My letter to the Financial Stability Board was received.

http://www.fsb.org/wp-content/uploads/Per-Kurowski.pdf

From: Per Kurowski

Sent: 18 March 2019 19:16

To: Financial Stability Board (FSB)

Subject: SME financing evaluation

I have not found sufficient strength to sit down and formally write up my comments, because I feel I would just be like a heliocentric Galileo writing to a geocentric Inquisition.

The Basel Committee’s standardized risk weights are based on the presumption that what is ex ante perceived as risky is more dangerous to our bank system.

And I hold a totally contrarian opinion. I believe that what is perceived a safe when placed on banks balance sheets to be much more dangerous to our bank system ex post than what is perceived ex ante as risky; and this especially so if those “safe” assets go hand in hand with lower capital requirements, meaning higher leverages, meaning higher risk adjusted returns on equity for what is perceived safe than for what is perceived as risky.

The following Basel II risk weights are signs of total lunacy or an absolute lack of understanding of the concept of conditional probabilities.

AAA to AA rated = 20%; allowed leverage 62.5 times to 1. Below BB- rated = 150%; allowed leverage 8.3 times to 1

The distortion the risk weighting creates in the allocation of credit to the real economy is mindboggling. Just consider the following tail risks.

The best, that which perceived as very risky turning out to be very safe. The worst, that which perceived as very safe turning out to be very risky.

And so the risk weighted capital requirements kills the best and puts the worst on steroids... dooming us to suffer an weakened economy as well as an especially severe bank crisis, resulting from especially large exposures, to what was especially perceived as safe, against especially little capital.

In relative terms all that results in much more and less (see note) expensive credit to for instance sovereigns and the purchase of houses, and less and more expensive credit to SMEs

I am neither a banker nor a regulator but I do believe that the following post helps to give some credibility to my opinions on the issue. And, as a grandfather, I am certainly a stakeholder.

http://subprimeregulations.blogspot.com/2004/11/some-of-my-early-public-opinions- on.html

And here is a more detailed list of my objections to the risk weighting

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

Now if by any chance you would dare open your eyes to the mistakes of your risk weighted bank capital requirements and want more details from me, you know where to find me.

Sincerely

Per Kurowski

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

@PerKurowski

Note: In the original letter I erroneously wrote "more and more expensive credit to sovereigns" and not "less expensive", but this should be easily understood as a mistake.

PS. FSB keeps avoiding the issue: June 7, 2019 FSB published a Consultative Document: “Evaluation of the effects of financial regulatory reforms on small and medium-sized enterprise (SME) financing” I quote two parts of it.

1. “For the reforms that are within the scope of this evaluation, post-crisis financial regulatory reforms, the analysis, does not identify negative effects on SME financing in general.” 

Comment: The scope of the analysis does explicitly not include pre-crisis financial regulatory reform, like Basel II. When compared to what was introduced in Basel II, the changes in Basel III produced not really that much “more stringent risk-based capital requirements”. Therefore to limit the analysis to the impact of Basel III changes to risk-based capital requirements, is basically to avoid the issue of how these have, especially since Basel II, profoundly distorted the allocation of credit, and negatively affected the financing of SMEs.

2. “There is some evidence that the more stringent risk-based capital requirements under Basel III slowed the pace and in some jurisdictions tightened the conditions of SME lending at those banks that were least capitalised ex ante relative to other banks.”

Comment: That the Basel III risk-based changes, which in my opinion are minor relative to their importance, “tightened the conditions of SME lending at those banks that were least capitalised ex ante relative to other banks” is something to be expected. There, close to the roof, on the margin, is where the risk weighting most affects; think of “The drowning pool”

PS. A letter to the IMF: "The risk weights in the risk weighted bank capital requirements are to access to credit, what tariffs are to trade, only more pernicious.

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

Task Force on Climate Related Financial Disclosures is clueless about the allocation of resources to the economy.

The Task Force on Climate Related Financial Disclosures begins the summary of its “Final TCFD Recommendations Report” with: 

“One of the essential functions of financial markets is to price risk to support informed, efficient capital-allocation decisions. Accurate and timely disclosure of current and past operating and financial results is fundamental to this function, but it is increasingly important to understand the governance and risk management context in which financial results are achieved. The financial crisis of 2007-2008 was an important reminder of the repercussions that weak corporate governance and risk management practices can have on asset values. This has resulted in increased demand for transparency from organizations on their governance structures, strategies, and risk management practices. Without the right information, investors and others may incorrectly price or value assets, leading to a misallocation of capital.”

Efficient credit and capital allocation to the real economy is indeed the most essential function of financial markets, but let me here inform TCFD that bank regulators, like the Basel Committee and the Financial Stability Board gave zero importance to that. Had they done so, they would never ever have come up with the risk weighted capital requirements for banks, which make that impossible. 

“The financial crisis of 2007-2008 was an important reminder of the repercussions that weak corporate governance and risk management practices can have on asset values”

No! It was an important but ignored reminder of what dangers lie in allowing regulators to regulate within a mutual admiration club breeding intellectual incest. 

When you allow banks to leverage more their equity with what is ex ante perceived, decreed or concocted as safe, so that banks can earn higher risk adjusted returns on equity on what’s “safe”, then you will end up, sooner or later, with dangerous excessive bank exposures, against little capital, to what’s “safe”, like AAA rated securities backed with mortgages to the subprime sector and loans to sovereigns like Greece, but that ex post can turn out to be very risky.

Who the hell authorized regulators to direct (distort) the allocation of bank credit that way?

Listen up Mark Carney, Michael Bloomberg and you other! Any risk, even if perfectly perceived, if excessively considered, causes the wrong actions. Let banks be banks!

Let me end this comment by just asking: How many profiteering climate-change consultants will now banks have to employ in order to fulfill what is requested by this report?

Want some more detailed objections to the idiotic current bank regulations? Here!

Dear Mr Kurowski, here is our answer to your doubts. Sincerely, the experts in Basel Committee, FSB and affiliates

(I dreamt I got this letter from our bank regulators in response to my questions.)

Dear Mr Kurowski

It does not matter whether the risky already get less credit and pay higher interest rates, they must get even less credit and pay even higher interests… because they are risky. Don’t you get that!

It does not matter whether the safe already get more credit and pay lower interest rates, they must get even more credit and pay even lower interests… because they are safe. Don’t you get that!

It does not matter that the risky have never caused a major bank crisis. Risky is risky and that’s that! 

It does not matter that there could be too large exposures to what’s perceived safe but could in act not be; which could cause a huge crisis. Safe is safe and that’s that.

Yes, yes we understand, (we think) that our risk weighted capital requirements might introduce some serious credit austerity for the risky, like SMEs and entrepreneurs, and that this could affect the economic growth of the real economy. But that’s not our problem. Our sole concern is to keep banks safe. 

For economic growth there are infrastructure projects, like bridges, to be undertaken by the Sovereign taking advantage of the exceptionally low rates it is awarded, because it is really and truly safe. If we can’t trust the Sovereign who are we to trust? The citizens?

Oh, that the 2007-08 crisis was caused primarily because of too much investment in securities rated AAA that was supposed to be super-safe? Yes, but now we are imposing huge fines on those credit rating agencies, so they should have learned their lessons, and all will be fine and dandy. Trust us Mr Kurowski. We are after all, as you know, the experts. 

PS. For your own good stop writing those letters about us to the Financial Times. How many now, around 2500? You’re crazy! Don’t you see FT doesn’t care?

Yours sincerely,

Names withheld (by me)… out of delicacy

PS. Friends, as you can see, our bank regulators remain as captured as ever in their cognitive bias, poor us.

Evidence that demonstrates, without any reasonable doubt, we have landed us some very feeble-minded bank regulators

What are the chances banks build up huge exposures to those rated prime, AAA to AA, and which could be dangerous to the bank system, if these, ex post, turn out to have been worthy of a much lower rating? Big!

What are the chances banks build up dangerously large exposures to those rated “highly speculative “ and worse below BB-? None! 

And yet the regulators, for the purposes of determining the capital requirements for banks, in Basel II, assigned to the AAA to AA rated, a risk weight of 20%, and to the below BB- rated, a risk weight of 150%.

And to top it up, the risk weights are portfolio invariant.

Do we really need more evidence that the Basel Committee regulators and those affiliated to it are cuckoo?

They behave like nannies telling the children “Stay away from the ugly and foul smelling, and embrace the nice gents bringing you candy”, and so dangerously distort the allocation of bank credit to the real economy.

Voltaire to the Basel Committee: “May God defend me from my friends [AAA rated]: I can defend myself from my enemies [BB- rated]”

Here is a brief memo that further explains their idiocy.

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!

Global Association of Risk Professionals (GARP) Have you no comments on bank regulators’ risk management?

One of the few and perhaps even only risks that banks clear for, with risk premiums and size of exposures, is the ex ante perceived credit risks, that quite often expressed in credit ratings.

But regulators did not find that sufficient and decided that banks should also clear for the same ex ante perceived credit risk, in their capital.

And as far as I understand any perceived risk, even if it is perfectly perceived leads to the wrong action if it is excessively considered. Would you agree GARP?

And if I was a bank regulator I would be much more interested in why banks fail than in why their borrowers fail. Wouldn’t you be too GARP?

And knowing that bank capital is to be there to cover for unexpected losses, then the last thing I would do would be to base the capital requirements on some expected losses… especially when we know that the safer something is perceived the larger its potential to deliver some truly nasty unexpected losses. Would you not agree with that GARP?

And, if I was a bank regulator, managing risks, the first thing I would do is to be certain about the purpose of banks. That would indicate me that probably the risk we least can afford banks to take, is that of not allocating bank credit efficiently to the real economy. And that is something that becomes impossible when allowing banks to leverage differently with different assets, and thereby earning different and not market based expected risk adjusted returns on equity. Would you not agree with that GARP?

Right now the world is becoming a sad place, especially for coming generations, since regulators having given banks the incentives to stop financing the riskier future, and to make their profits by concentrating on refinancing the safer past. 

GARP do you not have a responsibility is speaking up against the Basel Committee’s and the Financial Stability Board’s particularly harmful and lousy way of managing risks?

I ask because your stated mission is: “As the leading professional association for risk managers, the Global Association of Risk Professional's mission is to advance the risk profession through education, training, and the promotion of best practices globally.”

And also because in “What we do” you state: “GARP enables the risk community to make better informed risk decisions through “creating a culture of risk awareness®”. We do this by educating and informing at all levels, from those beginning their careers in risk, to those leading risk programs at the largest financial institutions across the globe, as well as, the regulators that govern them.”

Banks regulators believe what’s rated AAA, is more dangerous to the banking system than what’s rated below BB-… Really?

Bank regulators, when trying to make our banks safe, decided that the risk weight for AAA rated assets, a rating described as “prime”, was to be 20%. That, since the basic capital requirement in Basel II was 8 percent, meant that banks needed to hold 1.6 percent in capital (equity) against those assets; and could leverage their equity 62.5 times to 1 with these assets. 

For assets rated below BB_ though, ratings described as moving from “highly speculative”, through “extremely speculative” and up to “default imminent”, the risk weight was set at 150 percent. And that, with Basel II’s basic 8 percent, meant that banks needed to hold 12 percent in capital against such assets, and which allowed banks to only leverage about 8.4 times to 1.

But let me ask all of you. What do you think can create those kind of excessive exposures that could endanger the stability of our banking system; exposures to what ex ante was thought to be AAA but that ex post surprised banks by being very risky, or exposures to what was rated below BB- and actually turned out to be very risky?

I hear you… so what did we do to deserve such bad bank regulators?

Professors around the world, please, we are urged you teach our bank regulators a good Statistics 101.

Please, professors in statistics, explain to our bank regulators in the Basel Committee and the Financial Stability Board that when you try to make banks safe, you should be interested in what has made banks fail, and not in whether bank clients have failed.

As is, regulators have set higher credit risk weighted capital requirements for banks when lending to those perceived as being risky from a credit point of view; namely to those poor unlucky ones who anyhow have to pay more for credit and get smaller loans. And of course that means that “The Risky” receive even less credit and have to pay even more for it.

While those ex ante perceived as safe, but who are always those who detonate all major bank crises when they suddenly ex post turn out to be risky, their access to bank credit has been subsidized by the fact banks need to hold much less equity when lending to them. And of course that means banks might lend too much and at too low risk premiums to “The Safe”, and that, when disaster strikes, we find our banks standing naked there with little or no capital to cover themselves up with.

In fact, empirically, any statistic research could conclude in out that banks should in fact hold more capital when lending to The Safe than when lending to The Risky.

Professors, as you can see our bank regulators can’t seem to understand that the safer an asset is perceived ex ante, the bigger its potential to deliver ex post those unexpected losses that the bank capital is supposed to help cover. The banks themselves should, of course manage any expected credit losses.

So you see current bank regulators need a good Statistics 101. Can we count on you to lend us a hand? Please?

Current bank regulators have no moral right to address the misconduct of other in the financial sector.

The Financial Stability Board (FSB) published November 6 a progress report for the G20 on the FSB’s work on addressing misconduct in the financial sector. The progress report on the Measures to reduce misconduct risk sets out details about the FSB-coordinated work to address misconduct in the financial sector and the timeline for the actions.

For many years argued that the bank regulators themselves carried out the most serious misconduct in the financial sector.

With their portfolio invariant credit-risk weighted capital requirements for banks, imposed without the slightest evidence of having empirically studied why bank crises occur, and without defining what is the purpose of banks, they manipulated the world’s bank credit markets with serious consequences for millions.

Compared to that, the manipulation of of example the Libor rate, although clearly not to be excused in any way, is simply peanuts.

When we consider the millions of SMEs and entrepreneurs who have been impeded fair access to bank credit, and the loss of job creation for the coming generations that must have resulted from that; and the trillions of public bailout/stimulus debts hanging over us, the regulators should better retire in shame than preach about the misconduct of others.

Who helps me getting bank regulators to even acknowledge the biggest systemic error in Basel I, II and III?

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 its collapse”

A Big Bang happened. I know what that systemic error is, but embarrassed regulators don’t want to even acknowledge the problem… and so they keep us traveling down the same crazy road... on route to the next Big Bang.

The most fundamental systemic error, is the credit risk weighted capital requirements.

To estimate the unexpected losses for which banks should have capital, the dummkopfs used expected credit risk. 

Banks consider credit risks when setting the interest rates, the amounts of exposures and other contractual terms.

So when regulators decided that the capital banks should hold against unexpected losses was to be based on ex ante expected credit losses, then they force-fed the banks to consider credit risk twice.

And any risk, even when perfectly perceived, produces a wrong decision if excessively considered.

And so here are our bank lending too much to The Safe, like the governments (sovereigns) and the AAArisktocracy, and too little, or nothing to The Risky, the SMEs and entrepreneurs… those tough we need to get going, especially when the going gets tough.

And you can find in my blogs and in several publications innumerable occasions when I have presented this argument… and most other “experts”, or media like the Financial Times, have not yet even acknowledged the existence of the problem in clear terms.

Friends, can you help me stop these besserwisser busybody hubristic bank regulators from interfering with the allocation of bank credit to the real economy?

What important institution dares to set up a conference on the theme “Do credit-risk weighted capital requirements dangerously distort the allocation of bank credit to the real economy? World Bank? IMF?

PS. Perhaps I should refer to the Basel regulators as just another bunch of statists? I say this because, believe it or not, in the Basel Accord of 1988, they assigned a zero percent risk weight to the sovereign, and a 100 percent risk weight to the private sector. 

PS. There was of course another systemic error. The exaggerated use of the credit ratings On that, in January 2003, in a letter to FT I wrote: “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.”

PS. While I was an Executive Director of the World Bank, 2002-04, the following were my totally ignored comments on bank regulations.

Q. Watson, what about requiring banks to hold more capital against risky assets than against safe? A. Dumb!

Let me explain:

If banks must hold more capital against assets perceived ex ante as risky than against assets perceived as safe then: banks will earn higher risk adjusted returns on equity for assets perceived as safe than for assets perceived as risky; and that distorts the economic efficient allocation of bank credit to the real economy, which of course attempts against a vital purpose of banks.

More dumbness: Since major bank crisis always occur because something ex ante perceived as safe turns out ex post as very risky, this would guarantee that banks stand there with the pants down and little capital to cover themselves up, precisely when they most need it.

More dumbness: Bank capital is required in order to cover for unexpected risks so as to estimate these based on the expected losses from perceived credit risks is, to put it delicately, not smart at all.

More dumbness: To make it more difficult for The Risky, like SMEs and entrepreneurs to have fair access to bank credit, does certainly produce increased inequality

Do you want me to keep going on its dumbness?

What about this? The risk weight for those that being perceived as safe could pose so much danger for the banking system like the AAA rated, was set at 20% in Basel II. The risk weight for those totally innocuous below BB- rated, was set at 150%.

No Mr Watson, that should be more than enough. Thank you. I will immediately call the Basel Committee, the Financial Stability Board and the IMF, and suggest they consult you on this delicate matters, that in my opinion is taking our economies down.

BoE´s Mark Carney should mind his own business, as a bank regulator managing risks he has no right to throw stones.

Mark Carney, the current Chair of the Financial Stability Board, has recently been warning many about the financial risks that could be derived from climate change, like leaving a lot of fossil fuels stranded. He should first take better care of his own risk management responsibilities. In that area he has not earned the right to throw stones.

Regulators allow banks to hold much less capital against what, from a credit risk point of view, is perceived as safe than against what is from a credit point of view ex ante perceived as risky.

That means that banks can earn much higher risk adjusted returns on equity when lending to what is perceived safe, than when lending to those perceived risky, like the SMEs and entrepreneurs.

That is a huge economic risk, because the risky need to have fair access to bank credit in order to help the real economy to avoid to stall and fall.

That is a huge financial risk, because it guarantees excessive exposures against little capital, to precisely that of which great bank crisis are made of, that which ex post can come up as having been erroneously perceived as absolutely safe.

Should not the Financial Stability Board discuss the risk that the Basel Committee has no idea about what its doing?

The Financial Stability Board plenary met in London to discuss policy measures to end too-big-to-fail, concerns on market liquidity, shadow banking, derivatives, misconduct risks, audit and climate change.

For me, the number one issue they should discuss is whether their colleagues in the Basel Committee have the faintest idea of what they are doing and whether it is not hight time for capital requirements for banks to be set based on the risk their regulators are loony... or are smoking something not so good.

The Financial Stability Board makes efforts to identify “Risk Free Benchmarks”...and I don't know whether to laugh or cry

The Financial Stability Board issued a report on trying to identify “Risk Free Benchmarks”

That, in ordinary circumstances, is a very difficult thing to do, since so many other factors than just pure risk considerations, are involved in creating interest rates… for instance tax considerations. 

But, when bank regulators, with Basel I and II, introduced credit-risk weighted capital requirements for banks, by distorting the allocation of bank credit so completely, they made it impossible to determine anything close to real risk free-rates.

The easiest way I have found to explain this issue is by making the following question: What would the rates on for instance US Treasury Bonds and Germany’s Bunds be, if banks were required to hold the same percentage of capital against these that they are required to hold against a loan to an American or a German SME?

PS. The subsidized risk free rate

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?

Follow my adventures battling the Basel Committee for Banking Supervision (and the Financial Stability Board)

Banks when deciding to give credit to safer or to the longer riskier, used to clear their risk adjusted rates freely, with no regulatory interference. That was before the outright insolent Basel Committee came along wanting to manipulate, and concocted that banks could leverage their equity 60 times or more to 1 on assets considering as safe, while not more than 12 to one on assets perceived as risky. And so of course, it couldn’t be any other way, banks lend too much at too low rates to what is ex ante perceived as safe, and too little at too high relative interest rates to what is perceived as risky.

And this is now destroying our economies.

Recently the Basel Committee released a consultative document titled “Revisions to the Standardised Approach for credit risk”. 

And below are my comments to that document. You might want to follow me and see what the Basel Committee answers, if it answers. I have been trying to extract a reaction from them for over a decade now, but no such luck.

March 27, 2015: Comments on the Basel Committees’ consultative document “Revisions to the Standardised Approach for credit risk”.

Sir, I object the whole document “Revisions to the Standardised Approach for credit risk”, on account that it does not yet acknowledge, much less correct, the most fundamental mistakes with the whole approach of setting bank equity requirements based on credit-risk weights.

The mistakes I refer to and that I would briefly like to point out are:

1. When referring to the “probability-of-default estimates” of borrowers and assets… it ignores that bank already manage and clear for these perceived credit risks, and so that these probabilities have little or nothing to do with the probabilities of a bank having problems. 

Again, the regulator has no business looking at the basically the same credit risks bankers are seeing and clearing for through interest rates, size of exposure and other terms. The regulator should look at the risk of banks not perceiving the credit risks correctly or not managing these correctly. If you do so you can empirically establish that all major bank crises are derived from excessive exposures to what has been erroneously perceived as safe, and not from what has been correctly perceived as risky. And, in this respect, the realities would point 180 degrees in the opposite direction… higher equity for what is perceived as safe. 

2. The regulator has not considered that allowing banks to leverage their equity, and the support they receive from taxpayers, differently depending on the perceived risk of the borrower/asset, introduces a violent distortion of the allocation of bank credit to the real economy. This because it allows banks to obtain different risk-adjusted returns on equity that what would have been the case without this regulatory distortion.

In the medium and long term, in an environment where bank credit is misallocated, there will be no safe banks. In a game of roulette, every bet has exactly the same expected value, and that is why the game works and survives. Changing the payout rates in roulette, by using something like your risk-weights, would crash a casino in seconds… and with “casino”, I refer to our economies.

3. The regulator has de facto exceeded whatever authority it could have been given, by for instance setting the risk weight for central governments at zero while imposing a risk weight of 100 percent on the loans to an unrated SME or entrepreneur. That can only be explained in the context of a statist ideology. That has transformed the “risk-free rate” into a subsidized risk-free rate. 

In fact, it is morally reprehensible for regulators to discriminate the access to bank credit in favor of “the safe” and against “the risky”… that creates a regulatory-subsidy to the safe and a regulatory-tax on the risky. By limiting the opportunities of “the risky” to have fair access to bank credit, the regulator is de facto increasing the inequalities in the world.

4. To top it up, the risk-weighted equity requirements are portfolio invariant, something that is absolute lunacy, since it ignores both the benefits of diversification and the dangers of excessive concentration.

5. As I warned in a letter in the Financial Times in January 2003, the excessive importance given to some few human fallible credit rating agencies introduced a serious source of systemic risk. What we read in this proposal only increases the complexity, and therefore increases the possibility of gaming the regulations, and increases the distortions, all without really diminishing any systemic risks. 

6. Borrowers are always interested in presenting themselves to the banks as being a low credit risk, in order to obtain lower risk premiums. And bankers used always to be interested in questioning the creditworthiness of the borrowers, in order to obtain higher risk premiums. That struggle helped to allocate bank credit efficiently to the real economy.

But, credit-risk-weighted equity requirements for banks and changed the relations. Now more important for the risk adjusted return on bank equity than the negotiation of risk premiums with borrowers, is dressing up the credit operation in such a way so as to allow the highest possible leverage of bank equity. And so, instead of using the tensions between borrowers and lenders, regulators managed to align both of these parties against them. Not too bright!

7. The distortions are causing serious economic risks. Just an example of it, is that the liquidity provided by current QEs cannot reach “the risky”, those we perhaps most need bank credit to reach. It is saddening to now see your proposal, in the case of senior corporate exposures, to set the risk-weights in function of size… as if the larger you are the safer you are… ignoring that the larger and the safer they seem the more you will be hurt if something goes wrong. Why on earth should The Large have even better access to bank credit relative to The Small than what they would usually anyhow have? 

8. It is stated: “The credit risk standardised approach treatment for sovereigns, central banks and public sector entities are not within the scope of these proposals. The Committee will consider these exposures as part of a broader and holistic review of sovereign-related risks.” “Holistic” Ha! Don’t you understand that what is someone’s light risk-weight, becomes immediately someone else’s very heavy risk weight?

9. The document does not indicate any concerns with how to go from here to there. Basel III introduced the not risk weighted leverage ratio, which will act as an equity floor, and you are also currently consulting on “Capital floors: the design of a framework based on standardised approaches”. But, raising the equity/capital floor, while maintaining the roof of the credit-risk-weighted equity requirements, will only increase the distortions, and could cause irreparable damages to the economies. For a more figurative explanation I refer you to the movie “The drowning pool”.

I have some other objections, but, for the time being, these will do.

Regulators, please, before you keep on regulating, go back and define the purpose of banks. It has to be more than to just be safe mattresses. It has to at least include not distorting the allocation of bank credit. 

With these credit risk adverse regulations, banks are financing less and less the risky future; and only refinancing more and more the safer past. That has to stop, for the good of our children and grandchildren. “A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926

In 1999, in a Op-Ed in 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”.

We have already seen too many low-risk-weights AAA bombs detonate with disastrous consequences. So when are you bank regulators going to stop trying being the self appointed risk managers for the world? You’re doing a lousy job at it, and not being held accountable for it.

Per Kurowski

PS. What do I like in the document? Though subject to all my other concerns, like not agreeing with the risk weighing, I do like the CET1 ratio used when setting risk-weights for banks. That ratio indicates that the better capitalized a bank is, the less will other banks be required to hold equity when lending to it, so the better borrowing conditions it can obtained, thereby leveraging the usual market response. That looks like a relative unobtrusive way to nudge banks into being better capitalized.

@PerKurowski

A former Executive of the World Bank (2002-2004)

Did they get my comments? Well here is the reply I received:

Comments on Basel Committee documents open for consultation

Thank you, your comments have been successfully submitted

Name of institution/individual:	Per Kurowski
E-mail address:	perkurowski@gmail.com
Document:	Revisions to the standardised approach for credit risk - consultative document
Classification:	Public
Uploaded file:	Comments on the consultative document Revisions to the Standardised Approach for credit risk.docx