on earth would bank regulators expect the bank to keep on lending to Mr. Risky if it cannot leverage its equity as much as it is allowed to do when lending to Mr. Safe?

Q. And if banks only lend to the Mr. Safe of this world and avoid all the Mr. Risky, what might become of this world… a safer or a riskier place?

Bank of England keeps mum about its shady distortions of the allocation of bank credit to the real economy.

View the episode of the splendid educational video produced by the Bank of England.

There you will see that at no moment does BoE indicates that it, like their colleagues in other places, require banks to hold different amounts of shareholder´s capital against different assets, and therefore allow banks to obtain different returns on equity for different assets, and therefore distort the allocation of bank credit in the real economy… with disastrous medium and long term results, even for the banks.

Why could that be? Does BoE not know it distorts, or does it have a bad conscience about it? Who knows, it does not really matter. The pain for a medium and small businesses, entrepreneur or start-up, "the risky", of  not gaining access to bank credit or having to pay more for it, is the same.

Why our nations are failing!

Daron Acemoglu and James A. Robinson have written an interesting book titled “Why Nations Fail”. In it they detail the importance of having adequate economic institutions and of creating incentives that rewards innovation and allows everyone to participate in economic opportunities. 

To my surprise though, the importance of the willingness to take risks, is not mentioned. 

Bank regulators, about a decade ago, with Basel II, out of the blue, authorized by I don’t know who, suddenly decided that our banks should take less risks than usual, and allowed the banks to hold much lower capital when exposed to assets perceived as “The Infallible” than when holding “The Risky”. 

That meant that banks would be able to earn immensely higher expected risk adjusted returns on their equity when lending to “The Infallible” than when lending to “The Risky”. 

That meant that our bank regulators effectively locked out “The Risky”, like small businesses and entrepreneurs from having access to bank credit on equal terms. 

And that also meant the bank regulators doomed our banks to end up overexposed and holding too little capital to assets that though they ex-ante could qualify as “The Infallible” got too much access to bank credit, on too generous terms, and therefore, ex-post, turned into extremely risky assets. 

And I know for sure, that when a nation starts worrying more about its “History”, “What It Has Got”, “The Infallible”, “The Old”, than about its “Future”, “What It Can Get”, “The Risky”, “The Young”, it will stall and fall… no doubt about that. Risk-taking is the oxygen of any economic development.

And now our bank regulators are even doubling down on their mistakes. Basel III will not only conserve the capital requirements based on perceived risk, it will now also have liquidity requirements based on perceived risks. 

Come on, Europe, America (Home of the Brave)… what happened to our “God make us daring” that we used to pray for in our churches?

Regulators, please, temporarily, lower capital requirements for banks on exposures to “The Risky”

Current capital requirements for banks, based on perceived risks, allow banks to expect to earn much more risk and transaction cost adjusted returns on equity when lending to “The Infallible”, than when lending to “The Risky”. 

And therefore, the already dangerous huge exposures of banks to “The Infallible” or to “The Infallible” who morphed into being risky are growing day by day, while the exposures to those originally perceived as “The Risky”, like small business and entrepreneurs, are, equally or even more dangerously for the economy, drying up. 

And, as bank capital gets scarcer and scarcer, the de-facto discrimination in favor of “The Infallible” and against “The Risky” increases. And now, with regulators doubling down on their mistake and also creating liquidity requirements based on perceived risk, it will all just get worse. 

Day by day “The Infallible” needs to pay lower interest rates, and “The Risky” higher ones, than what would have been the case without the distortions imposed by the regulators, or, as The Joker would call them The “Schemers”. 

We must urgently put a stop to this. Not only do our best chances of revitalizing economic growth rates lie in giving “The Risky” equal access to bank credit, but also we need to give our small savers, our widows and orphans and our pension funds, an equal opportunity to save with exposures to “The Infallible” that produce the returns they should produce. 

Therefore regulators, please…..temporarily lower the capital requirements for banks on exposures to “The Risky” and draw up a schedule for over some few years, making the capital requirements to be the same for the exposures to “The Infallible” and to “The Risky”. 

In fact since “The Risky” have never ever caused a major bank crisis and these have always, no exceptions resulted from excessive exposures to “The Infallible” that turned risky, if you schemers cannot refrain yourself from interfering and distorting, perhaps to feel you earn your salary, then why do you not set the capital requirements for banks slightly higher on exposures to “The Infallible” than on exposures to “The Risky”. That would make much more empirical sense, you dummkopfs! 

And you congressmen, please come up fast with some good tax incentives for those who inject fresh capital into our banks and that is so much needed.

Banks regulators, please, more humility… and also read more Hayek

Friedrich Hayek in his essay of 1945 “The use of knowledge in society” wrote the following: 

“The peculiar character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess. 

The economic problem of society is thus not merely a problem of how to allocate "given" resources—if "given" is taken to mean given to a single mind which deliberately solves the problem set by these "data." It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know. Or, to put it briefly, it is a problem of the utilization of knowledge which is not given to anyone in its totality. 

This character of the fundamental problem has, I am afraid, been obscured rather than illuminated by many of the recent refinements of economic theory, particularly by many of the uses made of mathematics.” 

And this truth was completely ignored by our current generation of bank regulators, who arrogantly thought themselves capable to act as the risk managers for the whole world, and so haphazardly set their risk-weights which determined the effective capital requirements for banks, based on perceived risks.

Of course that distorted it all and the banking system blew up… but these regulators still think they are up to the task of managing risks… As I see it the only possibility we have to make them humbler, at least for a while, seems to be, unfortunately, humiliating them.

Helping the Financial Times’ experts to understand the distortions produced by risk-weighted capital requirements for banks

Since I do not belong to any Academic Community, or special sphere of influence, or mutual adoration club, I have very little voice, even when noisy, even when being an Executive Director of the World Bank, 2002-2004. 

So, in this respect I decided long ago to try to use the Financial Times as my channel to express my absolute rejection of bank regulations coming out from the Basel Committee. If for instance a Martin Wolf got to understand my arguments, he would be much more effective communicating these to the world than little me. 

What I had not counted on, were the immense difficulties in making the FT experts understand what I was talking about, even now after more than eight hundred letters on the subject. But, I am insistent, and I will manage to do so, one day. 

And so here below is another attempt to explain, in the simplest possible terms, so that perhaps even FT experts could understand, if they wanted to, the distortions produced by the risk-weighted capital requirements for banks, and which represent the pillar of Basel II and III regulations.

If for instance a German bank, lent to Greece as one of “The semi-Infallible” Greece was rated just a couple of years ago then, according to Basel II, if it could earn doing so a 1 percent net after perceived risk and cost, then it could earn 62.5 percent on its equity. But, if instead lent to a small German or Greek unrated business and earn the same net margin then it could only achieve 12.5 percent on equity. Does this make any sense to FT? Sincerely I cannot think so. And yet, what am I suppose to think?

And so the result is a world with dangerous obese bank exposures to “The Infallible”, and for us equally dangerous anorexic exposure to “The Risky”, and all aggravated by the fact that even the most infallible safe-haven can become extremely dangerous, if overpopulated. 

Capisce FT, or do I need to explain it again?

PS. Me, London, banks,regulators, lions, pussycats and FT’s pink

Why?

Why if they call bankers immoral greedy gangsters, or worse, there is almost no protest, but, if I simply call regulators dumb, because I hold their dumb regulations to be directly responsible for the current crisis, I then get so many admonishments to be more polite? 

Is it that bank regulators are of a kinder and gentler breed, and so therefore we must treat them with more delicacy? Well forget it! Too much is at stake!

I am not giving up on making the thick as a brick bank regulatory establishment, understand.

By allowing banks to hold much less capital when lending to “The Infallible” than when lending to “The Risky”, the regulators allow banks to earn immensely higher risk-adjusted returns on their equity when lending to “The Infallible” than when lending to “The Risky”.

That is very dangerous because it makes “The Infallible”, those including sovereigns and triple-A rated, so much riskier for banks than what they normally are… remember that it is excessive exposures to “The Infallible” which always been the origin of major bank crises.

That entirely distorts the economic efficient resource allocation banks are supposed to do; for instance by disfavoring more than normal the lending to “The Risky”, the group that includes as members, small businesses and entrepreneurs.

And, that regulatory discrimination in favor of those normally already favored, creates disfavors against those already disfavored, and is therefore also, simply put, odiously immoral.

The regulatory destruction of the 1 plus the 99 percent

Chrystia Freeland begins her thought provoking “The self destruction of the 1 percent”, New York Times, October 13, describing how Venice became one of the richest cities:

“At the heart of its economy was the colleganza, a basic form of joint-stock company created to finance a single trade expedition. The brilliance of the colleganza was that it opened the economy to new entrants, allowing risk-taking entrepreneurs to share in the financial upside with the established businessmen who financed their merchant voyages.”

But then the wealthy closed up, with La Seratta, which sounds like a quite natural reaction from those who have more interest in defending what they’ve got than what they could get. And that began to hinder the opportunities for new entrants, and, of course, it all went downhill from there.

Yes, that certainly explains a lot of what happened, and much of a “La Seratta” is most certainly present in the USA, as it is in most other places where truly important fortunes or powers have been accumulated by some few plutocrats or some few of a party nomenklatura.

And, Freeland concludes her article with “The irony of the political rise of the plutocrats is that, like Venice’s oligarchs, they threaten the system that created them.”

But, to give you my own perspective on this issue, and on its possible relation to the current crisis which is indeed threatening all of us, most plutocrats included, I would like to ask:

What would have happened if a group of prominent Venetian bureaucrats, acting as colleganza regulators, in order to safeguard the investors, had decided to impose a tax on any venture perceived as risky, and pay a subsidy to any venture perceived as particularly safe?

The simple answer is that Venice would not have become one of the wealthiest cities, or, if already wealthy when these regulations were imposed, would not have remained a wealthy city, and this, no matter how much a L'Apertura reigned. 

What is now bringing down our economies, is precisely some truly loony bank regulations which, by their capital requirements and risk-weights based on ex-ante perceived risk, hugely favor the access to bank credit of “The Infallible” and thereby hugely discriminates against “The Risky”.

And that immoral discrimination gave the banks incentives to stay away from taking manageable risks on “The Risky”, like the small businesses and entrepreneurs, those who never ever caused a major bank crisis, and to instead take on unmanageable risks on “The Infallible”, like the AAA rated, real estate, or some “absolutely safe sovereigns”.

And here we are. Of course we need to control our plutocrats, but we also need to control our modern bank regulatory mandarins. I sincerely doubt they had to take a sufficiently rigorous Imperial Examination before they've got started; and neither can I understand who really authorized them to do what they did.

Bank Regulator! How dare you distort the markets this way! Look at what you’ve done! And you’re not even sorry. Shame on you!

Arrogant regulatory busybodies thought they could stop bank crisis forever, by setting capital requirements for banks based on perceived risk. The higher the perceived risk, the higher the capital needed to be, and the lower the perceived risk, the lower the capital.

And, in doing so, the regulators completely ignored the fact that banks and markets already clear for risk by means of interest rates, amounts exposed and contractual terms. And as a result banks could earn much higher returns on equity when financing what was officially perceived as “not-risky” than when financing what was officially perceived as “risky”, like our small unrated businesses and entrepreneurs.

And we are not talking about minor differences. Basel II required banks to hold 8 percent in capital when lending to small businesses, which meant banks could leverage 12.5 to 1, but allowed banks to hold only 1.6 percent in equity against a private asset rated AAA, (or a loan to Greece) allowing the banks to leverage a mindboggling 62.5 to 1. Five times less bank equity!

And the result is that these regulations added immense regulatory bias in favor of what is perceived as not risky, on top of the natural bias that already existed in their favor, and, consequentially, added immense regulatory bias against what is perceived as “risky”, on top of the natural bias that already existed against the risky.

And all this the regulators did without ever bothering to ask themselves the question of…what is the purpose of the banks?

And all this the regulators did without ever bothering to reflect on the fact that all bank crises ever have occurred because of excessive exposures to what was erroneously perceived ex ante as “not risky” and never because of excessive exposures to what was ex-ante correctly perceived as risky.

And as a consequence here we find us mired in a deep crisis with obese bank exposures to what was ex-ante perceived as “not risky” and anorexic banks exposures to what was considered “risky”.

And, of course, by maintaining the same fundamental capital requirement discrimination based on ex-ante perceived risk, there is no way we can work ourselves out of a crisis, in which our economies are turning flabbier and flabbier by the second.

Regulators, don’t you know that nations develop by generously allowing for daring opportunities, and fail and fall when turning stingy and coward?

What would the US Supreme Court opine about bank regulations which discriminate against The Risky and favor The Infallible?

No! Shame on you bank regulators! Who gave you the right to distort our economy this way? And shame on you too financial journalists who keep silencing this, not daring to question the regulating establishment.

A small question about bank regulators

In relation to bank regulations I have frequently found myself in need to comment that never ever has a major bank crisis resulted from excessive exposure to those perceived as “risky” (consult your Mark Twain), these have always resulted from excessive exposures to what was ex ante erroneously considered as “absolutely-not-risky”. 

But, between us... are not bank regulators supposed to know this very basic stuff? 

Where did all our current bank regulators, those who are writing up Basel I, Basel II, Basel 2.5, Basel III or what have you, study their Bank Regulations 101? Who checks the CVs of these appointees, or do they appoint themselves? Might they just have dropped in like any Chauncey Gardiner?

Chauncey: "If you do not like weeds use pesticide on them and fertilize the flowers" Basel Committee: "Ah, smart! If we want our banks to avoid risks, we need to pay them a lot in return on their equity to make them grow us the not-risks we so much desire"

Mark Twain, the bankers, and the nannies of the Basel Committee. What a sad tale.

I guess you have all read Mark Twain’s description of bankers as those who lend you the umbrella when the sun shines and want it back when it rains. And that most definitely rang true for someone as me trying to get banks to cooperate giving credit to my small and medium sized businesses and entrepreneur clients. 

But then along came the nannies of an outfit known as the Basel Committee, and their advisor the Financial Stability Board and said that that banker mode was still way too risky for them. And the nannies and, told the bankers that if they lent to those the sun was shining upon, the absolutely not risky, then they only needed 1.6 percent or less in capital, which meant they could leverage their equity 62.5 to 1 or even more in some cases, but if they dared lend to the “risky” who it seemed could be rained upon, then they needed 8 percent in capital and could only leverage 12.5 to 1. 

And, we all saw what happened. Here we are now with our banks up to their necks in dangerous excessive, really obese, exposures to what was erroneously perceived as “absolutely not-risky”, and anorexic exposure to those officially perceived as “risky”, like the small businesses and entrepreneurs, precisely those our young most count on generating the next generation of good jobs for them. 

Is it not a sad tale? Especially for a Western World that has become what it is thanks to risk-taking? Especially for an America that feels proud being known as the “land of the brave”? I wonder what Mark Twain would have to say about those nannies and the parents who entrust them with their banks?

Who do bank regulators think they are, unqualified and unauthorized, with immense hubris, playing risk managers for the world and destroying our economies?

Do conservatives and progressives not know or care about how regulators, with their silly risk weights based on perceived risk which determine the capital requirements for banks, so fundamentally distort the markets? 

Do conservatives and progressives not know or care about how regulators, with their silly risk weights based on perceived risk which determine the capital requirements for banks, so fundamentally increase the inequality between the “risky” and the “not-risky”? 

Does the Congress not know or care about how the regulators, with their silly risk weights based on perceived risk which determine the capital requirements for banks, effectively intrude in its domain and create subsidies for the “not-risky” and taxes for the “risky”? 

Are the current bank regulators really unqualified as risk managers? Absolutely yes!

The number one rule in any risk management must be to identify what risks you cannot risk not to take.

Regulators who do not define the purpose of what they are regulating cannot know one iota about risk-management. Or is it that they don’t care about our economies falling to pieces, as long as the banks stand there in shining armors among the rubble? 

Regulators who care about the perceived risks of bank assets, and not about how bankers react to the perceived risk of assets, have no idea of what they are up to. 

Regulators who give banks immense incentives to hold assets perceived as “not-risky” ignoring that all bank crisis ever have resulted, exclusively, from banks holding excessive assets that had erroneously been perceived as absolutely “not-risky”, have no idea of what they are up to. 

Regulators who do not know that when they allow a bank to hold less capital when an asset is perceived as “not-risky” discriminates against the access to bank credit of the “risky” like small businesses and entrepreneurs, and fundamentally distort the markets, have no idea of what they are up to. 

Regulators who do not understand that helping the “risky” to access bank credit is a fundamental part of building a growing and strong economy and jobs, and that favoring bank lending excessively to what is perceived as “not-risky” will only make for a flabby and imploding economy, have no idea of what they are up to. 

Risk managers who do not understand that risk-taking is a fundamental part of building a flexible and sturdy system, and that going excessively solely for what is perceived as “not-risky” makes for a

fragile system, have no idea of what they are up to.

Unauthorized? Yes! You tell me who authorized them to do what they did. Any volunteer?

What did the regulators really do? Scared witless by the possibility that bankers would expose themselves too much to assets deemed as “risky”, something that bankers never or very rarely do, they created huge incentives for banks to concentrate on assets that were, ex ante, perceived as “not risky”. In doing so, they fomented an incredible dangerous highly leveraged bank exposure to the “not risky”, and a truly anorexic exposure to the “risky”, like to the small businesses and entrepreneurs, something which has placed us almost over the brink of disaster.

What did the regulators really do? They created the prime cause for why now the US and other sovereigns are saddled by immense, almost unserviceable public debt burdens.

What did regulators really do? As I see it, by excessively promoting bank credit to “super-safe” sectors, like real estate in Spain, and to “infallible” sovereigns, like Greece, they have almost singlehandedly taken the eurozone down.

Sincerely, I am sick and tired of regulators who do not seem to care where they are taking our Western World, as long as they keep their “important” bureaucratic posts within their little mutual adoration club, apparently not accountable to anyone. 

Sincerely, I am sick and tired of those incapable of grasping the possibility of our current bank regulators being so fundamentally wrong, so that they, even when they proclaim “Without fear and without favor” do not even dare to ask the questions that needs to be asked.

Sincerely I am sick and tired, and anguished, about my children and grandchildren having to grow up in a world were so much de-facto power lies in the hands of some petit bank regulating bureaucrats.

The mother of all lacks of confidence

We so often hear about the lack of confidence, of so many, being the largest obstacle to manage to fully recover from this crisis. But, one of the most significant lacks of confidence, indeed the mother of them all, is not even mentioned. I refer to the lack of confidence in bankers, and the markets, shown by bank regulators.

Bank regulators, scared witless by the possibility that bankers would expose themselves too much to assets deemed as “risky”, something that bankers never or very rarely do, created incentives for bankers to concentrate on assets that were, ex ante, perceived as “not risky”. In doing so they fomented an incredible dangerous highly leveraged bank exposure to the “not risky”, something which has basically already placed us over the brink of disaster. 

What could help us is for bank regulators to show more confidence in those so useful and needed “risky”, like the small business and entrepreneurs, those who bring energy and vitality to the economy... but no!, the current generation of worried to death nannies of bank regulators just don’t seem to have that in them.

A conversation with a prominent, probably brilliant, though mostly silent and invisible bank regulator

You must all have heard Mark Twain’s description of a banker; he who lends you the umbrella when the sun shines and wants it back when it rains. 

But, over the last couple of decades, bank regulators, by allowing banks to have less capital when an asset is perceived as safe, began to even pay the bankers more to lend the umbrella when the sun shines; and, by requiring banks to hold more capital when something is perceived as risky, to even charge the bankers more for not taking the umbrella back fast when it rains. 

And that silliness is the result of regulating banks without defining the purpose of the banks... and of regulators considering the credit ratings, instead of considering what bankers do when they consider credit ratings.

Frankly, who authorized bank regulators to do to our banks what they did?

Regulators, consider yourselves officially challenged to debate the wisdom of your bank regulations

I hold that current bank regulations, most especially capital requirements based on perceived risk, are utterly absurd, and dangerous, and that regulators have behaved irresponsibly when imposing these; and should be held accountable for participating directly, though certainly unwittingly, in causing the current economic difficulties... which are threatening to take the Western world down. 

I have argued the above in hundreds of conferences and thousands of blog comments, emails and articles, soon for a whole decade, and I have never ever received the hint of any type of counterargument from any regulator. 

Therefore I challenge all regulators, most especially the hot-shots like Mario Draghi, Lord Turner, Michel Barnier, Timothy Geithner, Mervyn King, Ben Bernanke, or of course whoever they want to designate to champion their cause, to publicly debate the issue with me, in depth.

Regulators, please stop waging war on the "risky"... they have it hard enough as is!

Per Kurowski 

A former Executive Director at the World Bank (2002-2004) 

Currently also censored by the Financial Times 

perkurowski@gmail.com

PS. Do you really want me to lower myself so much as to name you “The sissy bunch”, in order to get your attention? Well, if you absolutely want me to, if I absolutely have to... I guess I must and will.

PS. If you do not know what it is to wake up in the middle of the night, sweating, thinking, “what is it that I have missed” you have no clue about how it feels to question, so fundamentally as I do You… The Regulatory Establishment.

PS. Do I have the necessary qualifications to participate in the debate? You bet! Just read some of my earliest comments and warnings on this issue. Few if any has been so clear so early on what was expecting us.

PS. A similar challenge, more than a year ago!

PLEASE!, all those of you who feel regulators should dare to debate their regulations, do whatever you can do to support this challenge… tweeting re-tweeting or even calling your congressman!