Who on earth authorized the Basel Committee to do more than regulate or supervise banks?

The Basel Committee for Banking Supervision, whose recommendations the USA has committed to follow, has decided that when a bank lends to the government it requires zero capital but that when it lends to a small businesses or entrepreneur, it needs 8 percent of generously defined bank capital (Basel II), or 7 percent of more strictly defined bank capital (Basel III).

In doing so the Basel Committee is doing much more than regulating and supervising banks, it is de-facto introducing a monstrous, almost communistic, pro-government bias into the world’s financial system, as well as an unexplained risk-adverseness that could easily jeopardize the creation of the next generation of decent jobs. 

Besides it is utterly stupid because never ever has a bank crisis originated because of excessive lending to those who like small businesses or entrepreneurs are perceived as more risky, and therefore already pay higher interest rates, which goes into the capital accounts of the banks.

Who on earth authorized the Basel Committee to do what they do and which, by the way, sounds so un-American?

Crazy bank regulations explained in red and blue

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!

A letter from a citizen to Mme Christine Lagarde

Dear Mme Christine Lagarde.

I wish you all the best of luck as the new Managing Director of the International Monetary Fund… albeit that luck I wish not only for yourself, but also because at this moment it really behooves us all that you’ll have lots of it.

But, just as another of the most humble stakeholders in the IMF, an ordinary citizen, and since IMF has a fundamental role in leveraging knowledge and ideas with respect to the world’s financial system, I would beg you to consider the following that I feel is crucial for yours and our chances of success.

Currently the “capital requirements for banks” are set by discriminating borrowers based on their “perceived risk of default”, mostly as perceived by the credit rating agencies. More perceived risk, more capital, and vice-versa.

But, this is not logical, given the fact that what regulators need not to concern themselves much with the risks that are perceived, but should concern themselves mostly with the risks that are not perceived.

And, it is also not logical, given the fact that there has never ever been a financial crisis resulting from excessive lending to what is perceived as “risky”, since, except for cases when fraudulent behavior has been present, they have all resulted from excessive lending to what is perceived as “not-risky”. Just look at the current crisis, 100% caused by leveraging the perceived as "not-risky" and then discovering these, later, as being very-risky!

And, it is also not logical, given that those perceived as “risky” are already compensating the capital accounts of the banks by means of paying higher risk-adjusted interest rates.

And, it is also not logical, given that it imposes on those deemed as “risky”, like the small business and entrepreneurs, the need to pay additional interest margins to banks, which I currently calculate in the order of 270bp, just to compensate for the regulatory advantages given to those who are perceived as “not-risky”, the triple-A rated.

And, it is also not logical, given that those deemed as “risky”, like the small business and entrepreneurs, with little or no access to capital markets, are often those whose credit needs we most expect our banks to serve.

Mme Lagarde, if you absolutely think bank regulators must interfere by defining capital requirement for banks in ways that discriminate among borrowers, then… why not have the regulators discriminate the capital requirements for banks based on the potential of the different borrowers to generate the next generation of decent jobs?

Again, wishing you (and us) the best of luck

Yours sincerely,

Per Kurowski

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

Our crazy bank regulations explained in 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?

What would Le Vieux Lion Winston Churchill had said about the bank regulators in the Basel Committee?

These regulators bribe the banks by means of ultra-low capital requirements to go where their official risk perceivers, the credit rating agencies, perceive the risks of default to be low, and to avoid like a plague servicing the needs of the risk-taking small businesses and entrepreneurs upon whom Europe´s greatness and future jobs depends?

You wimps!?

Per Kurowski’s quiz for the candidates to Managing Director of the IMF

Q1. Which type of bank clients can generate such a massive exposure so as to trigger a systemic bank crisis?

a. Those perceived as risky (small businesses and entrepreneurs)

b. Those perceived as not risky (triple-A rated)

Q2. The needs of which clients do we most expect our banks to attend to?

a. Those perceived as risky with no access to capital markets (small businesses and entrepreneurs)

b. Those perceived as not risky and with access to capital markets (triple-A rated)

Q3. The Basel Committee allows for much lower capital requirements for banks (five times less) when lending to those perceived as not risky (triple-A rated). Based on your previous answers, which would be your most likely opinion?

a. I fully agree with the Basel Committee

b. The Basel Committee might have got it all completely upside down.

Note: The responses of “b, a, and b” would qualify the candidate to proceed to further tests.

TWO EXAMS

The bank regulator’s exam

1. Which type of bank clients can create such a massive exposure so as to generate a systemic bank crisis?

a. Those perceived as risky (small businesses and entrepreneurs)

b. Those perceived as not risky (triple-A rated)

2. The needs of which clients do we most expect our banks to attend to?

a. Those perceived as risky with no access to capital markets (small businesses and entrepreneurs)

b. Those perceived as not risky and with access to capital markets (triple-A rated)

The bank regulators, represented by those in the Basel Committee answered (a) to the first question, and totally ignored the second. As a consequence they imposed higher capital requirements on banks when lending to client “officially” perceived as riskier, and vice versa.

Our exam

1. How did the bank regulators do?

a. They failed miserably

b. They excelled!

2. If your answer is (a) but we are yet leaving our regulations in the hands of exactly the same regulators what does that say about us?

a. We’re stupid

b. We’re smart

Our crazy bank regulations explained in red and blue

Nannies care for risks perceived, regulators should care for the risks not perceived. So you tell me, the Basel Committee, the FSA and the FSB, what are they?

2003: During many days I’ve not heard a single word indicating that growth and credits, are also a function of bank regulations.

2009: Please free us from imprudent risk aversion and give us some prudent risk taking

2023: Chatting with AI – Open AI – ChatGPT, about the kind of credit diet, nutrients, banks should feed the economy.

How sad bank regulators didn’t listen to Pope John Paul II

The Basel Committee for Banking Supervision, and other assorted bank regulators, decided to increase the risk-adverseness of banks by imposing on them capital requirements based on officially perceived risk, among other as perceived by some few officially appointed risk-perceivers, the credit rating agencies.

And, naturally, if when doing so one favors the financing of houses, public debt and whatever has managed to temporarily hustle up a good credit rating, and discriminate against all of what is officially perceived as “risky”, like small businesses and entrepreneurs, one will, naturally, end up with a lot of houses, dangerously excessive lending to what is triple-A rated, a huge public debt, and very few jobs which, to create, requires a lot of risk-taking.

How sad the regulators did not listen to Pope John Paul II when he said “Do not be afraid. Do not be satisfied with mediocrity. Put out into the deep and let down your nets for a catch.” "Duc in Altum"

My letter to the Basel Committee on Banking Supervision and the Financial Stability Board

Basel Committee on Banking Supervision
Financial Stability Board

Dear Regulators

Since you still seem to be completely unaware of it, let me put forward a kindly reminder:

There has never ever been a major bank crisis caused by excessive lending or investments to what was perceived as risky, and these have all resulted from either unlawful behavior or excessive lending or investment into what was perceived as not risky, but later turned out to be.

Against that fact your capital requirements, based on the perceived risk, as perceived by your official risk-perceivers, the credit rating agencies, that establishes higher capital requirements for what is perceived as risky and lower for what is perceived as not risky, seems to be sort of a dumb idea. If anything, on a purely empirical basis, higher capital requirements for what is perceived as not risky would make more sense.

And, while I am at it, let me also remind you that the banks already use the information provided by the credit rating agencies when deciding what amounts and at what margins to lend to a client, and so to force them to also consider these for their capital base, gives the credit ratings a double weight, and, as we all know, even the best information, if it is excessively considered, is wrong.

By the way, your capital requirements, amount to an outright discrimination of those who we most need our banks to attend, the small businesses and entrepreneurs. Shame on you!

Best regards,

Per Kurowski
A former Executive Director at the World Bank (2002-2004)
http://subprimeregulations.blogspot.com/

Basel‘s monstrous regulatory mistake

The regulators notwithstanding that the market and the banks already considered the credit ratings when setting their risk premiums and interest rates, considered exactly the same information when setting their capital requirements for the banks. This double consideration, which would have been wrong even in the case of perfect credit ratings, leveraged incredibly the systems dependence on the human fallible credit ratings.

And now, more than three years into the crisis, the Basel Committee, FSB, FAS, Fed, IMF, World Bank, PhDs and finance experts, specialized journalists, like all those in FT, and most other who have and give opinions on the issue of bank regulations, have yet to say one single word about a mistake that really makes it impossible to construe any worthy bank regulation on top of it.

One really wonders what world we live in, when the regulators is turning our whole banking system sissy... and making it impossible for banks to allocate credit efficiently to the real economy.

PS. The monstrous mistake, which evidences our bank regulators have never walked on main-street, is that they believe what’s perceived as risky, is much more dangerous to our bank systems than what’s perceived as safe:  My 2019 letter to the Financial Stability Board 

Postscript: Basel Committee, please listen to Violet Crawley, don't be so defeatist, it’s so middle class. 

https://youtu.be/g9XQ3_LCl-Q

Fraulein Basel’s Chocolate Cake

There was once a family where mother father, elder brothers and sisters and, of course, the grandparents, all lovingly cared for the well-being of the youngest family member, little Bob. For instance, they always informed little Bob about the risks they perceived existed in park AAA when compared to those present in the riskier park BBB. But, that said, they were also very careful of not producing any undue temerity in little Bob, since, besides wanting him to grow up and become a daring man, and not remain a frightened boy, they also knew he needed to go and play in park BBB, quite often, because there was where he could get the exercise that could make him strong. All in all, little Bob was growing up nicely.

Unfortunately, one day the family hired a governess to watch out over young Bob, Fraulein Basel. She, scared stiff she would be blamed for anything bad that could happen to little Bob, promised him a whole chocolate cake every day, if he would only go and play in the super-safe park AAA. Little Bob, as any healthy young boy, was naturally thrilled with the idea, and thereafter visited only park AAA. But, after eating a whole cake every day, one day in park AAA, suddenly, out of the blue, an  extremely slow but yet venomous snake appeared, and little obese Bob could not run away, and so little Bob tragically died.

And that my friend is what happened to our banks when we placed them in the overly caring nervous hands of Fraulein Basel Committee. 

But now, more than three years into a crisis that has caused so much misery around the world, we have yet to hear the World Bank and the IMF or anyone else for that matter commenting on the role of Fraulein Basel’s stupid chocolate cake. 

And our banks are still in Fraulein Basel hands even though we know she has not abandoned the stupid idea of the chocolate cake, and thinks it is only a matter of a better chocolate cake, Basel III; which she will soon present to another little Bob… or Hans… or Pedro… since her reach is global.

Translation: The mother of all regulatory mistakes

The Basel Committee even though they knew that banks were already considering the information on risks of default when they calculated the risk premiums and set the interest rates, decided to use that same risk information to set their capital requirements. Of course, considering the same risk information twice, exposed the bank more than ever to the very real possibility of that risk information not being perfect.

That stupid and unforgivable mistake resulted in: 

1. The setting of minimalist capital requirements that served as growth hormones for the ‘too-big-to-fail’. 

2. That banks overcrowded and drowned themselves in shallow waters, whether of triple-A rated securities backed with lousily awarded mortgages to the subprime sector, or of equally or slightly less well rated “infallible” sovereigns, like Greece. 

3. A serious shrinkage of all bank lending to small businesses and entrepreneurs, as lending to these generated, in relative terms, much higher capital requirement, which made it difficult for them to deliver a competitive return on bank equity.

And the dumb regulators have still not understood, that you do not regulate banks based on perceived risks, but based on what banks might do with perceived risks.

PS. Now, in 2024, I asked AI’s opinion on whether as a grandfather I should be concerned with the future current bank regulations might have doomed my grandchildren to encounter. It answered: "You're absolutely right to be concerned, and it's completely understandable to question the decisions that have shaped the financial world your children and grandchildren will inherit."

A sort of a shoddy investigation!

I refer to the “Wall Street and the Financial Crisis: Anatomy of a Financial Collapse” report by the Senate Permanent Subcommittee on Investigations. It is a sort of shoddy investigative work. Why?

On April 28, 2004 the Securities and Exchange Commission authorized the investment banks to dramatically increase their leverage, among other when investing in securities backed by mortgages to the subprime sector. The SEC resolution establishes the explicit condition that it has all to be done “consistent with the Basel Standards”.

The Report of 650 pages, does not mention the Basel Committee once!

And why do the Basel Standards, issued by the Basel Committee matter? The answer is simple; it was the Basel Committee which produced and disseminated the regulatory mistake that caused this crisis. Here follows a very brief description of that fatal mistake.

The Basel Committee’s mistake

If all sovereign and private bank clients were paying the banks exactly the same risk-premiums, then the risk-weights used in Basel II to apportion the basic capital requirements for banks according to the various categories of credit ratings could have been right. But, they don’t!

The banks and the markets already incorporates in the setting of their risk-premiums the risk information provided by the credit rating agencies, and so when the regulators also used the same credit ratings for setting their risk-weights they made these ratings count twice. That huge mistake resulted in:

1. The setting of minimalistic capital requirements that served as growth hormones for the ‘too-big-to-fail’.

2. That banks overcrowded and drowned themselves in shallow waters, whether of triple-A rated securities backed with lousily awarded mortgages to the subprime sector, or of equally or slightly less well rated “rich” sovereigns, like Greece.

3. A serious shrinkage of all bank lending to small businesses and entrepreneurs as lending to these generated, in relative terms, much higher capital requirement, which made it difficult for them to deliver a competitive return on bank equity.

With Basel III, regulators might be trying to correct for this mistake, instead of correcting the mistake. In other words, the Basel Committee is digging us deeper in the hole where they placed us.

The Shocking Basel II Discrimination

The market, looking at all risk information, which includes that of the credit rating agencies establishes some risk premiums that will make lending to different perceived risks equivalent. But then tha Basel II regulators made the mistake of using the same information provided by the credit rating agencies by mean of the risk-weights they applied and in doing so discriminated excessively in favor of what was officially perceived as having a very low risk of default. the AAAs. The following table illustrates the gigantic magnitude of that regulatory anti-risk-bias for a figurative example of how the market could be viewing a  AAA risk versus a Not Rated risk:

Is “Inside job” doing an inside job on us?

“Inside Job” the Oscar winning documentary on the financial crisis that has put the global financial stability in jeopardy touches upon most issues and actors involved, spending even several minutes of the role of cocaine and prostitutes. Yet, amazingly, it does not mention even once the Basel Committee for Banking Supervision, the global bank regulator and that in my opinion is the one most to blame for the crisis.

Should it? In one of the opening scenes of “Inside Job” refers to the Securities and Exchange Commission’s meeting on April 28, 2004 when the SEC authorized the investment banks to dramatically increase their leverage, among other when investing in securities backed by mortgages to the subprime sector. That SEC resolution explicitly made an explicit reference that it has all to be done “consistent with the Basel Standards”.

Is “Inside job” doing an inside job on us?

The Basel Committee makes a shocking confession!

The Basel Committee for Banking Supervision, speaking for all sophisticated bank regulators around the world, issued today an urgent statement regarding the discovery of a fundamental mistake committed in Basel II and which they now understand was responsible for causing the current financial crisis.

The mistake was that though the markets and the banks were already incorporating the information about the possibilities of default that were contained in the credit ratings when calculating the corresponding risk premiums to set interest rates for their clients, the regulators based the capital requirements for banks on exactly the same credit ratings, and so, unwittingly, accounted for said credit information twice.

The result of it was, of course, the excessive financing of everything that was officially deemed as having a low risk of default, like whatever had swell ratings like Greece and securities backed by lousily awarded mortgages to the subprime sector; and the insufficient financing of whatever was officially deemed as more risky, like the small businesses and entrepreneurs who are vital for maintaining that dynamism of the economy that creates jobs.

The Basel Committee expresses its most sincere regrets for such a mistake and promises to take immediate corrective action.

PS. April Fool´s joke disclaimer: Sorry, unfortunately, the Basel Committee and the sophisticated bank regulators, three years into a crisis of its own making, are still not (publicly) aware of their mistake.

The Independent Evaluation Officer of the International Monetary Fund has recently in an Evaluation Report come to the conclusion that, for IMF at least, “the ability to correctly identify the mounting risks was hindered by a high degree of groupthink…” The reason why the truth of what happened does not come out must probably now be attributed to group-interests.

What Lord Turner hasn´t the foggiest about!

Since the 8 per cent capital requirement of Basel II and applied with a risk-weight of 100 per cent proved to be more than sufficient to cover for the risks of bank lending or investing in what was officially perceived as “risky”, it is clear that the problem does not lie with a too low basic capital requirement but with the too low risk-weights applied to all what is officially perceived as “not risky”.

This is what a Mr. Lord Turner, who now says “security can only come with 15 to 20 per cent” capital requirements, hasn´t the foggiest about.

Mr. Lord Turner also says “Financial instability is driven by human myopia and imperfect rationality” Absolutely! But when is he going to realize that the regulator´s myopia, including his own, might be the most systemically dangerous.

Our banks… a bad road leading from nowhere to nowhere!

A road can be extremely well constructed but lead from nowhere to nowhere. That is why it so extraordinary that we allow the global regulators in the Basel Committee to regulate our banks without defining a purpose for our banks. That said, since the Basel Committee proved that it was not even good at regulating basic road engineering, we now have a bad road coming from nowhere and leading to nowhere.

Let me explain why besides lacking a purpose, the regulations of our banks are so lousy.

The only risk the regulators considered in order to set the capital requirements for the banks in Basel II was the risk of default of their clients, mostly as this was perceived by the credit rating agencies. The higher the perceived risks, the higher were the capital requirements and vice versa.

The above though sounding logical completely ignored that the market already arbitrages for the information provided by the credit rating agencies about risk of defaults, by means of adjusting the risk-premiums it applies. Therefore, the unforeseen but should have been foreseen results of these capital requirements based on risk, was to dramatically increase the risk-adjusted return on bank capital when lending to anything perceived as “not-risky”, while making it, in relative terms, dramatically much less attractive to finance anything officially perceived as “risky” and that for its same adjusted risk premium requires more bank capital.

No wonder that the banks stampeded into the triple-A rated waters where, since real triple-As are and will always be extremely scarce or non-existent, the market had provided some Potemkin triple-A ratings.

The only real Black Swan event that caused this crisis was that amazingly inept regulators got hold of the Basel Committee… and the most amazing thing is that they are still there!

Is the USA now a submerging country?

"Are America's Best Days Behind Us?" by Fareed Zakaria in Time of March 3, 2011

Risk taking is the soul and essence of a country emerging, growing and moving forward. Risk-aversion is the natural reflection of a country that has had enough.

When the USA, which proudly refers to itself as “the land of the free and the home of the brave”, decided that their banks, their frontline of risk-takers, were going to be allowed to have immensely less capital when dealing with what was perceived as “not risky”, like what’s dressed up in triple-A ratings or lending to the government, than when lending to their small businesses and entrepreneurs, then the USA called it quits, and placed itself on the slippery slope of going down and down… fast or slow… but submerging.

The first thing the banks did was then to obediently go and massively enter the triple-A rated waters, where the sharks of the real economy where waiting for them… If that is not submerging what is?