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.

The importance of being ignored… by for instance the Basel Committee, the IMF and the Financial Times

The pillar of current bank regulations is risk weighted capital requirements for banks; or more exactly portfolio invariant credit risk-weighted equity requirements for banks. It signifies banks are allowed to hold much less equity against assets perceived as safe, than against assets perceived as risky.

Though intuitively it might sound extremely correct, it is extremely flawed, primarily for three reasons:

First, it just doesn’t make any sense from the perspective of making the banking system safe, since all major bank crises have resulted from excessive exposure to something perceived as safe but that ex post turned out not to be; and none from excessive exposures to something ex ante perceived as risky.

Second, allowing banks to leverage their equity, and the support the society lends them, differently, depending on perceived credit risk already cleared for by other means, introduces a tremendous distortion in the allocation of bank credit to the real economy.

Third, by discriminating the access to bank credit against those who by being perceived as risky are already naturally discriminated against, it kills equal opportunities and thereby fosters inequality.

I have voiced my furious objections to that regulation, for way over a decade, to no avail.

The indifference with which my arguments have been met, by the Basel Committee, the Financial Stability Board, the IMF, the Fed, the Bank of England and all other institutions related to bank regulations; plus that of medias such as the Financial Times, has undoubtedly been a source of frustration. And worst has it been when I am told that my questioning is obsessive, something which I have never negated, but when I have always felt that the way they have ignored this issue shows even more obsessiveness.

But, little by little, I have started to appreciate the fact that being ignored, has added a much more important aspect to my criticism. Had regulators accepted and corrected for their mistakes immediately, that would have undoubtedly been good. But at the same time that would also perhaps have shed less light on the importance issue of how little contestability and accountability there exists in institutions ruled by a self-appointed technocrats.

And so, when the world wakes up to the horrendous implications of this regulatory risk aversion, it might hopefully also be able to wake up and correct for the horrible regulatory procedures... and for the sort of bias in favor of regulators that many in the media show.

Then perhaps the SMEs and entrepreneurs could get a real hearing about their difficulties to access bank credit in Basel, in Davos or in Washington during the Spring or Annual Meetings of the IMF and the World Bank. 

The curious case of the not curious journalists

Even though absolutely all major bank crisis have resulted from excessive exposures to what was ex ante perceived as absolutely safe, and none from excessive exposures to what was ex ante perceived as risky, current capital requirements for banks are much higher for what is perceived as risky than for what is perceived as safe. And that sounds quite curious indeed.

And one could have thought that financial journalists, like those at the Financial Times, would find that sufficiently curious so as to at least ask a bank regulator for a satisfactorily understandable explanation.

But no, they do not. Is not that quite curious too?

FT, the Financial Times of London, is not interested in possibly the greatest financial horror story ever.

Banks are allowed by their regulators to hold much less capital (equity) against assets which are ex ante perceived as absolutely safe, like loans to some sovereigns and to the AAAristocracy, than against assets perceived as “risky”, like loans to small and medium businesses and entrepreneurs.

That translates directly into banks being able to earn a much expected higher risk-adjusted return on its equity when lending to “The Infallible” than when lending to “The Risky”.

And that translates directly into the danger that some of The Infallible might get too much bank credit and as a result run into problems which, if and when this occurs, will catch banks standing there naked, with precious little capital to cover them up with, signifying a huge systemic bank crisis.

And that also translates directly into The Risky getting much less access to bank credit and having to pay much higher margins than what would have been the case in the absence of these regulations, signifying, among other, less job opportunities for our youth.

That very dangerous risk-aversion, or call it exaggerated embracement of safety, which is destabilizing our banks, and threatening the future of economies developed based on risk-taking, could be the greatest financial horror story ever.

Strangely enough, the journalists in the Financial Times of London, and to whom collectively I have written more than a thousand letterson the subject, seem not to be much interested.

I wonder why?

In other words, helped along by FT and other, the Baby Boomers’ après nous le deluge regulatory mentality, has the world consuming its past without creating its future

Small businessmen or entrepreneur, if only you knew, you would be raving mad at bank regulators.

Suppose you were an entrepreneur or a small or medium sized business with no credit rating as you cannot afford that. And then that in order to realize your dreams you should have been able to access a $400.000 loan at 7%, had the banks not been regulated, but now, only because they are regulated with the Basel Committee's criteria, the banks will only offer you $200.000, and this at 10%. Would you not be mad at this Basel Committee? 

Why $200.000 and not $400.000? Because the bank has to hold much more capital five times more when lending to you, correctly perceived as risky, which is why the bank charges you a higher interest rate, than when investing in or lending to something perceived as “absolutely safe”. And because bank capital is scarce, especially now, since some of the “absolutely safe”, like AAA rated securities collateralized with badly awarded mortgages to the subprime sector or Greece, and to which the banks held large exposures against which they were only required to hold a minuscule 1.6 percent in capital, ended up being very risky. 

Why 10% and not 7%? The banks are allowed to invest or lend to other those perceived as “absolutely safe” holding much less capital, five times less, than when lending to you, and so you surely must understand that you have to pay them much extra, in order for them to make the same expected risk adjusted return on equity. 

But why have I not been told this? Because the Basel Committee and the “absolutely safe” and the too big to fail banks that have been able to become too big to fail only because they were allowed to hold ridicule low equity have powerful friends, like the Financial Times who does not want to raise this issue on how regulators distort and discriminate, even though I have written soon 1.000 letters on it to its editor.

And now it is only going to get worse for you, “The Risky”, the commoner, since now with their Basel III decree, the Basel Committee, with liquidity requirements, is intent on favoring even more the aristocracy of “The Infallible”. 

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

I saw something. I said something. No one listened. C'est la vie?

October 1998, Op-Ed Venezuela: History is full of examples of where the State, by meddling to avoid damages, caused infinite larger damages”

November 1999, Op-Ed Venezuela: “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”

January 2003 in a letter published by the Financial Times: "Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds. Friends, please consider that the world is tough enough as it is."

March 2003, in a formal discussion as and Executive Director (ED) at the Executive Board of the World Bank: The sole chance the world has of avoiding the risk that Bank Regulators in Basel, accounting standard boards, and credit-rating agencies will introduce serious and fatal systemic risks into the world, is by having an entity like the World Bank stand up to them—instead of rather fatalistically accepting their dictates and duly harmonizing with the IMF.

April 2003, in a formal written statement delivered as an ED of the World Bank: “Ages ago, when information was less available and moved at a slower pace, the market consisted of a myriad of individual agents acting on limited information basis. Nowadays, when information is just too voluminous and fast to handle, market or authorities have decided to delegate the evaluation of it into the hands of much fewer players such as the credit rating agencies. This will, almost by definition, introduce systemic risks in the market and we are already able to discern some of the victims, although they are just the tip of an iceberg. 

May 2003 In a workshop for bank regulators at the World Bank I simply cannot understand how a world that preaches the value of the invisible hand of millions of market agents can then go out and delegate so much regulatory power to a limited number of human and very fallible credit-rating agencies. This sure must be setting us up for the mother of all systemic errors.

May 2003, Op-Ed Venezuela: “Perhaps we need to include a label that states: Warning excessive banking regulations from the Basel Committee can be very dangerous for the development of your country”

June 2004 “Central bank governors and the heads of bank supervisory authorities in the Group of Ten (G10) countries met today and endorsed Basel II” the publication of the International Convergence of Capital Measurement and Capital Standards: a Revised Framework, the new capital adequacy framework commonly known as Basel II… It’s lunacy