Basel I, II, and III are all examples of pure unabridged regulatory statism

In July 1988 the G10 approved the Basel Accord. For its risk weighted bank capital requirements it assigned the following risk weights:

0% to claims on central governments and central banks denominated in national currency and funded in that currency. 

100% to claims on the private sector.

That means banks can leverage much more whatever net margin a sovereign borrower offers than what it can leverage loans like to entrepreneurs. That means banks will find it easier to earn high risk adjusted returns on their equity lending to the sovereign than for instance when lending to entrepreneurs. That means it will lend too much at too low rates to the sovereign and too little at too high rates to entrepreneurs.

In other words Basel I introduced pure and unabridged statism into our bank regulations. 

Basel II of June 2004 in its Standardized Risk Weight, for the same credit ratings, also set lower risk weights for claims on sovereigns than for claims on corporates.

In a letter published by FT November 2004 I asked: “How many Basel propositions will it take before they start realizing the damage they are doing by favoring so much bank lending to the public sector. In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits.”

And the European Commission, I do not know when, to top it up, assigned a Sovereign Debt Privilege of a 0% risk weight to all Eurozone sovereigns, even when these de facto do not take on debt in a national printable currency.

And, to top it up, the ECB launched its Quantitative Easing programs, QEs, purchasing European sovereign debts.

At the end of the day, the difference between the interest rates on sovereign debt that would exist in the absence of regulatory subsidies and central bank purchases, and the current ultra low or even negative rates, is just a non-transparent tax, paid by those who save. Financial communism

And all this began one year before the fall of the Berlin Wall

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%?

Anat Admati explains the financial crisis better than most, but does still not get to the real heart of it.

I refer to Promarket.org and Evonomics.com where Stanford professor Anat Admati discusses her paper “It Takes a Village of Media, Business, Policy, and Academic Experts to Maintain a Dangerous Financial System” May 2016.

In it she explains how a mix of distorted incentives, ignorance, confusion, and lack of accountability contributes to the persistence of a dangerous and poorly regulated financial system.

Here some quotes and comments:

1. “Admati draws a contrast with aviation. Although tens of thousands of airplanes take off and land, often in crowded skies, busy airports, and within short time spans, crashes are remarkably rare. Everyone involved in aviation collaborates to maintain high safety standards”

PK. The main explanation for that is that everything in aviation is considered risky… and there are no aviation regulators giving anyone the excuse of “at this point you can relax”.

2. “When they seek profits banks effectively compete to endanger their depositors and the public. An analogy would be subsidizing trucks to drive at reckless speed even as slower driving would cause fewer accidents.”

PK. Of course allowing reckless speeds, like no limit at all when lending to Greece, and 62.5 times when AAA to AA ratings are present, must cause serious crashes.

But, the worst part of it all is that banks are not allowed to drive all assets at the same speed. As a consequence, being paid on delivery, banks will not go to where they must go slower, like the leverage speed limits that apply when lending to entrepreneurs, and will therefore not perform their vital function of allocating credit efficiently to the economy. The words “the purpose of banks is” are sadly nowhere to be seen in bank regulations.

3. “Politicians, find implicit guarantees attractive because they are an ‘invisible form of subsidy’ that appear free because they do not show up on budgets, as the costs associated are ultimately paid for by the citizenry.”

PK. At this moment the statist regulators and politicians find those “implicit guarantees” especially attractive because of its quid-pro-quo component. “We scratch your back with implicit guarantees and you scratch ours something for which we in 1988, with the Basel Accord assigned to the sovereign a 0% risk weight, and one of 100% to the citizen” And ever since the “good and friendly” sovereigns have had access to subsidized credit… and the regulators have now painted themselves into a corner. 

4. “Credit rating agencies, “private watchdogs,” have conflicted interests because they derive revenues from regulated companies as well as sometimes from regulators.”

PK. Yes but notwithstanding that, even if the credit rating agencies have behaved totally independent, there can be little doubt that assigning so much decision power to some few human fallible credit rating agencies would introduce the mother of all systemic risks.

And besides, since bankers already consider risks perceived when deciding on size of exposures and risk premiums to charge, to have perceived risks also reflected in the capital requirements, violates the “Kurowski dixit” rule: “Risks, even when perfectly perceived, leads to the wrong actions, if excessively considered.” 

5. “I had expected academics and policy makers to engage and care about whether what they were saying and doing was appropriate, particularly since they often know more than the public about the issues and are entrusted to protect the public”

PK. So had I. They, Anat Admati included, are still not able to explain to regulators about conditional probabilities. And so regulators keep on regulating based on the perceived risk of assets and not based on the risk of assets based on how these are perceived.

In terms of airplanes they regulate based on how the pilots perceive the risks and not based on that the pilots could perceive the wrong risks or act incorrectly when facing the correct risks.

6. “Lawmakers are rarely held accountable for the harmful effect of implicit guarantees combined with poor regulations.”

PK. Yes not one single regulators have been forced to parade down 5thAvenue wearing a dunce cap. On the contrary many of them have been promoted and are still regulating without even considering the possibility they have been mistaken all the time.

PS. Even though Daniel Moynihan is supposed to have opined: “There are some mistakes it takes a Ph.D. to make”, the challenges still remain for the PhDs about what to do with the opinions of the lowlier graduates, like with just an MBA. Do we dare to quote him?

Here my very early opinions on this issue

Here some letters Washington Post have published

And here my soon 2.800 letters to the Financial Times on this. Am I obsessed? Sure, but so are they ignoring my arguments.

And finally here a humble home-made youtube https://youtu.be/TUdKhm6_a8Y

It behooves us to revise the purposes of our banks, as these are defined by current capital requirements

The lower a capital requirement is, the higher can a bank leverage its equity, the higher is the risk adjusted return on equity it can obtain.

Risk weights of: sovereign 0%, AAA rated 20%, residential housing 35% and unrated SMEs 100%, clearly indicate that the de facto purpose regulators have imposed on banks, is to finance sovereigns, those who already enjoy the lowest risk-premiums, and those buying houses and therefore implicitly house prices. 

Regulators have told us this is so that our banks are made safe. Silly! Our bank systems are never threatened by “risky” SMEs and entrepreneurs, only by that perceived ex ante as very safe and that ex post turns out to be very risky. 

I would expect much more from our banks, like financing development, sustainability and job creation; and I would assume many would agree with me.

If we want that produced by banks, by means of allocating credit as efficiently as possible to the real economy, then we should make sure every single bank asset, except for cash, generates exactly the same capital requirement.

Now if regulators absolutely insist on nudging, so to be perceived as earning their pay, then perhaps they could base their capital requirements on how the asset helps to finance development, sustainability and job creation.

And, if regulators want to be really sophisticated about it, then the could even fill each box of a purpose/credit risk matrix with individual capital requirements… always of course remembering the golden rule of the riskier it seems ex ante the safer it is ex post. 

PS. Perhaps the capital requirements could even be slightly based on gender, so as to give women some compensation for all the disadvantages we are told they suffer. (Psst some tell me that loans to women also carry less risk)

10 years after, the problem is not that some are forgetting bank regulations, but that most never learned about these.

1. Allowing banks to leverage their equity more with The Safe, like with Sovereigns and AAA rated, than with The Risky, like with SMEs, allows banks to earn higher risk-adjusted returns on their equity with The Safe than with The Risky. 

2. That distorts the allocation of bank credit to the real economy causing banks to lend too much to The Safe and too little to The Risky.

3. And all for nothing because all major bank crisis have resulted from excessive exposures to what was perceived as belonging to The Safe, and never ever from exposures to something perceived as belonging to The Risky when placed on bank's balance sheets. 

Since risk weighted capital requirements for banks are still used, we are still on the same route to new similar failures.

 

Here is much more on this

Our modern statist rulers insidiously debase our currencies with their decreed zero-risk weighting of sovereigns

Lawrence W. Reed in “Did You Know about the Great Hyperinflation of the 17th Century?” FEE August 2017, quotes Nicolaus Copernicus (1473–1543) with: “The greatest and most forbidding mistake has to be when a ruler tries to make a profit from the minting of coins by introducing and circulating new coins with an inferior weight and fineness, alongside the originals, and claims that they are of equal value”

And Reed notes: “Desperate to raise cash and secure material for war, many of the German states in 1618 resorted to the debasement of coinage. They clipped and they melted. At first, they adulterated their own coin but then discovered that they could do the same to that of their neighbors too.”

Our modern governments use much more refined and insidious debasement methods. In order they say to make our banks safe, regulators came up with the risk weighted capital requirements which assigned to the sovereign a risk weight of 0%... yes, you read it well, zero percent.

That means that banks are able to leverage any little net margin obtained on public debt, into great returns on equity. That means that banks will be offering to hold a lot of public debt at low rates which will help to confound all the rest of investors into believing the markets believe that debt to be intrinsically safe.

That also means banks are going to absorb much more of the governments injections of liquidity than would otherwise have been the case.

One day buyers of public debts of these by regulators decreed ultra-safe sovereigns, are going to wake up.

When that happens all bets are off. Interest rates on public debt will shoot up, repaying governments will inject liquidity that will be impossible to drain… and economic realities will be hyper-inflation/hyper-recession messy.

When will that happen? Who knows, in Europe governments have already recruited insurance companies to also operate under a scheme similar to the banks’ Basel I, II and III, and which has quite cynically been named Solvency II.

Why is this all unsustainable? Any system, in which government bureaucrats can, without being responsible for its repayment, have easier access to other peoples’ money than for instance the 100% risk weighted SMEs and entrepreneurs, simply cannot end well.

PS. I often hear the argument that if sovereigns borrow in their own currency they represent indeed a zero risk because they will always be able to repay. Wow they’ve got to be kidding! True repayment does only happen when done with purchase power that has not been diluted by inflation.

PS. The confession that shall not be heard: “Assets for which capital requirements were nonexistent, were what had most political support: sovereign credits… A simple ‘leverage ratio’ discouraged holdings of low-return government securities" Paul Volcker 2018

PS. Here is a current summary of why I know the risk weighted capital requirements for banks, is utter and dangerous nonsense.

PS. My 2019 letter to the Financial Stability Board