IMF does still not understand how the risk weighted capital requirements for banks distort. Why? Groupthink?

IMF’s Global Financial Stability Report 2017 on page 43 and 44 Box 1.2. “Regulatory Reform at a Crossroads” states:

Finalization of the Basel III package of reforms— the revision of the “standardized” approach to the calculation of risk-weighted assets and limits on the use of internal models to assess risks—appears to have faltered… The outstanding challenge is to reconcile views on the weight to attach to each element, particularly to the balance between reliance on internal models and constraint through the calibration of the floor [based on a standardized approach]”

So regulators wants to reconcile between:

Use of internal risk models, which is basically similar to allowing Volkswagen to calculate their own carbon emissions. 

Using the standardized approach designed by regulators and which included, for instance risk weights of only 20% for what is perceived very safe, like what’s AAA rated, and which precisely because of that perception can lead banks to build up dangerously large exposures; and a 150% risk weight for what is rated below BB-, something to which banks would never dream to expose their balance sheets much to.

We all know that minus times minus leads to a positive number but does reconciling one craziness with another craziness lead to a sane regulation. NO!

Box 1.2 also includes: “countries outside the central standards-setting bodies [in particular emerging markets]…rely heavily on a strong global standard to level the playing field and support financial stability”

Question: Does allowing the safe to have better access than usual and the risky less than usual really signify to “level the playing field”?

Box 1.2 concluding states: “Completion of the reforms is vital to address previously identified fault lines and thus ensure that the global financial system is safe and can promote economic activity and growth.”

Congratulations! I believe this is the first time I have read from somebody close to the regulators, as IMF is, that besides “safe and resilient”, the banking system needs also to “promote economic activity and growth.”

It is truly sad this comes at such a late stage. Anyone wanting banks to promote economic activity and growth, would never have accepted the risk weighted capital requirements for banks, as these dangerously distorts the allocation of credit to the real economy. 

So clearly, IMF still has much internal analysis to do before they get there. I hope its groupthink allows it.

3 questions on IMF’s Global Financial Stability Report’s, “Where Are the U.S. Corporate Sector’s Vulnerabilities?”

That section, on page 9 states:

“The corporate sector has tended to favor debt financing, with $7.8 trillion in debt and other liabilities added since 2010. Bank lending to the corporate sector has continued to recover and could well rise further in response to more favorable market valuations. In contrast, equity finance has traditionally been outstripped by share buybacks and has recently leveled off. A drop in the cost of equity capital may stimulate equity financing, but it could coincide with higher corporate debt—particularly if additional share buybacks are financed through debt.” 

That begs three questions: 

First: How much of the recent increase in the stock markets is the result of buybacks; that which helps earnings per share to get a sort of artificial boost; that which results in less equity controlling the corporations? 

Second: Do the recent stock-market prices increases duly reflect the increase riskiness derived from much higher corporate debts? 

Third: Have Central Banks therefore, with their low interests rate policies, de facto, dangerously lowered the capital (equity) requirements of corporations? 

On the first two questions I have no answers, though just having to ask them should suffice to at least raise some eyebrows. 

On the third the IMF clearly seems to respond, “Yes!” when on that same page, under the subtitle “High Leverage Combined with Tighter Borrowing Conditions Could Affect Financial Stability” it writes: 

“As leverage has risen, so too has the proportion of income devoted to debt servicing, notwithstanding low benchmark borrowing costs. Although the absolute level of debt servicing as a proportion of income is low relative to what it was during the global financial crisis, the 4 percentage point rise has brought it to its highest level since 2010, which leaves firms vulnerable to tighter borrowing conditions. The average interest coverage ratio—a measure of the ability for current earnings to cover interest expenses— has fallen sharply over the past two years. Earnings have dropped to less than six times interest expense, close to the weakest multiple since the onset of the global financial crisis.” 

Holy Moly! And interest rates have not yet returned to something more "normal"; and the Fed's balance sheet is still so huge it leaves little space for any future QE assistance...and not to speak of the already too large public debts. 

My intuition tells me that if we do not develop something along the lines of a Universal Basic Income, fast, we will not be able to counter sufficiently upcoming recessions and huge unemployment so as to keep truly horrendous populists away.

Really, how on earth can we have left so much power in so few so intellectually incestuous hands?

IMF, "cash" what cash? Have you any idea how the $2.2 trillion in retained foreign earnings is invested?

I quote from page 7 and 8 of IMF’s Global Financial Stability Board 2017.

“Is the U.S. Corporate Sector Ready to Accelerate Expansion—Safely?

The potential for a one-off repatriation of retained foreign earnings, including liquid funds held abroad.

Repatriating liquid assets held abroad by U.S. companies would also benefit the information technology and health care sectors, where 60 percent of the $2.2 trillion in unremitted foreign earnings held abroad is concentrated.

Cash windfalls from repatriation would likely accrue to cash abundant sectors”

In order to analyze the effects of any repatriation of retained foreign earnings, one would need to know how that money is invested… because you can be absolutely sure it is not in cash under corporate treasurers’ mattresses.

That is why I ask IMF whether they know. If they don’t then they better find out before they speculate on what the repatriation of these retained foreign earnings would signify. 

What if the $2.2 trillion is all invested in treasuries? J

This is somewhat similar to all those divisive statements that reference that the wealth of the 62 richest equals that of 3.6 billion poorest, without the slightest thought given to how that wealth could be transferred.

IMF: The “I scratch your back if you scratch my back” crony statism deal between sovereigns and banks, must stop.

In 1988, with the Basel Accord, Basel I, for the purpose of capital requirements for banks, regulators assigned to the sovereigns a risk weight of 0%, while citizens got one of 100%.

That meant banks would be able to leverage more their capital when lending to sovereigns than when lending to citizens. 

That meant banks would be able to earn higher expected risk adjusted returns on equity when lending to sovereigns than when lending to citizens. 

That meant that banks would lend more and at lower rates than usual to sovereigns and in relative terms less and at higher rates than usual to citizens.

That de facto established the Sovereign-Bank Nexus. I Sovereign help to guarantee you banks, and you help to finance me abundantly and cheap.

IMF, in its Global Financial Stability Report 2017, page 36 and 37 have a section titled “The Sovereign-Bank Nexus could reemerge”. It correctly spells out how banks can be affected by difficulties of sovereigns and how sovereigns can be affected by difficulties of banks. 

But it makes absolutely no reference to the regulatory support of the Sovereign-Bank Nexus previously described. Why?

That runaway statism must stop!

IMF, Basel Committee for Banking Supervision: Don’t tell me you do not know who did the Eurozone in?

PS. November 2016 Olivier Blanchard agreed on that there was a need to research the distortions produced by these regulations. Has that started?