My bank regulator went to Basel, and all he brought me was this lousy credit risk weighted capital requirements

I sent my bank regulator to learn with the big boys in the Basel Committee for Banking Supervision about how to regulate banks. Among what he was supposed to pick up was an idea of how much capital he should require banks to hold, primarily against any unexpected losses.

He could have come back with capital requirements that considered all type of events that unexpectedly could blow a hole in a banks solvency like: cyber-attacks, a weather event with disastrous consequences, a major earthquake, the central banks or even the regulators themselves not knowing what to do, inflation suddenly popping up, crazy governments (I am from Venezuela), a set of important companies suddenly turning up engaged in some hanky panky, Systemic Important Financial Institutions (SIFIs) going belly up, internal or external fraud, a major loss from an authorized or unauthorized position in a speculative trading, unexpected consequences from new regulations and thousand of other things… BUT NO all he brought me was this silly risk weighted capital requirements based on expected credit risks, about the only risks banks are supposed to really take care of on their own.

If only it had been based on the risk that banks were not able to manage expected credit risk, then I could have accepted it… but that had of course nothing to do with the credit risk per se, in fact usually it is what is perceived as safe that could pose the biggest dangers for a bank. 

And, to top it up, these credit risk based capital requirements were portfolio invariant, meaning independent of the size of the exposures, only because otherwise it would be too hard for him and his regulating colleagues to handle.

And, to top it up, these credit risk based capital requirements also smuggled in the absurd statist notion that sovereigns were infallible, de facto implying government bureaucrats knew better what to do with bank credit than "the risky" SMEs and entrepreneurs.

And to top it up, during his whole stay with the Basel Committee, and during his study visits to the Financial Stability Board and the IMF, not one single word was said about the societal purpose of banks.

And, so these credit risk based capital requirements guarantees to dangerously distort the allocation of bank credit to the real economy... which they did, look at how much credit Greece got... which they do, look at how little credit SMEs get.

And so these credit risk based capital requirements now guarantee that the next time a bank crisis results from excessive exposures to something that was erroneously perceived as very safe, which is precisely the stuff major bank crisis are made of, then banks will stand there with their pants down and no capital to cover themselves up with.

No! I will surely never ever send my bank regulator to Basel again.

A Financial AAAristocracy… in the US?

Bank regulators, who knows based on what right, created a financial aristocracy. It is composed by “The Noble Infallible” borrowers, like “The Noble AAAs”, and “The Noble Systemic Important Financial Institutions”, technically known as “The Noble SIFI’s” or, in more vulgar terms, “The Noble Too-Big-To-Fail banks”, “The Noble TBTF”.

When compared to the commons, like any unrated borrower, “The Risky”, like small businesses and entrepreneurs, and to smaller banks, like community banks, also known as “systemic un-important financial institutions”, the Financial Aristocracy has been endowed with immense privileges.

Just as an example, according to the Basel II orders, a bank can lend to a “Noble AAA” holding only 1.6 percent in capital, while if lending to any lowly member of ‘The Risky”, it needs to hold 8 percent in capital, five times as much!

The previous signifies of course that every dollar paid in risk adjusted interest rates by a Noble AAA represents five times in return on bank equity that the same risk-adjusted dollar in interests paid by the unrated "risky" commoner.

Of course to keep their rulers happy, bank regulators also named these as “The Absolute Infallible” and which, again according to the rulings of Basel II, signified that banks needed to hold no capital at all when lending to the Supreme Sovereign.

I can understand perhaps how this appointments of a Financial Aristocracy, or more precise yet an AAArisktocracy might have slipped through in Europe, but, in America, where its Constitution establishes: “No Title of Nobility shall be granted by the United States”... how on earth did that happen?

And though the United States in June 2004 formally committed to implementing the Basel II bank regulations; and though the SEC in April 2004 delegated supervision decisions to the Basel Committee,  there is surrealistically enough not one single mention of these regulations, or of the Basel Committee for Banking Supervision, in the 848 pages of the Dodd-Frank Act. And this though that Act makes reference to foreign organizations like the Extractive Industry Transparency Review (EITI). It would seem like someone somewhere, has been playing some dirty tricks on someone.

And, by the way, discriminating against risk-taking, in a land which became what it is thanks to risk-taking, in “the land of the brave”… You’ve got to be kidding!

Poor "systemic irrelevant financial institutions"

So now except for 29 banks all the rest have de-facto been qualified as systemic irrelevant financial institutions. Is this going to make the lucky few less too-big-to-fail? Against a requirement of only 1 to 2.5 percent in additional equity, to be paid in comfortable installments? They've got to be kidding! 

Please, someone, save us from these regulators who keep digging us deeper and deeper in the hole where they've placed us.

All systemic unimportant and irrelevant financial institutions need to fight back... or they’re toast!

These days some lucky banks, by paying with a little of capital increase spread out over many years, will be denominated by the Basel Committee as Globally Systemic Important Financial Institutions G-SIFIs. 

At that moment all other banks become de-facto Globally Systemic Unimportant Financial Institutions, in other words almost declared as irrelevant. 

If the G-SUFI’s do not fight back or protest they’re toast! Our dear George Bailey would not have stood a chance against a Basel Committee. Did we really authorize the bank regulators to do that?

Crazy bank regulations explained in apolitical red and blue!

And what about Systemically Un-Important Financial Institutions?

Anyone thinking about how to reign or prepare for what could happen with Systemically Important Financial Institutions, should put on your hats of bankers of Systemically Un-Important Financial Institutions, and think about what you need in order to be able to compete so as to survive, as an independent and not as a satellite.

For instance Daniel K. Tarullo has not yet done so, and though he is probably not aware of it he is on that dangerous route that leads to awarding some behemoths a “Too-big-to fail” franchise.

Do not even think of selling “Too-big-to-fail” franchises, much less for a meager 3 percent of additional bank equity.

It would seem like some regulators want to sell “Too-big-to-fail” franchises to Systemically Important Financial Institutions (SIFIs/G-SIFIs), and even for a mere 3 percent in additional capital. Do not even think of it! 

Not only will 3 percent of additional bank capital end up being almost meaningless in the case of a systemic explosion or implosion of these huge banks, but it is also probable that precisely those Too-big-to-fail banks that we least should want to be too big to fail, will be those most likely to exploit the franchise for all it is worth, in order to compensate the additional equity required, in the ways we would least like to see these franchises exploited. 

Of course regulators will argue these franchises will be the subject of special supervision. Who are they fooling? Is it not hard enough for them to supervise these behemoths without labeling them as the most likely candidates for special support?