Universities, standardized tests, tuition fees, banks, credit ratings, capital requirements

What if someone suggested that the tuition fees of universities should bear direct relation with the results of standardized tests? The better the results, the much lower the fees, the lower the results the much higher the fees. Sounds reasonable eh? 

That is, until sometime questions if those standardized tests really measure the diversity of capabilities we want to be present at our universities, because just the fact that already so much of the current selection process is based on these standardized tests that might be bad enough. 

In terms of bank regulations, the credit ratings, the risk perceptions, are the equivalent to those standardized tests. If those ratings are not good, borrowers will already need to pay higher interest rates, will get smaller loans and on stricter terms and so, to also have these risk perceptions count for setting the capital requirements might risk excluding some risky borrowers who could truly benefit the economy. 

And that is one of the many reasons I am so opposed to those utterly silly capital requirements for banks based on perceived risk and which by the way, in terms of the university, do not even guarantee that between those with excellent results in the standardized tests, there are not some really rotten apples, who will spoil it all.

I am truly concerned about the future of the Western world

Regulators, on their own initiative, instructed banks, by means of capital requirements based on perceived risk, to stay away, more than usual, from what was perceived as “risky” like the small business and the entrepreneurs, and embrace, more than usual, what was perceived as “not-risky”, like the triple A-rated or the “infallible” sovereigns. The fact, that this does not raise any eyebrows, bodes badly for a Western world, which became what it is thanks to risk-taking. 

If we do not rid ourselves of these dumb overly nanny regulators, the Western world is doomed to perish in some dangerously overpopulated absolutely safe-haven.

Mr. Bank Regulator. Please explain yourself!

In banking (as with most in life) with respect to perceived risks, there are only four possibilities: 

Risky/risky: What was perceived as risky turns out to be risky. Because of the higher interest rates usually charged to those perceived as risky, which serves as a shield, the harsher terms, and the lower bank exposures that follow, this quadrangle has never ever been the source of any major bank disaster. 

Risky/not-risky: What was perceived as risky turn out not to be risky. This can only be of course, a source of good news. 

Not-risky/not-risky: What was perceived as not-risky turn out not to be not-risky. In other words, all as expected. 

Not-risky/risky: What was perceived as not risky, turned out to be risky. This is of course the only source of all major bank crises, namely when major bank exposures gone sour. 

But, the current “pillar” of bank regulations, is capital requirement for banks which allow for much less bank capital when lending in the danger area of the perceived “not-risky”… and that does not seem too smart. 

Not only will the increased possibilities of leveraging bank equity attract too much bank interest in lending to the “not-risky”, but also, when things go sour, the banks will stand there naked, with little or no capital. And it also creates a regulatory disincentive for banks to lend to the safe area of the perceived as risky… and which by the way includes the small businesses and entrepreneurs we so much need to have access to bank credit. 

Indeed that regulation sounds very dumb, which leads me having to consider you, as a bank regulator, to be very dumb. I have for almost a decade now tried to get an explanation from you, but you have consistently refused to do so. You have not even acknowledged the arguments. And so, here is a new opportunity for you to explain yourself. 

Let me assure you that I would love for you to be able to convince me that, with your regulations, you are not castrating our banks, that important channel by which a risk adverse society takes the risks it needs for it to take, without making these safer, but in fact even endangering these. 

What’s my problem? I tell you! If you would run a regression between all the obese bank exposures that have lately gone bad, and the extremely low capital requirements allowed banks for holding these assets, one should conclude that your dumb regulations fundamentally caused this crisis. And, for that, you need to be held accountable, most especially when you seem quite unwittingly to be digging our economies even deeper in the hole. 

Sincerely 

Per Kurowski 

Two whys on bank regulations

How can I, as an ordinary citizen, obtain a decent return on my savings when investing in safe securities, having to compete with banks who can leverage their equity more that 60 to 1 when they do so?

How can I, as an ordinary small businesses or entrepreneur, get a decent interest rate on my bank loans, when banks can leverage their equity so much more when lending to those officially perceived as not-risky? 

It is so unfair! Who are these bank regulators? Who invested them with so much power?

You will not get the jobs you need while bank regulators discriminate against the safe perceived as risky.

Current capital requirements for banks are lower when these lend to those officially perceived as not-risky and that amounts to an outright discrimination of those officially perceived as “risky”, the small businesses and entrepreneurs. As a consequence, these safe-risky, have to pay much higher interest rates and get smaller loans on tougher terms than they would have had without this regulatory distortion. It is not right for this to be happening in a land that prides itself to be brave, and much less will it help America (or Europe for that matter) to get the jobs it needs. 

Stop it! Start working immediately for one and the same capital requirement for banks on any type of assets, to any type of client.

And please, don´t worry. Those perceived as risky have never ever caused a major bank crisis, and your regulators should know that.

Here is the complaint I presented to CFPB

Do bank regulators suffer from damage in the ventromedial prefrontal cortex?

All major bank crises originate not from too much lending to what is perceived as risky, that never happens, but from too much lending to something perceived as absolutely not risky but that later becomes very risky, and this often because too much has been lent to it. This is a fact, and regulators, financial journalists and other experts know it. 

And yet, bank regulators set up capital requirements for banks that were much higher when the perceived risk were higher than when the perceived risk were lower, and thereby generated the incentives for too much lending to the latter… as a result of that since banks were allowed to leverage their equity more when doing so, banks could obtain a higher return on their equity when lending to what was officially deemed as absolutely not risky. 

And that not only caused the current crisis but it also keeps us from digging ourselves out of it, as it discriminates against all the “risky” small businesses and entrepreneurs we need to help us. 

And no matter how much I have written about it, the regulatory nannies don’t seem to get it, and keep on digging us, deeper and deeper, into what I have called “L’economia castrata”, that which so dangerously discriminates against what seems as “risky”. Why is this so? 

Well Malcolm Gladwell, in his book “Blink”, 2005, wrote that those who suffer from damage in the ventromedial prefrontal cortex, “can be highly intelligent and functional, but they lack judgment”, and that it “causes a disconnect between what you know and what you do”. Could that be it?

Capital requirements for banks, according to any behavioral finance, should NOT be based on perceived risk, but on what banks do with any perceived risk.

PS. Here my 2019 letter to the Financial Stability Board

It’s the stupid bank regulations stupid!

Those perceived as “not risky”, they have always paid lower interest rates, gotten larger loans, on softer terms, and attracted that type of large bank exposures that has caused all major bank crises, when some of them turn out to be very-risky. And so why, Mr. Bright Bank Regulator, do you allow the banks to hold less capital when lending to the “not risky”? That way the "not risky" get even lower interest, even larger loans, on even softer terms and we risk an even major systemic crisis, when some of these “not-risky”, like the triple-A rated securities, the infallible sovereigns like Greece, Icelandic banks, Spanish real estate borrowers and what awaits us, turn out to be very risky. Why are you so chummy with the dangerous not-risky, are you stupid? 

Those perceived as “risky”, like the small businesses and entrepreneurs, they have always paid higher interest rates, gotten smaller loans, on harsher terms, and never ever caused a major bank crisis. And so why, Mr. Bright Bank Regulator, do you require the banks to hold more capital when lending to the “risky” than when to the “not risky”, and so that the "risky" get charged even higher interests, get even smaller loans, on ever hasher terms, and so have even less chance of helping us to generate the growth and job opportunities we need, and, like now, help us out of the crisis generated by some “not-risky” ex-ante, turning very-risky, ex-post. Why do you treat the useful risky so bad, are you stupid? 

Mr. Bright Bank Regulator, if you absolutely must mess around with market signals, so you feel you have earned your salary, then why do you not at least base the capital requirements for banks on job creation and environmental sustainability ratings. That way these would at least serve a purpose.

The Western world is being brought to its knees by mad bank regulators

The Western world is the result of risk-taking in all shapes and forms… “God make us daring!” ends one of the psalms sung in its churches… and we honor the successful and feel for the unsuccessful. 

But regulators, concerned only with bank failures, decided on capital requirements for banks based on perceived risk. And with these they gave the banks additional incentives to embrace lending to those perceived as “not-risky”, like the triple-A rated and “infallible” sovereigns, and to further avoid the “risky”, like the small business and entrepreneurs. And with this they stuck a dagger in the very soul of the Western world. 

And the dagger proved also to be more than useless for its initial purpose. Since it is precisely when banks embrace too much something that is perceived as absolutely not risky, that they fail en masse, the regulators doomed the world to this the mother of all systemic bank crises. 

The survival of the Western world now needs to begin by rescuing the possibilities of its risky risk-takers to take the risks we depend upon as a society, and that requires to allow the “risky” to compete for bank credit without regulators discriminating against them. 

And that begins by firing the nannies in the Basel Committee and in the Financial Stability Board, and renaming the latter immediately the Financial Functionability Board so that the regulators do not forget what they are there for.

“L'economia castrata”: The castrated economy which resulted from when regulation nannies castrated our banks

What would you think of a military high command that ordered a testosterone reducer to be fed to the soldiers so they would expose themselves less to risks, and so fewer of them would die? Right! That would indeed be high treason, as it would guarantee defeat. 

But that is precisely what bank regulators have done to our banks: 

Current capital requirements for banks, based on ex ante perceived risk, allow banks to hold much-much less capital on assets perceived as “absolutely safe” than on assets perceived as “risky”. 

That allows banks to earn much-much higher risk-adjusted returns on equity, when lending to “The Infallible”, than when lending to “The Risky”; 

And that results in that banks will lend, even more than usual, at even lower rates than usual, to sovereigns, housing and the AAAristocracy; and even less than usual, at even higher rates than usual, to medium and small businesses, the entrepreneurs and start-ups. 

And those regulations signify, as you can understand, a powerful testosterone inhibitor. 

And so the regulators have effectively castrated the banks and as a result we have a castrated economy with growing dangerous obese exposures to what was or is officially deemed as “not-risky”, triple A rated instruments and “infallible” sovereigns and housing; and equally or even more dangerous anorexic exposures to what is officially perceived as “risky”, like small and medium businesses, entrepreneurs and start-ups. 

God save us! From dumb regulators who do not understand that risk-taking is the oxygen of any movement forward. 

And before we get the testosterone level of banks back to normal, there is no stimulus package that will work, and we will only be wasting away whatever little fiscal and monetary policy space remains. 

God make us daring!

The crisis explained in a tweet

Setting capital requirements for banks regulators cared about perceived risks, and not about how bankers react to these http://bit.ly/PcPq63

Registering a complaint with the Financial Ombudsman Service in UK

Sir, http://www.financial-ombudsman.org.uk/

The current capital requirements for banks are based on perceived risk, and are set considerably higher for when lending to “risky” subject than when lending to an “infallible”. 

This does not make sense, and it discriminates against those who are already discriminated against by being perceived as "risky", like small businesses and entrepreneurs, and benefits those who are already benefitted by virtue of being perceived as "infallible", like the triple-A rated and some temporarily lucky sovereigns.

That discrimination translates into that bank lending to the “infallible” can be leveraged many times more on bank equity than lending to the “risky”, and which in its turn signifies that the “risky”, on top of the higher risk margins already paid to the bank, have also to compensate the banker for this regulatory opportunity cost. That cost can often signify well over a hundred basis points… in fact it could be qualified as the mother of all interest rate manipulation schemes. 

Now if you absolutely cannot convince the regulator to stop discriminating based on perceived risks, then try at least to convince them of not using the perceived risks as such, but instead base their capital requirements on how bankers react when they see these perceive risks. 

And then, please remind them of Mark Twain’s banker, you know he who lends you an umbrella when the sun shines but wants it back the minute it looks like it could rain. Perhaps then they would be able to understand that if some bank assets should require higher capital than others, it is the assets perceived as absolutely the safest… and not the poor “risky” who have never ever caused a major bank crisis.

Thanks

Me, as a bank investor!

As an investor in a bank the first thing I want from it is to dedicate itself exclusively to lending to what is officially considered as “risky”, like small business and entrepreneurs, and for which the bank is required to have capital... meaning I count. 

I abhor my bank to lend to anything that is officially considered as “absolutely safe” for 4 reasons: a.- it will probably mean they will be less careful, b.- they can do so with much less bank capital and so therefore as a shareholder I become less important, c.- it is only in what is considered as not risky that the banks can build up exposures that can lead me to lose it all, d.- if I want to invest in something perceived as “absolutely not risky”, I do not need a bank for that... anyone can read a credit rating.

By the way, I suppose you have heard about risk-adjusted returns?

There are two completely different narratives explaining the crisis.

One narrative, the one favored by Matt Taibbi and alike is “It was all criminal intent… those banksters… they have to be destroyed…in fact everything in our society is rotten and it has to be destroyed”

The other, the one I know to be truer is “Of course, as always plenty of criminal action and human frailty was present, but is was primarily a consequence of almost criminal regulatory stupidity”.

Guess which version gets the highest ratings in our polarized reality show world?

You´ve got it! Mine does not even come close.

Run for your lives! A baby has peed in the pool!

I really do not care much about The Libor Affair, an interest rate manipulation scandal that has some winning and others losing, not really of much importance in the grand scheme of things.

And so, when compared to other official interest manipulations, like what happens when regulators dole out risk weights based on perceived risks to set the specific capital requirements for banks, The Libor Affair is basically the same as a little baby peeing in a big swimming pool. If chemical elements are used to detect it, and water turns blue, then everyone screams, though in fact no one really needs to care that much about it.

What really should upset us all is The Basel Affair, the greatest and most dangerous interest rate manipulation ever.

The complaint I presented to the Consumer Financial Protection Bureau CFPB

Introduced by means of:

https://help.consumerfinance.gov/app/tellyourstory

I refer to the Equal Credit Opportunity Act (Regulation B) in order to present the following complaint: 

Banks consider credit risk information, like that contained in credit ratings, when setting interest rates, amount of loans and other contractual terms… this causes a natural market based discrimination of those perceived as risky. We all know well Mark Twain’s description of a banker: that as the one who lends you the umbrella when the sun shines, and wants it back, urgently, when it looks like it is going to rain. 

But when bank regulators use the same credit risk information, in order to also determine the capital requirements for the banks, then they produce artificial regulatory discrimination in favor (a subsidy) of those already favored by being perceived as not risky, and against (a tax) those already being disfavored by being perceived as risky. And I argue that this regulatory discrimination is contrary to the spirit of the Equal Opportunity for Credit. 

The discrimination occurs in the following way. If a bank is allowed to have less capital when lending to the not risky that signifies he can leverage its equity more and therefore obtain larger returns on equity when lending to the “not-risky”. If a bank is forced to have more capital when lending to the risky that signifies it can leverage less its equity and therefore obtains lesser returns on equity when lending to those perceived as “risky”. To make up for this regulation and present the banks with the same opportunity of returns on their equity, the “risky” need to pay an additional interest rate, and this additional is quite substantial. 

The capital requirement regulations are explained in terms of making the banks safer, but that is not the case, in fact it makes the banks more unsafe. There has never ever been a major bank crisis that has resulted from excessive exposures to what was perceived as risky, think of Mark Twain’s banker, they have all resulted from excessive exposures to what was ex ante considered not risky, but, ex post, turn out to be very risky. And in that respect it allows for excessive leverage buildup precisely in those areas that contain the greatest risk and consequences of bad surprises, namely the lending to what is perceived as “not-risky”. 

Let me just end by commenting on the great contradiction that the discrimination of those perceived as risky, like the small businesses and entrepreneurs, really signifies in “a land of the brave”. 

Please help stop that odious discrimination. To deny those perceived as risky fair access to bank credit, is an act of regulatory violence.

PS. https://subprimeregulations.blogspot.com/2013/11/have-risk-weights-of-current-bank.html

PS. Just in case, the returns on equity I speak of are of course the risk-adjusted ones.

PS. You doubt what I say? Ask regulators these questions.

A brief summary of my thoughts on banks and risks

Capital requirements for banks which are lower when the perceived risk of default of the borrower is low, and higher when the perceived risk is high, distort the economic resource allocation process. This is so because those perceptions of risk, have already been cleared for, by bankers and markets, by means of interest rates and amounts of exposures. 

All current dangerous and obese bank exposures, are to be found in areas recently considered as safe and which therefore required these banks to hold little capital. What was considered as “risky” is not, as usual, causing any problems. This is not a crisis caused by excessive risk taking by the banks, but by excessive regulatory interference by naïve and nanny type regulators. 

And, if that distortion is not urgently eliminated, all our banks are doomed to end up gasping for oxygen and capital on the last officially perceived safe beach… like the US Treasury or the Bundesbank.

Bank regulators have no business regulating based on perceptions of risks being right, their role is to prepare for when these perceptions turn out to be wrong. 

You do not regulate banks based on perceived risks but based on what banks might do with the perceived risks.

A nation that cares more for history, for what is has got, for the haves, for their baby-boomers, for "The Infallible", the AAA rated or sovereigns, than for the future, for what it can get, for their young, for the not-haves, for "The Risky", the small businesses or the entrepreneurs, is a nation on its way down.

With capital requirements for banks based on perceived risk interest rates were manipulated… where do the risky sue?

When regulators set the capital requirements for banks based on perceived risks, even though these perceived risks are already priced in by the bankers in the interest rates, they are effectively manipulating the interest rates. The direct consequence is that those officially perceived as not-risky, have to pay much less interest than what would be the case without this distortion, and those officially perceived as risky need to pay much more… and all for absolutely no good reason at all.

And so when I read that Barclays has been fined £290m ($450m) for trying to manipulate a key bank interest rate which influences the cost of loans and mortgages, my first thought was, where can the “risky” small businesses and entrepreneurs sue the regulators for all the monstrously excessive interests they paid?

My simple calculations, here, indicate that a not rated bank client, exclusively on account of this odious regulatory discrimination, has to pay about 270 bp (2.7%) more in interest rates when compared to an AAA rated bank client… or, like now, in times of extremely scarce bank capital, suffer the consequences of being excluded from access to bank credit.

On bankers and weathermen

Do you remember Mark Twain’s banker, he who wants to lend you the umbrella when the sun shines but wants to take it back as soon as it seems like it is going to rain? Well that banker would surely be taking some notice of what the weathermen opined, in order to set the interest rates, the amounts and the other terms of the loan. 

But what if the regulators also told this banker that if the weatherman spoke of sun, his bank was allowed to hold very little capital, which meant being able to leverage its equity much more, but, if he spoke of rain, it was then required to hold much more capital and leverage less? 

Obviously, since a banker must love returns on bank equity, since otherwise he would be booted, that would doom Twain’s banker to choke on sunny forecasts (like AAAs and infallible sovereigns), and avoid like the pest all possible rains (like small business and entrepreneurs)… only to find out, much too late, that weather reports are not always that accurate. 

And so shall we exclude using weather forecast from bank capital requirement calculations, or shall we regulate the weatherman… so that he gives our bankers absolutely accurate forecasts… so that our Mark Twain banker can trust these even more?

Ps. here a letter published by the Financial Times in January 2003.

A Wicked Question on Bank Regulations

If bankers do as Mark Twain says, namely “lend you the umbrella when the sun shines and wanting it back when it rains”, and all bank crisis ever have resulted from excessive lending to what was perceived as “not risky”, and any perceived risk has already been considered in the interest rates and the amounts of the loans, what is the logic behind allowing banks to hold less capital requirements when they engage in what is perceived as “not risky” as current bank regulators do?

My urgent proposal for the capital requirements for banks

I propose that regulators urgently calculate any individual bank´s capital to total assets ratio, and ask for it to apply a capital requirement that increases ever so slightly over a fairly long time on any new asset it acquires… until reaching some basic goal, like the original 8 percent of Basel II, but more real. 

That way we should be able to put our banks on a stronger footing to lend, with so much less distortion.