J'accuse the Basel Committee for Banking Supervision

The following are facts that should be understood by any economist.

The Basel Committee’s risk weighted bank capital/equity requirements distort the allocation of credit.

By favoring the refinancing of the safer present, it builds up dangerous large exposures to what’s perceived or decreed safe e.g., public debt, residential mortgages and AAA rated securities.

By hindering the financing of the riskier future, e.g., loans to small businesses and entrepreneurs, the economy weakens and grows less.

These are extremely procyclical. When times are good and risk perceived low, banks are allowed to hold less equity, therefore able to pay much dividends and buy back shares. When times turn bad, banks stand there naked, just when its hardest for these to raise new equity.

As valiantly confessed by Paul Volcker the risk weights are much influenced by politics. 

The Nobel Prize in Economic Sciences has not been awarded to anyone who has warned or much less criticized this risk weighted regulations. As a very active member of the Basel Committee, Sveriges Riksbank that stands behind such prize, has a serious conflict of interest it has not been able to manage.

#AI #OpenAI #ChatGPT Do regulators favor refinancing the safer present over financing the riskier future? If so, what about its consequences?

I asked ChatGPT:

"By imposing lower bank capital requirements against what’s perceived or decreed as safe, than against what’s perceived as risky, could one argue the regulators prefer the refinancing of the safer present over the financing of the riskier future?"

ChatGPT answered:

Yes, one could argue that by imposing lower capital requirements on what is perceived as "safe" compared to what is perceived as "risky," regulators are implicitly encouraging the refinancing of existing, less risky assets rather than the financing of potentially riskier, future-oriented ventures.

Here's the reasoning:

1. Lower Capital Requirements for "Safe" Assets: When regulators impose lower capital requirements on assets deemed "safe" (such as government bonds or highly rated corporate debt), banks are incentivized to allocate more capital to these assets. This makes it easier and cheaper for banks to hold or refinance existing, safe assets.

2. Higher Capital Requirements for "Risky" Assets: Conversely, higher capital requirements for riskier assets (like loans to startups or investments in innovative but uncertain technologies) make it more expensive and less attractive for banks to finance these ventures. This could discourage banks from providing capital for new, potentially transformative projects that carry higher risk but also higher potential for future growth.

3. Preference for Stability: Regulators typically focus on financial stability and risk mitigation. By encouraging banks to hold safer assets, they aim to reduce the likelihood of financial crises. However, this also means that the flow of capital is directed more towards maintaining and refinancing the present state of the economy rather than taking risks that could lead to future innovation and growth.

4. Impact on Economic Growth: Over time, this bias towards safety could lead to underinvestment in riskier, forward-looking projects that are necessary for long-term economic growth and innovation. The economy might become more stable in the short term, but at the cost of slower growth and reduced dynamism in the long term.

In summary, the structure of capital requirements can indeed reflect a regulatory preference for maintaining the status quo (the "safe" present) over investing in uncertain but potentially more rewarding future opportunities (the "risky" future).

I asked ChatGPT:

"If so, could one also argue such regulation favors the wants of the current generation (grandfathers and parent) over the needs of the future generation (children and grandchildren)?"

ChatGPT answered:

Yes, one could argue that such regulation, by favoring the refinancing of safer, established assets over riskier, innovative ventures, implicitly prioritizes the wants and stability of the current generation over the needs and potential opportunities for future generations. Here's how this argument might be structured:

1. Focus on Present Stability: Regulations that encourage banks to favor "safe" assets—often linked to established sectors or government debt—aim to maintain financial stability. This approach aligns with the interests of the current generation, who may prioritize preserving wealth and stability in the short to medium term.

2. Underinvestment in Future-Oriented Ventures: By imposing higher capital requirements on riskier investments, which often include funding for new technologies, startups, or infrastructure, these regulations can lead to underinvestment in areas that are crucial for long-term growth and innovation. The future generation, which would benefit from these developments, may find fewer opportunities for economic advancement and growth.

3. Intergenerational Equity: The preference for maintaining the current state of the economy could be seen as catering to the immediate needs and desires of the current generation, particularly those in or nearing retirement (grandfathers and parents), who might be more risk-averse. This can come at the expense of the future generation (children and grandchildren), who may face a less dynamic economy with fewer resources for innovation and growth.

4. Long-Term Consequences: While the current generation enjoys the benefits of stability, the future generation may inherit an economy that is less resilient to new challenges, less innovative, and potentially less capable of sustaining long-term growth. This could lead to a scenario where future generations are left with fewer opportunities and greater challenges.

5. Moral and Ethical Considerations: This situation raises questions of intergenerational equity, where the decisions and policies of one generation disproportionately affect the prospects of future generations. If regulations prioritize the short-term stability and preferences of the current generation, they might be neglecting the broader, long-term needs of those who will inherit the economy.

In summary, the regulation of capital requirements that favors safer, present-oriented investments could be seen as prioritizing the immediate wants of the current generation over the long-term needs and opportunities of future generations.

I said: Thanks!

ChatGPT said: You're welcome! If you have any more questions or need further clarification on anything, feel free to ask.

Note: The answers are copied exactly from those given to me by ChatGPT

Here my many other questions to ChatGPT – Grok on bank regulations

In Martin Wolf’s Economic Forum in October 2009, I wrote: “Please free us from imprudent risk-aversion and give us some prudent risk-taking”

Here more about the fundamental violation of that Intergenerational Social Contract Edmund Burke wrote about.

Easy Money - Easy Street

By favoring banks financing the “safer” present, public debt and residential mortgages, over the “riskier” future, loans to small businesses and entrepreneurs, the regulators, generously assisted by central banks with abundant QE, and by the MMT preachers, provided the last generations loads of Easy Money, something which allowed these to live very happily on Easy Street. 

But, now it is all coming home to roost. Nations, needing more debts in order to service their current debts, are turning into zombies. 😢

Q. If we compare the economy to a human body, have not regulators, with risk weighted bank capital/equity requirements, imposed a lousy diet with way too much carbs and way too little proteins? Has that not produced dangerous obesity? 😡

Bank regulators dynamited our today.

In Washington Post’s Obituaries of May 18, Brian Murphy quotes Kemal Dervis, as Turkey’s minister of economic affairs in 2001 with: “We all should tighten our belts. Don’t expect me to produce policies to save us just for today. We can’t dynamite our future in order to save today.” 

Sadly, that is exactly what bank regulators, with their risk weighted bank capital/equity requirements, have been doing for the last decades.

Favoring so much easy-credit, refinancing a perceived safer present, over harder-credit, financing a more uncertain riskier future; like Treasuries and residential mortgages over e.g., loans to small businesses and entrepreneurs, has landed us precisely where we find ourselves. 

I don’t think I have to detail where that is. Just open any newspaper to read about that. E.g., the debt ceiling

November 2015 published a letter in which I argued about a “de facto reverse mortgage on the economy, which extracted the value it already contained, as banks focused more on refinancing the safer past than the riskier future.”

How do you regulate a regulator’s algorithm?

Sir, I refer to your opinion “Want to regulate ‘the algorithm’? It won’t be easy” Washington Post December 3, 2021, in which you discuss the thorny issue of how to regulate social media in general and Facebook in particular.

Regulators, like the Federal Reserve, de facto also use an algorithm, the risk weighted bank capital requirements. This one determines how much capital/equity banks need to hold and, by its incentive of allowing more or less leverage of bank capital, influences how credit is allocated to the economy.

Let me list a few of too many worrisome aspects of that algorithm:

That what’s perceived as risky is more dangerous to bank systems than what’s perceived as safe

That bureaucrats know better what to do with taxpayer’s credit than e.g.., entrepreneurs with theirs.

That banks should refinance much more our “safer” present than finance our children’s and grandchildren’s’ “riskier” future.

That residential mortgages should be prioritized over small business loans.

How did we get there? My briefest answer: Groupthink by deskbound members of a mutual admiration club. Anyone who has walked on main-streets would e.g., understand that the real risks are conditioned to how risks are perceived, signifying assets can become very risky by the sole fact of being perceived very safe.

John A. Shedd, in “Salt from my attic” 1928 wrote: “A ship in harbor is safe, but that is not what ships are for”. Sir, I submit that goes for banks too. Try to ask current regulators about the purpose of our banks.

PS. IBM, we need our bank regulators to be helped by your Watson.

PS. Rachel Siegel wrote on December 3 “Biden’s pledge to bring ‘new diversity’ to Federal Reserve to soon be tested” I just hope the true meaning of diversity is really understood.

J’Accuse[d] the Basel Committee for Banking Supervision (BCBS) a thousands times, but I am no Émile Zola and there’s no L’Aurore

J’Accuse the Basel Committee of setting up our bank systems to especially large crises, caused by especially large exposures to something perceived as especially safe, which later turns into being especially risky, while held against especially little capital.

My letter to the Financial Stability Board

J’Accuse the Basel Committee for distorting the allocation of bank credit to the real economy by favoring the sovereign and the safer present, AAA rated and residential mortgages, while discriminating against the riskier future, SMEs and entrepreneurs.

My letter to the International Monetary Fund

A question to the Fed: When in 1988 bank regulators assigned America’s public debt a 0.00% risk weight, its debt was about $2.6 trillion, now it is around $22 trillion and still has a 0.00% risk weight. When do you think it should increase to 0.01%?

IMF, your main role in supporting social spending, is helping to make sure the resources needed to be spent, are there.

I refer to IMF Policy Paper “A Strategy for IMF Engagement on Social Spending” dated June 2019.

The best strategy for IMF to engage on Social Spending is making sure the real economy, in a sustainable way, provides the most resources to it. That must at this moment begin by loudly protesting the risk weighted capital requirements for banks, something on which the IMF, sadly, has kept silence on for soon three decades.

Since 1988, with the Basel Accord, bank regulations have included, as its pillar, risk weighted capital requirements for banks. The higher the perceived credit risk is, the higher the capital banks need to hold and vice versa, the lower the perceived credit risk is, the lower the capital banks need to hold.

In Basel II of 2004 these risk weights ranged from 0% assigned to AAA to AA rated sovereigns, to 150% assigned to corporates rated below BB-. With a basic capital requirement of 8% that allowed banks to leverage their capital from, an infinite number of times till about 8.3 times.

By doing so that piece of regulation has seriously distorted the allocation of credit, putting both our bank systems at great risk and weakening the possibilities of our real economy to grow in a sustainable balanced way.

We already heard a canary clearly sing in the mine when a crisis exploded because of excessive demand for the securities backed by mortgages to the subprime sector. That demand resulted from that US investment banks and European banks, were allowed to leverage their capital with these securities a mind-boggling 62.5 times, if only a human fallible rating company had assigned it an AAA to AA rating. 

And all that “safe” financing of houses, have only caused these to morph from being homes into being investment assets, at great risk of causing future financial instability. 

And all those “risky” SMEs and entrepreneurs, who used to have their credit needs primarily serviced by banks, are now forced to fish in other less adequate waters. 

And what to say about the 0% risk weighting of all eurozone sovereigns that assume debt denominated in a currency that de facto is not their domestic printable one?

A lower risk weight assigned to the sovereign than to an entrepreneur implies the opinion that a bureaucrat knows better what to do with bank credit, than the entrepreneur who puts his own name to it. If that’s not statism what is? 

In summary: To favor the financing of the ‘safer present’ over the ‘riskier future’ only guarantees the weakening of the economy; and especially large bank crises, because of especially large exposures to what is especially perceived as safe, against especially little capital.

And sadly IMF has kept notorious silence on this.

Are these reasons not enough cause for impeaching the current bank regulators?

By setting higher bank capital requirements for what is already perceived as risky than against what could wrongly be perceived as safe, the regulators guarantee especially large bank crises, from especially big exposures to what’s perceived as especially safe, against especially little capital.

By the same token they guarantee more than ordinary access to credit for the “safer” present, which will cause bubbles, like in house prices, and less credit to the “riskier” future, like to entrepreneurs, which will weaken the real economy.

By the same token, giving the banks huge incentives to finance what’s safe, has expelled the rest of the economy, like pension funds and private savers into the shadow banking system, having to take on much more “risky” investments, like leveraged loans, for which they are much less prepared for than banks.

My 4 tweets on the access to bank credit war

1. Way too much discussions on whether bank capital requirements should be 4%, 8%, 15%, 20% or whatever, and way to little about the fact that different capital requirements for different assets, dangerously distorts the allocation of bank credit.

2. The risk weights in the risk weighted capital requirements for banks are de facto tariffs on the access to bank credit. Sovereigns 0%, AAA rated 20%, residential mortgages 35%, unrated citizens 100%, below BB- corporates 150%.

3. So why do all those who tear their clothes about trade protectionism, keep silence about the access to bank credit protectionism imposed by “the safe” on “the risky”, and which can have even much more serious implications for the world economy.

4. As is it guarantees especially large bank crises from especially big exposures to what’s perceived as especially safe, against especially little capital.

As is, by favoring credit to the “safer” present over the “riskier” future it guarantees stagnation.

http://subprimeregulations.blogspot.com/2019/03/my-letter-to-financial-stability-board.html

PS. It has caused houses to morph from being homes into being investment assets.

PS. More than a trade war it is actually this access to bank credit war that is most likely to bring the euro and then EU down.

PS. 0% risk weights will turn sovereign into spoiled filthy rich brats that will end up defaulting.

PS. Are these reasons not enough cause for impeaching the current bank regulators?

Many experts read, agree and rightfully praise Hans Rosling, yet don’t understand him at all.

I quote from “Factfulness”, 2018 by Hans Rosling, Ola Rosling and Anna Rosling Rönnlund. 

“Fear vs. Danger. Being afraid of the Right Things:

Fear can be useful but only if it is directed at the right things. The fear instinct is a terrible guide for understanding the world. It make us give our attention to the unlikely dangers that we are most afraid of, and neglect what is actually most risky…

‘Frightening’ and ‘Dangerous’ are different things. Something frightening poses a perceived risk. Something dangerous poses a real risk. Paying too much attention to what is frightening rather than to what is dangerous--that is, paying too much attention to fear--creates a tragic drainage of energy in the wrong directions.”

But here we are, with expert bank regulators who, with their credit risk weighted capital requirements, decided that what is frightening to them, namely what is perceived risky, is more dangerous to our bank system than what is really dangerous to it, namely what is perceived as safe.

And so by imposing their fear on our banks we have:

A banking system that is doomed to especially large crises, as a result of building up especially large exposures to what is especially perceived as safe, against especially little capital.

A banking system that finances way too much the safer present and way too little the riskier future, dooming our economy to a lack of the oxygen it most needs, namely that of risk taking.

And it is seemingly impossible to make them understand their mistake 

Where would we be had they introduced their fright of what they perceive as risky a couple of hundred years before their 1988 Basel Accord?

To top it up they decreed a risk weight of 0% to the sovereign and 100% to the citizen, and with that, they guaranteed way too high exposures to what I am most scared of, namely a great overhang of public debt that will cloud the future of my grandchildren.

What if traffic regulators, to make your town safe, limited motorcycles to 8 mph but allowed cars to speed at 62 mph?

The fatality rate per 100 million vehicle miles traveled in cars is 1.14

The fatality rate per 100 million vehicle miles traveled in motorcycles is 21.45

That could indicate that in terms of risks measured and expressed as credit ratings, the cars should be rated AAA, and motorcycles below BB-.

But in 2011, in the US, 4,612 persons died in motorcycle accidents.

And in 2011, in the US, 32,479 persons died in vehicle accidents.

That explains the differences between ex-ante perceived risk and the ex-post dangers conditioned by the ex-ante perceptions. Cars are more dangerous to the society than motorcycles, in much because the latter are perceived as much riskier.

But what did bank regulators do in Basel II, 2004?

By weighting for ex-ante perceived risks their basic capital requirement of 8%, they allowed banks to leverage 62.5 times to 1 when AAA-ratings were present, and 8.3 times in the case of below BB- ratings.

So, what if traffic regulators, in order to make your hometown safe, limited motorcycles to 8 mph but allowed cars to speed at 62 mph?

Do you see why I argue that current bank regulators in the Basel Committee and in the Financial Stability Board have no idea about what they are doing?

But it is even worse. We need SMEs and entrepreneurs to access bank credit in order to generate future opportunities for our kids. Unfortunately, since when starting out these usually have to drive more risky motorcycles than safe cars, our future real economy gets also slapped in the face. 

An 8% capital requirement translates into a 12.5 to 1 leverage. Why can’t our regulators allow banks to speed through our economy at 12.5mph, independently of whether they go by cars or motorcycles?

PS: Here is a more detailed explanation of the mother of all regulatory mistakes.

Regulators looking after the same risks bankers look at

Regulatory risk aversion distorts credit and causes dangerous bank exposures to what is perceived, decreed or concocted as safe.

Mark Carney, Governor of the Bank of England, and the Chair of the Financial Stability Board, on April 7, 2017 gave a speech titled: “The high road to a responsible, open financial system”. 

Carney said: “The pillars of responsible financial globalisation eroded prior to the global financial crisis. Regulation became light touch and ineffective…. few participants were exposed to the full consequences of their actions as governance and compensation arrangements focused on the short term.”

But to call regulations that as a pillar has risk weighted capital requirements for banks, which allow banks to leverage assets differently because of perceived or decreed risk, “light touch”, is pure nonsense. And if there is anything as focused on the short term, that must be regulations that give banks incentives not to lend to the “riskier” future, but to take refuge in refinancing the “safer” past and present.

Carney bragged: “The system is safer because banks are now much more resilient, with capital requirements for the largest global banks that are ten times higher than before the crisis and a new leverage ratio that guards against risks that may seem low but prove not.” 

Since that “ten times higher” refers to capital in relation to risk weighted assets, and he has no way to ascertain the ex ante risk perceptions will coincide with the ex post realities, that number may or may not be true. The improvement might come from banks shedding a lot of safe “risky” assets and taking on more exposures to potentially risky “safe” assets. Finally, mentioning “a new leverage ratio that guards against risks that may seem low but prove not”, amounts to admitting they had no idea what they were doing before.

Carney opined: “The financial system is simpler. As banks have become less complex and more focused, they are lending more to households and businesses and less to each other. A series of measures are eliminating toxic and fragile forms of shadow banking while reinforcing the best of resilient market-based finance. And more durable market infrastructure is simplifying the previously complex – and dangerous – web of exposures in derivative markets.”

He wishes!

But when I object the strongest is when Carney states “The financial system is fairer because of reforms that are ending the era of “too big to fail” banks and addressing the root causes of a torrent of misconduct.”

Fairer? With regulators favoring those who perceived as safe were already favored with easier access to bank credit, and increasing the obstacles for those who perceived as risky already found it harder to access bank credit, has nothing to do with fairness. It is just odious regulatory discrimination.

Bank regulators, de facto, decreed more inequality.

François Villeroy de Galhau, I don’t think you have earned the right to quote Ortega y Gasset

François Villeroy de Galhau, Governor of the Banque de France, when addressing The Asociación de Mercados Financieros Annual Financial Convention in Madrid on November 21, 2016 ends his “Europe facing a new political economy” by quoting José Ortega y Gasset, the famous Madrid-born philosopher:

“Life is a series of collisions with the future; it is not the sum of what we have been, but what we yearn to be”. 

Absolutely Mr Villeroy de Galhau. But what are we to say of bank regulators like you who with their risk weighted capital requirements, give banks great incentives to earn the highest risk adjusted returns on equity when refinancing the "safer" past and present, so as to make them stay away from any collision resulting from financing a "riskier" future.

Regulators make banks finance “safe” basements where young can live with their parents, not the risky jobs they need.

Ever since regulators introduced credit risk weighted capital requirements for banks, these are not financing sufficiently the "riskier" future, only refinancing excessively the "safer" past and present.

For instance, the risk weight of 35% when financing “safe” houses, and of 100% when financing “risky” SMEs, results only in the building of basements where the young can live with their parents, and not in the creation of the new generation of jobs the young need.

Here's an aide memoire on the monstrous mistakes of such capital requirements.

P.S. Washington Post. December 2018: “Affordable homes or houses as investment/retirement assets?”

The Basel Committee, Financial Stability Board and other frightened risk adverse bank nannies, they mandated stagnation.

When you allow banks to hold less capital when financing what’s perceived as safe than when financing the risky; banks earn higher expected risk adjusted returns on equity when financing the safe than when financing the risky; and so you are de facto instructing the banks to stop financing the riskier future and keep to refinancing the safer past… something which guarantees stagnation… a failure to develop, progress or advance… something which guarantees lack of employment for the young and retirement hardships for the old. 

I would prefer not to distort the allocation of bank credit but, if I had to, then I would try to ascertain that bank credit goes to where it could do the society the most good; in which case I would consider basing these on job creation ratings and environmental sustainability ratings, and not on some useless credit ratings already cleared for by banks with the size of their exposures and interest rates.

PS. If you want more explanations on the statist and idiotic bank regulations that are taking our Western society down, here is a brief aide memoire.

PS. If you want to know whether I have any idea of what I am talking about, here is a short summary of my early opinions on this issue since 1997.

Mr Hiroshi Nakaso, you are wrong! You and your colleagues, so irresponsibly, changed the nature of our banks.

Mr Hiroshi Nakaso, Deputy Governor of the Bank of Japan gave on March 21, 2016 a speech titled “Challenges toward financial stability and the policy frontier – unconventional monetary policy, macro-prudence, and financial institutions’ low profitability” 

In it he said: “Joseph Alois Schumpeter, in his seminal “The Theory of Economic Development” stresses the important role played by the “banker”, as well as that of the “entrepreneur”. The banker profits from her ability to identify those entrepreneurs who develop truly innovative undertakings that are high-quality startups, and from generating information that leads to improved corporate performance. Schumpeter expects that such profit motives of the banker backed up by her exceptional ability to pick winners would bring about a more efficient reallocation of risks in the macro economy and lead to an endogenous rise in the economic growth rate.

This role of the banker- promoting the creative destruction through financial intermediation – has not changed since the time of Schumpeter.”

You are so wrong Mr Nakaso! You and your colleagues have changed the role of the banker.

With your risk weighted capital requirements for banks, which allow banks to leverage more their equity with what is perceived safe than with what is perceived risky; and thereby be able to obtain higher expected risk-adjusted returns on equity when financing what’s “safe” than when financing what’s “risky”, have certainly changed the role of the banker.

Nowadays his role, as you and you colleagues have seen it fit, is simply to avoid taking credit risks.

If you do not believe me look at the following authorized bank equity leverages in Basel II. (The risk weights in Basel III remains the same)

When lending to prime sovereigns, the sky is the limit. 

When lending to the AAArisktocracy 62.5 times to 1.

When financing residential housing 35.7 times to 1

And when lending to risky unrated SMEs and entreprenuers, only 12.5 times to 1

And that Mr Nakaso, is why banks do not any longer finance the riskier future, they just refinance the, for the very short time being, safer past.

The next generations will hold you and your colleagues accountable for this regulatory atrocity.