When it comes to discrimination, EU cares more about the access to a monastery than about the access to bank credit

If I had the right to vote I would have voted for Britain to stay in EU. But I would have hoped for that this option had won by just one vote, so that there was huge pressure on EU to clean up its act. It sorely needs it.

For instance, the European Commissioner for Internal Market and Services is in charge of promoting free movement of capital and therefore has a lot do to with the extremely important area of regulating the financial services. 

It is a topic of much interest for me since, for more than a decade, I have argued that the Basel Committee’s risk weighted capital requirements for banks, is impeding the free movement of capital with disastrous consequences for the real economy.

But in 2012, during a conference in Washington by the then Commissioner Michel Barnier, I was handed a brochure that presented, as a success story of his office, the following: 

“A French citizen complained about discriminatory entry fees for tourists to Romanian monasteries. The ticket price for non-Romanians was twice as high as that for Romanian citizens. As this policy was contrary to EU principles, the Romanian SOLVIT centre persuaded the church authorities to establish non-discriminatory entry fees for the monasteries. Solved within 9 weeks.” 

And then I knew for sure something smelled very rotten in the EU, with its full of hubris besserwisser not accountable to anyone technocrats.

How can they waste time on such small time discrimination when those borrowers ex ante perceived as risky, and who therefore already got less bank credit and at higher interest rates, now suffer additional discrimination caused by regulators requiring banks sot hold more capital when lending to them that when lending to those ex ante perceived as safe? And on top of it all, for absolutely no reason, since dangerous excessive bank exposures, are always built up with assets perceived as safe.

Barnier, as Frenchman should know Voltaire’s “May God defend me from my friends: I can defend myself from my enemies.” But now bank regulators tell banks “trust much more your friends”, the AAA rated, and to which in Basel II they assigned a risk weight of 20%; and “beware even more of your enemies”, the below BB- rated, and which were given a risk weight of 150%.

As a result banks can leverage more their equity with “safe” assets than with “risky” assets, and so they now earn higher risk adjusted returns on equity when lending to sovereigns, members of the AAArisktocracy or financing houses, than when lending to SMEs and entrepreneurs.

And as a direct consequence of this regulatory risk aversion, banks do not any longer finance the riskier future, they only refinance the for the short time being safer past.

So there is no wonder EU is not doing well. And if Brexit helps to push for the reform that are needed, then Britain should be given an open invitation to return to it at its leisure.

PS. During the Washington conference I just could not refrain from asking what the French citizen did for 9 weeks while waiting for SOLVIT to come to his rescue.

PS. Lubomir Zaoralek the minister of foreign affairs of the Czech Republic in FT “Europe’s institutions must share the blame forBrexit” July 1. Hear hear!

This is the mumbo jumbo that the Basel Committee bet our whole western world banking system on. Shame on it!

Here is the document which describes the risk-weight functions of Basel II

An Explanatory Note on the Basel II IRB Risk Weight Functions, Bank for International Settlements, July 2005

And these are the 3 papers referenced therein:

A risk-factor model foundation for ratings-based bank capital rules, by Michael B. Gordy, October 2002

Robert C Merton, On the pricing of corporate debt: The risk structure of interest rates. 1974, Journal of Finance 29, 449 - 470. 

Oldrich Vasicek, O. (2002) Loan portfolio value. RISK, December 2002, 160 - 162

All put together, does not make any sense!

And on that the Basel Committee, and the Financial Stability Board bet our whole western world banking system. Shame on it! How could they?

And that same crazy risk-weighing function is still part of Basel III

I wonder who wrote that “Explanatory Note”. “The confidence level is fixed at 99.9%, i.e. an institution is expected to suffer losses that exceed its level of tier 1 and tier 2 capital on average once in a thousand years”. That must indeed be the Bank Regulator’s real New Clothes.

Come on Mario Draghi, Adair Turner, Mark Carney, Stefan Ingves, Michel Barnier, or anyone else involved with bank regulations... have a go at explaining it to us! I bet you do not understand it either... but your egos stop you from recognizing that.

But when will Europe debate “Regulatory Abuse of Market Regulation”?

In Europe the European Parliament, and others related, are debating a “Market Abuse Regulation”. That is OK, though I must wonder about when they will begin debating “Regulatory Abuse of Market Regulation”?

Allowing banks to hold much less capital when lending to “The Infallible” than when lending to “The Risky”, as Basel II and III regulations do, allow banks to earn much higher expected risk-adjusted return on their equity when lending to the AAAristocracy than when lending for instance to small- and medium-sized enterprises… and that, as anyone should be able to understand, is as abusive to the market as can be!

Ask the regulators!

Basel Committee, Financial Stability Board, please do not make fun of us, or bullshit yourselves

Here is a document, which in 2005 explains why bank regulators like Mario Draghi, Lord Turner, Alan Greenspan, Mark Carney, Stefan Ingves, Michel Barnier and many other, and commentators like Martin Wolf, decided to give their full backing, in 2004, to Basel II capital requirements based on perceived risk.

It says: “This paper purely focuses on explaining the Basel II risk weight formulas in a non-technical way by describing the economic foundations as well as the underlying mathematical model and its input parameters”… and so unfortunately “By its very nature this means that this document cannot describe the full depth of the Basel Committee’s thinking as it developed the IRB framework”… but luckily for us “For further, more technical reading, references to background papers are provided.” 

Is someone trying to make fun of us? 

The document details: 

“The model should be portfolio invariant, i.e. the capital required for any given loan should only depend on the risk of that loan and must not depend on the portfolio it is added to. This characteristic has been deemed vital in order to make the new IRB framework applicable to a wider range of countries and institutions. 

Taking into account the actual portfolio composition when determining capital for each loan - as is done in more advanced credit portfolio models - would have been a too complex task for most banks and supervisors alike. The desire for portfolio invariance, however, makes recognition of institution-specific diversification effects within the framework difficult: diversification effects would depend on how well a new loan fits into an existing portfolio. 

As a result the Revised Framework was calibrated to well diversified banks. Where a bank deviates from this ideal it is expected to address this under Pillar 2 of the framework. If a bank failed at this, supervisors would have to take action under the supervisory review process (pillar 2).” 

And so that means to tell us our and all other bank supervisors around the globe who have adopted Basel II are up to this? 

Bullshit!

PS. Who wrote it?

PS. Please help me ask the question that debunks all this Basel II nonsense.

You bank regulators... get your priorities right, urgently, or we depict you on some shame poles.

Very few of us like having banks "too big to fail" or bankers receiving exaggerated bonuses. 

But, if banks are “too big to fail” and bonuses to bankers seem immorally large, but our banks still do a good job allocating economic resources efficiently, that is hard, but still quite livable. 

But if banks do not allocate economic resources efficiently, then even if all our banks are small, and easy to liquidate, and all our bankers do not receive more compensation than anyone else, that is still, something completely unacceptable. 

So please, European Parliament, European Commission, Basel Committee, Financial Stability Board, Michel Barnier, Stefan Ingves, Mario Draghi, Mark Carney, Lord Turner, Ben Bernanke… get your priorities right! 

The way YOU allow banks to hold lower capital against exposures considered as risky, than for exposures considered as safe, and which allows banks to earn higher expected risk-adjusted returns on what is perceived as safe than on what is perceived as risky, is bloody murdering the economies of the Western World, those economies which became prosperous thanks to a lot of risk-taking. 

When I think of all those opportunities missed, forever, to generate good jobs for our youth, only because of your regulations, I tell you I would have no qualms whatsoever depicting you on some shame poles, and placing these totems all around the most public places in Europe and America.

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.

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!

Our crazy bank regulations explained in red and blue

Nannies care for risks perceived, regulators should care for the risks not perceived. So you tell me, the Basel Committee, the FSA and the FSB, what are they?