The Basel Committee, FSB and other bank regulators know dangerously little about risks. Why? Here it is!

What many perceive as very safe can lead to the build up of very large exposures that could threaten the bank system.

What many perceive as very risky never leads to the build up such large exposures that it could threaten the bank system.

Yet the Basel Committee, in Basel II of 2004, assigned a risk weight of only 20% to what rated AAA to AA and therefore so dangerous to the banking system, and one of 150% to what is rated below BB- and therefore so innocuous to the banking system.

The Basel Committee has refused to explain why they did so, and the only document purported to explain it, is pure GroupThink mumbo jumbo.

Additionally, risk weighted capital requirements for banks allow banks to leverage their equity differently with different assets, which produces quite different expected risk adjusted returns on equity than would have been the case in the absence of such regulations, and therefore this dramatically distorts the allocation of bank credit to the real economy. It introduced rampant risk aversion that have our banks no longer financing the riskier future, only refinancing the safer past.

Additionally, without obtaining due permission, the Basel Committee assigned a risk weight of 0% to a set of friendly sovereigns and 100% for the We the People of such sovereigns. This introduced rampant statism. As if government bureaucrats could use bank credit better than the private sector.

I have tried by all means possible to get explanations from the Basel Committee, even by using their formal consultation procedures, but all to no avail.

Please, you in the media who have more access to bank regulators ask them: Why do you think the below BB- rated are more dangerous to the bank system than the AAA rated?

Have you never heard of Voltaire’s “May God defend me from my friends, I can defend myself from my enemies”?

We also have John A Shedd (1850-1926) with his: “A ship in harbor is safe, but that is not what ships are for.”

With respect to that the Basel Committee is not only not allowing our banks to sail to explore riskier but perhaps more profitable bays, but it is also assuring to turn safe havens into overpopulated death traps. 

For our children and grandchildren’s case, help me to get rid of those dangerously incapable regulators.

P.S. Like during the Oscar it seems that at the Basel Committee there was also a mix-up of envelopes, in this case of those containing the names of what is the most and the least risky for our bank system. The saddest fact is that at the Oscar they got it fast, 2 minutes and 30 seconds, but in Basel they have yet to discover it after more than a decade.

World Bank, before Public Credit Guarantee Schemes (CGSs) help removing the obstacles to bank lending to SMEs

“The World Bank Group and FIRST Initiative are inviting stakeholders -- governments, credit guarantee schemes (CGSs) and lenders -- to provide input on how to improve access to finance for SMEs through an effective design, implementation and evaluation of Public Credit Guarantee Schemes CGSs.”

As a justification the document states something we can all surely agree on: “Financial inclusion, particularly for small and medium enterprises (SMEs), is widely recognized as one of the key drivers of economic growth and job creation in all economies. SME credit markets are notoriously characterized by market failures and imperfections including information asymmetries, inadequacy or lack of recognized collateral, high transaction costs of small-scale lending and perception of high risk.”

We also read: “In order to address these market failures and imperfections, many governments intervene in SME credit markets in various forms. A common form of intervention is represented by credit guarantee schemes (CGSs). A CGS provides third-party credit risk mitigation to lenders with the objective of increasing access to credit for SMEs. This is through the absorption of a portion of the lender’s losses on the loans made to SMEs in case of default, in return for a fee. The popularity of CGSs is partly due to the fact that they typically combine a subsidy element with market-based arrangements for credit allocation, therefore involving less room for distortions in credit markets than more direct forms of intervention such as state-owned banks.”

And I would want to draw your attention specifically to: “they typically combine a subsidy element with market-based arrangements for credit allocation, therefore involving less room for distortions in credit markets.”

That because the World Bank Group and the FIRST Initiative, are aware of the existence of risk-weighted capital requirements for banks which allow banks to leverage much less their equity when lending to “The Risky”, like SMEs than when lending to “The Safe” like sovereigns and the AAArisktocracy.

And they must also be aware that these regulations impede “market-based credit allocation, and cause huge distortions in credit markets”. We know that because already in the World Banks' The Global Development Finance 2003 (GDF-2003), “Striving for Stability in Development Finance” it had this to say on Basel II, pages 50-52

“The new method of assessing the minimum-capital requirement [proposed by the Basel Committee for Banking Supervision (BCBS)]… will be explicitly linked to indicators of credit quality… The regulatory capital requirements would be significantly higher in the case of non-investment-grade emerging-market borrowers than under Basel I. At the same time, borrowers with a higher credit rating would benefit from a lower cost of capital under Basel II….”

And so, though welcoming very much this initiative of the World Bank and the FIRST Initiative, I pray that it is not in substitution of getting rid of the portfolio invariant credit-risk weighted capital requirements for banks, which blocks SMEs from having fair access to bank credit. If it is, then let me assure you the “Public Credit Guarantee Schemes (CGSs) for SMEs” discussed amounts to a petty consolation prize for the SMEs, and could even increase the existing regulatory distortions.

We read the consultation invites “stakeholders -- governments, credit guarantee schemes (CGSs) and lenders” should not SMEs, or those who speak up for the borrowers’ rights of not being discriminated against by regulators, be specifically invited?

My comments to the Basel Committee on their paper titled “The Regulatory framework: balancing risk sensitivity, simplicity and comparability”

Members of the Basel Committee for Banking Supervision

In July 2013 you issued, for comments before October 11, 2014, a discussion paper titled “The Regulatory framework: balancing risk sensitivity, simplicity and comparability”

In reference to it let me declare that I totally reject, and protest, your whole perceived risk based capital requirement framework. It is based on the absolutely false premise that the perceived risks are not cleared for by banks in terms of interest rates, size of exposure and other contract terms.

Your perceived risk based framework, which re-clears for the same perceived risks in the capital (equity), only guarantees that banks will overdose on perceived risk, and makes it completely impossible for banks to help the society in allocating effectively bank credit in the real economy.

Your perceived risk based framework has also been the prime cause for the current crisis, as it, by allowing banks to make higher expected risk-adjusted returns on exposures to what is perceived as absolutely safe than on exposures to what is perceived as risky, has driven the banks to create excessive exposures to what is perceived as absolutely safe, which is precisely the kind of exposures that have caused all major bank crises in history, when the ex-ante perceptions, turn out ex-post to be wrong; in this case much aggravated by the fact that the capital of the banks will also be extremely small when such unfortunate thing occurs.

Your perceived risk framework has also, in my words, castrated the banks and introduced a risk-adverseness that is making of the developed countries, submerging countries.

As a private citizen I do not have the time or the resources to repeat all my arguments over and over again and so I refer you to my blog:

http://subprimeregulations.blogspot.com/

And in which, for a starter, you might find especially illustrating the following post

http://subprimeregulations.blogspot.com/2012/12/the-basel-ii-roulette-manipulation.html

And to follow up, you might want to read what was recently published in the Journal of Risk North Asia, Volume V, Issue II, Summer 2013

And please, before you regulate our banks one iota more, tell us what you think the purpose of our banks should be, to see if we agree.

Respectfully yours, sort of.

Per Kurowski

A former Executive of the World Bank (2002-2004)

PS. If I sound a bit disrespectful, forgive me, but I have been trying, for more than a decade now, to make you see the light. I do not ever shout in capital letters on the blogs, I am a grandfather, with a serious cv., but there has to be a way by which an ordinary citizen can get some answer, even from a Basel Committee.

http://subprimeregulations.blogspot.com/2013/04/questions-on-bank-regulations-which.html

PS. If I feel I have to add to these comments I will do it here…the link to this post.

Comments on Basel Committee's “The regulatory framework: balancing risk sensitivity, simplicity and comparability” of July 8, 2013

Basel Committee for Banking Supervision

Sir,

These are comments made in reference to your July 8, 2013 consultation document “The regulatory framework: balancing risk sensitivity, simplicity and comparability”

I would like to begin by clearly stating that for a long time I have completely objected the capital requirements for banks based on ex ante perceived credit risks. I consider these capital requirements to be totally insane and much responsible for causing the current bank crisis, as well as for impeding us getting out of it.

And to that effect I enclose a short opinion recently published in the Journal of Regulation and Risk - North Asia, Volume V Issue II Summer 2013. The “Mistake” that shall not be named

That said I would also like, just as an example of what I criticize, refer to the following in the document.

“73. For example, in increasing ex ante risk sensitivity and expanding risk coverage, the framework has progressively sought greater alignment of regulatory capital with economic capital. This approach is implicitly premised on the suitability of economic capital as an appropriate measure for regulatory purposes. But the relationship between economic capital and regulatory capital may need reexamination in the light of the recent shift in the focus of regulation and supervision from ensuring the soundness of individual institutions to, additionally, safeguarding the stability of the banking system.”

First, what are you saying? That “safeguarding the stability of the banking system” was not understood to be the role of the Basel Committee for Banking Supervision before? Do those who appointed you really agree with that statement?

Second, your regulatory capital based on ex ante perceived credit risk, even in the case of an individual bank, is an utterly incomplete reflection of economic capital, since it does not consider facts like the size of the exposures, meaning the portfolio diversification/concentration, or the duration of those exposures, for instance the interest rate risk.

And then let me briefly and partially answer some of your specific questions

Q1. Does the current framework, with its reliance on the risk-based capital at its core, appropriately balance the objectives set out in paragraph 29?

No! The core of the current framework, risk-based capital is completely wrong.

For instance, when in 29 you write “These ideas should be assessed against the primary aims of the capital adequacy framework: that is, the capital adequacy framework should…. take into account the effects of capital requirements on banks' risk-taking incentives, eg when faced with regulatory constraints on their capital (and therefore the size of their balance sheet), to seek higher-risk assets as a means of boosting expected returns”, you do not seem to comprehend the real problem.

The fact is that banks, “when faced with regulatory constraints on their capital”, primarily seek assets which have a low capital requirement, in order to boost expected risk-adjusted returns on equity

Q2. Are there other objectives that should be considered in reviewing the international capital adequacy framework?

Yes, like the little matter of the purpose of the banks; like that the capital adequacy framework should not be allowed to distort the bank credit allocation to the real economy. 

Q3. To what extent does the current capital framework strike the right balance between simplicity, comparability and risk sensitivity, given the costs and benefits that greater risk sensitivity brings?

To no degree at all, especially since the “greater risk sensitivity it brings” is only a quite arrogant ex-ante presumption.

Q4. Which of the potential ideas outlined in Section 5 offer the greatest potential benefit in terms of improving the balance between the simplicity, comparability and risk sensitivity of the capital adequacy framework?

In my opinion, a simple leverage ratio of 8 to 10 percent, complemented by a reporting requirement which includes; a report of risk adjusted leverage based on standardized risk-weights, and issued strictly for approximate comparative purposes; and some additional information on its portfolio diversification and duration, and that can be helpful for the market to get a sense of the risk structure of the bank.

The transition to such a reality though would have to be managed with a lot of intelligence in order not to make things worse.

Q5. Are there other ideas and approaches that the Committee should consider?

Yes!

How did Basel I, II and III evolve? How can we make sure that the serious mistakes in them and that I attribute to incestuous group-think within a mutual admiration club, are not repeated?

There is a need for a critical mass of qualified creditors in the market who know they will not be bailed out automatically from a bank problem.

Who authorized the Basel Committee to act as a risk-manager of our banks and the world?

If you want to do it right, you need to work with a whole set of new regulators who have no vested interest in defending what has been done in the past… remember, neither Hollywood nor Bollywood would ever dream of entrusting a Basel III to those responsible for Basel II flop.

Am I to harsh and impolite in my criticism? Considering the suffering and the millions of unemployed youth resulting directly from your faulty regulations, I do not think so.

Sincerely

Per Kurowski

http://subprimeregulations.blogspot.com/

Rockville, Maryland, USA

PS. If you want to download the whole journal from which my opinion was extracted you can go tohttp://www.scribd.com/doc/149858219/Journal-of-Regulation-Risk-North-Asia-Volume-V-Issue-II-Summer-2013