What do I, Per Kurowski, want with respect to the current bank regulations?

I want the current capital requirements for banks based on perceived risk of default concocted by the Basel Committee to be thrown out forever.

Why do I want that?

1st because these capital requirements ignore that the risk of default, as perceived, among other by the credit rating agencies, is already taken care of by the risk premiums charged by the markets and the banks, and so we end double counting for the same perceived default risk; which causes those who already are benefitted by lower interest rates, because they are perceived as having a low risk of return, to be additionally benefitted by having to provide a return on less capital; and punishes additionally those who already have to pay higher interest rates because they are perceived as “risky”, by means of having to provide a satisfactory return on more bank capital.

2nd because the more we strengthen the basic capital requirements like for instance going from a very wishy-washy 8 percent in Basel II to a more solid composed 7 percent in Basel III the more damage will the discrimination produced by the risk-weights cause.

3rd because the risk of default compared to many other risks we face, like climate change or a world with billions of young people with no jobs, is really a minor and almost innocent risk that is an integral part of an operating market, something which becomes even more apparent if we think about the possibilities of markets without defaults and which, of course, could only end up with the mother of the mother of all the too-big-to-fail banks.

4th because it is always dangerous to identify and empower a risk-assessment oligopoly of credit rating agencies, which will leverage whatever mistakes they make on their own or because they are captured.

5th because in order to go forward and not stagnate and fade away humanity always needs a hefty dose of risk-taking, and you can therefore not allow that the banks turn solely into mattresses, where to stash away your savings. To accept sending your children away to war where they could die but at the same time arbitrarily make it harder for young entrepreneurs to access the capital he feels he needs to take himself, and us, forward, does not seem like a reasonably balances proposition.

Why would they want to give it to me?

1st since the regulators have recently been reminded of the fact that all monstrous financial and bank crisis always occur because of excessive investments in what is perceived as not risky, the triple-A rated of each time, and never because of excessive investments or lending to like what is considered as not risky, that should get them thinking. Don’t you think so?

2nd because it is obvious that we need to give small businesses and entrepreneurs, of any age, more fair access to bank credit if they are going to have a chance to make something useful out of all that cash thrown on the economy by fiscal spending and quantitative easing. For your information, right now, the banks when lending to small businesses or entrepreneurs, because their Basel decreed risk-weight is 100 percent, need to have 5 TIMES as much capital than when lending to a triple-A rated client whose Basel decreed risk-weight are merely 20 percent.

And would that be all?

Absolutely not! If we are going to have global regulators, which we will need, it absolutely behooves us to make sure those regulators are chosen from an extremely diversified pool of talents, since the least we need is to allow for creation of incestuous mutual admiration clubs… like the Basel Committee is. Think of it, if the challenge of global climate change is placed into the hands of something like the current Basel Committee, we are all toast.

Are these extravagant wishes?

I don’t think so. Do you?

The Basel Committee on Banking Supervision has only a completely wrong and harmful tool in its toolbox.

Capital requirements based on the perceived risk of default as perceived by credit rating agencies or bank’s own internal risk analysis, is the most important tool in the toolbox of the Basel Committee for Banking Supervision.

The higher the perceived risk the higher the capital requirement, and the lower the perceived risk the lower the capital requirements. It all sounds so extremely logical. Unfortunately as all bank and financial crisis have exclusively originated from excessive investments in what has been perceived ex-ante as having a low risk; and none from excessive investments I what has perceived ex-ante as having high risk, this regulatory tool is totally counterfactual; and therefore totally counterproductive, as this crisis in triple-A rated territory clearly evidences.

And it is even worse than that. As that tool discriminates precisely against the type of clients banks are supposed to help the most, the small businesses and entrepreneurs who have little alternative access to finance, it harms the economy and job creation.

Day by day more get to be aware of this problem, and I had the chance to take it to the forefront by making questions in three of the events during the annual meetings of the International Monetary Fund and the World Bank, October 8-11, 2010

The problem though is that seem they do not yet know what to do about it… and so they try to ignore it and whistle in the dark. In one of the final seminars “The financial sector: navigating the road ahead, where there was no Q. & A. opportunity the basic problem with the capital requirements based on risk was not even mentioned, though the additional layers of confusion currently contemplated, such as capital requirements for liquidity risks, for systemic risk and for cyclicality risks were. Can there be something more pro-cyclical than helping the triple-A rated?

It is truly amazing to see how difficult it is for so many to extract themselves from the regulatory paradigm, or almost regulatory voodooism that has entrapped them. The only truly invisible hand at work was… that of the scheming banking regulators messing around with risk-weights under the table.

Below are the three events that I referred to, and where I asked my question.

The Civil Society Town-Hall Meeting

In the video you can find my question in minute 47.28, Dominique Strauss-Kahn’s answer in minute 1.01.08, and Robert Zoellick’s answer in minute 1.16.32

http://www.imf.org/external/mmedia/view.aspx?vid=628246206001

Structural Reforms: Effective Strategies for Growth and Jobs

Here my first and second question can be seen from minute 1.14.25 on.

http://www.imf.org/external/am/mmedia/view.aspx?vid=629575645001

Accelerating Financial Inclusion–Delivering Innovative Solutions

My question (not the best sound quality, but it is a similar question) can be found in minute 1.04.03 on

http://www.imf.org/external/am/mmedia/view.aspx?vid=629531170001

The bare-naked Basel Committee

The innocent child´s "But he isn't wearing anything at all!" in “The Emperor’s new clothes” tale by Hans Christian Andersen, would not have been written today, since modern emperors and their spin doctors are much too savvy to let an innocent voice get due attention.

As a sort of innocent child I have been clamoring for a long time that the Basel Committee on Banking Regulations, no matter their standing as the great global expert on these matters, is bare-naked and completely wrong… so wrong that they are in fact the primary cause of the current crisis… but the Basel Committee just ignores me.

In this respect I am searching for a voice stronger than mine who could pose some simple questions to the Basel Committee and have them answered. A Senator of the US concerned with that the banks in the land of the free and the home of the brave are not really free and are instructed to be coward, could be a perfect such voice.

Question 1: All major bank and financial crisis in the world have, without exceptions, resulted from excessive investments in what was ex-ante perceived as not risky but that ex-post turned out to be risky; and no crisis has never ever resulted from excessive investments in what was perceived as risky. In this respect, guys, what are your fundaments for creating regulations that give banks extra-incentives to lend or invest in what ex-ante is perceived as not risky; and thereby create extra disincentives for the banks to lend or invest in what is perceived as risky?

Question 2: In the whole set of bank regulations that has emanated from the Basel Committee over the last two decades, there is not one single word about the purpose of the banks. Guys, is not defining the purpose of the entity you are to regulate the basic required element for any successful regulation?

Question 3: Banks are allowed to lend to triple-A rated governments, like the US, with no capital at all, but are required to post 8 percent in capital when lending to any small business or entrepreneur. Guys, are you communist?

Question 4: Inducing the banks to follow too much the opinion of some few credit rating agencies must increase the risk that when these agents go wrong the banks will go dramatically and exponentially wrong. Guys why on earth would you do a dumb thing like this?

Question 5: Guys, when you have by the results been proven absolutely wrong are you not supposed to pause and perhaps even hit the reset button? Why then are you now forging ahead and perhaps digging us deeper in the hole we are in by now so arrogantly even trying to control for economic cycles?

Question 6: Guys, since even hedge funds rarely manage to leverage more than 15 to 1, would the banks without you explicitly allowing them to do so, even contemplate to leverage themselves 40 to 1?

Question 7: What was going on in your minds guys authorizing banks during the last five years to lend to a country like Greece or investing in triple-A rated securities, leveraging 62.5 to 1, and thereby converting for instance a .5 percent margins in an astonishing 31.25% return on equity… precisely that sort of returns that giant bonuses and too-big-to-fail banks are made of?

Question 8: It is evident that given the scarcity of bank capital, the small businesses and entrepreneurs, and who might be able to develop the next generation of jobs, are being crowded out from bank credits by your regulations are. Guys, why do you find that acceptable? Especially considering that these clients are supposed to be the banks´ most natural clients; and that they have nothing to do with creating a systemic crisis.

Question 9: Guys in the Basel Committee, who are you, how do you get appointed, who sets and pay your salaries?

There are of course many more questions, but for a starter these would do.

Is there any free and brave Senator fed up with being Razzle Dazzle Razzle Bazzled willing to make them? I sincerely hope so the whole world needs it… urgently!

My letter to the Independent Commission on Banking in UK

You’ve all been “Razzle Dazzle 'em, Razzle Bazzle 'em”… Get out of that trance!

Sir,

The regulatory paradigm on which the Basel Committee stands will quite soon be discovered as one of the biggest regulatory failures ever, and all the experts will be looking for ways how to disassociate from them.

This is so because those regulations are primarily based on requiring the banks to have more capital when risk are perceived as high while allowing for much lower capital when risks are perceived as low, even though all financial and bank crisis in history have occurred from excessive investments in what is perceived as having low risk.

Only what is perceived as having a low risk can grow into systemic risk. A high perceived risk always takes care of itself and does never grow to be a systemic threat.

The regulators fixated themselves so much on stopping a bank from failing, that they ignored the system. Besides, who would like to live in a world where banks did not fail?

Currently small businesses and entrepreneurs, only because of the arbitrary, regressive and discriminatory capital requirements, need to pay the banks 2 percent more per year in order to provide the banks with the same return on capital that a loan or an investment to a triple-A rated client yields them. And this on top of the higher interests the small businesses and entrepreneurs anyway have to pay. Crazy!

I invite you to a brief lesson on how bank regulators have become so fixated on seeing the gorilla in the room that they completely lost track of the ball. http://bit.ly/c66DLp

Per Kurowski

A former Executive Director at the World Bank (2002-2004)

The financial crisis: The simple why and what to do?

When I talk about an authorized leverage of "64.5 to 1" the real figure is "62.5 to 1". Since there could be some debate on whether I was trying to see if you were following me, catch you sleeping, or because I did not use a calculator I made a mistake... be my guest and pick any explanation you choose, it won´t matter anyhow for the conclusions… and I will not repeat the class just because of that.

You need to learn think more about your financial regulations in terms of national security.

If you deposit you money in your local bank the current bank regulations stipulate the following:

If your bank relends that money to a sovereign rated AAA, like the US Government, then it needs no capital at all, meaning being allowed an unlimited leverage;

If it lends to a sovereign country that has been rated A+ to A, like Greece was from July 2000 until December 2009, or to a private client rated AAA, then it needs only 1.6 percent capital, implying that a leverage of 62.5 to one is allowed;

But, if it lends it to a small businesses or entrepreneurs, those on whom we depend so much for our jobs, those who cannot afford being rated by the raters, those who the banks are supposed to help while they make it to the capital markets, then your bank is required to have 8 percent in capital and need to limit their leverage to 12.5 to one.

This means that what is perceived as having low risks and which therefore already benefits from lower interest is now additionally benefitted by generating very lower capital requirements; while what is perceived as having higher risks and which is therefore already punished with higher interest rates, is, in relative terms, further punished by having to cover the costs of the higher capital requirements they generate.

That signifies that, in the land of the brave, the regulators, in a very non-transparent way, have created a totally arbitrary subsidy of risk adverseness, which is changing the character of your country, for no good reason at all, like the current crisis proves.

These regulations created a huge demand for anything rated AAA, and the market, being what it is, supplied AAAs, though most of them were naturally fakes, since we all know there is very little in life so truly free of risks that it can merit an AAA.

Besides, even if the credit rating agencies were to be 100% accurate in their ratings, who can guarantee us that the future of this, or any other country, is to be found in never-risk-land. Risk is the oxygen of any development. I ask how can you risk the life of your sons and daughter for the future of your country and not risk your money with those most likely to take your country forward.

And that is why you have to learn think of your financial regulation more in terms of national security.

What should be done? For the time being, while the banks are slowly rebuilding their capitals to cover for all the losses incurred in triple-A rated operations, we should at least lower their capital requirements when lending to the small businesses and entrepreneurs, who had nothing to do with creating this financial crisis.