When banks play it too safe - putting inequality on steroids - the McKinsey silence

In his April 9 Outlook essay, “Public Policy, Inc.,” Daniel W. Drezner, writing about how consultancies such as McKinsey have started to act like policy knowledge brokers, mentioned that these “have their own biases.” Indeed.

Bankers love to hold assets perceived as safe against very little capital. It helps them earn great risk-adjusted returns on equity.

But we citizens have no reason for loving that:

By going too much for the safe, banks will not lend sufficiently to the riskier entrepreneurs who are the prime builders of our grandchildren’s future. Sooner or later, banks will get caught with little capital holding dangerously large exposures to something that was perceived safe but that turned out risky. Depositors and taxpayers will suffer.

There is no question that banks are more important clients for consultant companies such as McKinsey than citizens are. That must be why financial consultants have not denounced how the Basel Committee on Banking Supervision’s risk-weighted capital requirements for banks dangerously distort the allocation of bank credit to the real economy.

Millions of entrepreneurs around the world have, as a direct consequence of these capital requirements, been denied the opportunity of bank credit. Talk about putting inequality on steroids. 

Per Kurowski, Rockville

The writer was an executive director at the World Bank from 2002 to 2004.

Washington Post

Here other of my letters in the Washington Post on this issue:
September 6, 2007: Factors in the Financial Storm
June 20, 2008: An Aspect of the Bubble
December 27, 2009: Another 'worst': Faulty bank regulation

January 6, 2012: Handcuffed by a triple-A rating
May 1, 2013: An American approach to banking
December 23, 2014: Let the market rule on risky trades
November 11, 2015: Reverse-mortgaging the future
August 9, 2016: Banks, regulators and risk

July 11, 2018: There is another tariff war that is being dangerously ignored. 

December 30, 2018: Affordable homes or investment assets?

ECB, Single Supervisory Mechanism (SSM), with respect to banks, still pisses out of the pot; and McKinsey keeps mum

The declared supervisory priorities for 2016 of ECB's Single Supervisory Mechanism (SSM) with respect to banks are: “(i) business model and profitability risk, (ii) credit risk, (iii) capital adequacy, (iv) risk governance and data quality, and (v) liquidity”

As you can see, ECB still does not care one iota about the allocation of bank credit to the real economy. Not one single indication of trying to figure out what should be on banks’ balance sheets and is not.

And as you can see, ECB still thinks that if it only can make banks stay away from what is ex ante perceived as risky, all will be fine and dandy. It has no idea that what caused all bank crises has been, either unexpected events, like currency crises, or excessive exposures to something erroneously perceived ex ante as absolutely safe… never ever what was ex ante perceived as risky.

And leading consulting companies in the world, like McKinsey, play along and don't say a word, probably because they expect to profit hugely from the so inept bank regulators.

As far as consultancies go, bank regulations is the new piñata in town.

You want to know what I am talking about? Serve yourself a good cognac and read this.

Should not a consultant group like McKinsey, if it sees-something dangerous for the society, have to say something?

During many years I have been wondering why consultants, like those in McKinsey, have not spoken out against the risk-weighted capital requirements for banks.

I do understand that McKinsey must have many bank clients who just love the idea of being able to earn higher-risk adjusted returns on equity with assets deemed as safe than with assets deemed as risky.

But any financial consultant should also be able to understand that, in the medium or long term, that will cause banks to dangerously overpopulate safe-havens; just as he must understand that the resulting under-exploration of the risky-bays, like SMEs and entrepreneurs, poses great dangers for the sustainability of the economy. 

Or is it that McKinsey, like the Basel Committee does not understand the difference between risk and uncertainty?

Now I just read two new articles published by McKinsey. One “The future of bank risk management” by Philipp Härle, Andras Havas, and Hamid Samandari; and the other “Poorer than their parents? A new perspective on income inequality” by Richard Dobbs, Anu Madgavkar, James Manyika, Jonathan Woetzel, Jacques Bughin, Eric Labaye, and Pranav Kashyap.

None of these touch even remotely on the fact that current regulatory risk-aversion, distorts the allocation of bank credit to the real economy; and that the regulatory discrimination against those perceived as “risky”, cannot but increase inequality.

On its website McKinsey tells us: “Social Impact: We help address societal challenges” Again, why does it not address this super societal challenge? 

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

God make us daring!

Here is a brief summary of some of the monstrous mistakes in current bank regulations.

Are some consulting companies, e.g. McKinsey & Co. Too-Big-To-Think?

A book, “No ordinary Disruption”, which I paid for, arrived with my mail today. The authors are Richard Dobbs, James Manyika, Jonathan Woetzel all belong to McKinsey Global Institute, the economics and business research arm of the management-consulting firm McKinsey & Co

From its introduction “An intuition reset” I quote:

“Dramatic changes come from nowhere, and then from everywhere… The fortunes of industries, companies, products, technologies, and eve countries and cities rise and fall overnight and in completely unpredictable ways.”

That is true but it makes me ask: Where was McKinsey & Co when bank regulators decided that their capital [equity) requirements for banks, those that are expected to cover for unexpected losses, were to be based on the predictable expected losses derived from the ex ante perceived credit risks?

Why on earth should banks need capital against perceived credit risks, when what is perceived cannot really be what is that dangerous? 

Or is it that McKinsey does not understand the difference between risk and uncertainty?

And the McKinsey authors identifying their “Four great disruptive forces” list: (1) the locus of economic dynamism shifting to emerging markets like China; (2) the impact of technology; (3) demographics; (4) “The final disruptive force is the degree to which the world is much more connected through trade and through movements in capital, people, and information. 

But they leave out that monstrous source of disruptive force that can emanate at any moment from sheer regulatory stupidities with global reach. Why? 

And I ask this because I am convinced that McKinsey & Co., somewhere deep in its bowels, must have known that: allowing banks to hold so little equity against some assets, only because these were perceived as safe, had to end in tears; and that allowing for different capital requirements for different assets, based on perceived credit risk already cleared for, had to dangerously distort the allocation of bank credit to the real economy.

The authors present us with the management imperative for the coming decade, namely: “To realize that much of what we thought we knew about the how the world works is wrong.”... 

Wrong! That’s no excuse, McKinsey & Co. involved in so many areas should have known that when regulating banks you must do two things: First define what’s the purpose of banks, something which was not done; and second analyze what caused bank crises in the past… and it sure was not what was perceived as risky but always what was ex ante perceived as safe but that ex-pots turned out risky.

So if there is a management imperative for the next decade that should be: To realize why so much we think about how the world should work could turn out to be so fundamentally wrong; and how to avoid to become a silly mutual admiration club prone to groupthink.

When a consulting group is no longer able to freely question what’s going on, to freely be able to call the bluff of what’s dumb, then it will have grown too big. It will be weighed down by too many conflicts of interests of all nature; which hinders it from speaking or even thinking the truth… and finally, very sadly, it will end up as a highly paid endorser of stupidities.

When a consulting group with global reach reaches a point of too much importance, then it also becomes a dangerous source of systemic risks.

So do we now need capital requirements for banks based on the size of the consultant group they use? J