My proposal on capital requirements for banks

The Basel II bank regulations were built upon the pillar of a basic capital requirement of 8 percent, adjusted with risk-weights, based on the ex-ante perceived risk of default. Higher perceived risk, higher capital, and lower perceived risk lower capital. 

I have for years argued that this serves no useful purpose, and that it is outright dangerous because it stimulates the creation of excessive exposure to what is perceived as “not-risky” which is precisely what has caused and will cause all bank crises. Current Basel III proposal does nothing or very little to correct this fundamental fault. Here is what I propose. 

First of all, the capital requirement for all type of bank assets should be the same, for instance 8  to 12 percent, and this because the regulator has no role acting like a supreme risk manager for the world by arbitrarily assigning risk-weights, and which can only bring confusion to the market. 

But also if we want to try to have the banks fulfill their societal purpose, we could contemplate reducing somewhat those capital requirements, for instance with up to 4 percent, when the banks engage in loans that for instance serve the creation of jobs or environmental sustainability. 

The above is because if we taxpayers are going to shoulder some of the risks of a bank failing, as we indeed must, then we should at least make certain that if a bank fails, it does so while trying to do something useful for us.

Of course we need a transition period in order to allow the banks to obtain all that capital they should have held, had it not been for the minuscule risk-weights assigned by the regulator. And, in order not to squeeze those perceived as “risky”, like the small businesses and entrepreneurs, more than they are being squeezed, we should, during this transition period, reduce the basic capital requirement, for instance to 5 to 6 percent, which allows for a leverage of 20 to 1. 

A temporary reduction in the basic capital requirement would clearly create some risk, but so does government stimulus financed with public debt, and I firmly believe it is preferably to have our banks take the lending decisions than government bureaucrats.

My question at the Civil Society Townhall Meeting at the IMF and the World Bank:

The following is the question I made on September 22, at the Civil Society Townhall Meeting at the IMF and the World Bank: 

“Mme Lagarde, Mr. Zoellick, if bank regulators had defined a purpose for our banks, before regulating these, we might have had a different bank crisis, but none as large, systemic and dangerous as this one. 

And so I ask the World Bank and the IMF, our global development and stability agents, when are you going to require the regulators in the Basel Committee to openly and explicitly define the purpose of our banks… so as to see if we all agree.”

And Mme Lagarde answered: 

“On the purpose of banks, it is a very good debate to have, and it is one that I think the Vickers Commission Report is actually helping to build--what are banks for, and what are the state guarantees or general deposit guarantees intended for? Is it to actually guarantee the savers and the depositors, or is it something that is intended to fuel and benefit other activities that are really within a completely different realm of activities? 

My sense is that the most critical mission for the banks--and that is what we are trying to say when say that banks have to rebuild their capital buffers--is to actually finance the economy, first and foremost, and that should be really the critical mission” 

And here is how Mr. Zoellick answered: 

“Your point about the Bank regulators is a particularly intriguing one, and let me share with you a little anecdote. 

Bank regulators come out of the world of central banks, and central banks will be the last bastion to fall in openness and transparency. When Pascal Lamy, who is head of the WTO, who has dealt with civil society groups for many years, as I did, starting in the trade area--and I met with Mario Draghi at that time, head of the Financial Stability Board--we shared with him a story that some union groups had come to Basel and tried to get in the door and talk to people, and they were met with screams of uncertainty. And we have suggested--and I'll just pass this along--that they also have to build some outreach mechanism through the Financial Stability Board and openness and transparency. 

And I will just share this from my own learned experience. Some institutions--central banks in particular because of the sensitive market information--build in cultures of this, and it is understandable, but then, on the policy level, as you suggest, people need to get used to being more open about it. And I just think that that is something, again, that we can try to work with you with as a general principle. I think the world will move more in this direction, but it will take some time on it. 

And I agree with Christine's response to you about the fact that the good news is, as the discussion in Britain showed, that people are starting to debate the exact purpose of banks.” 

You can find the question in the video, minute 48:40, with Mme Lagarde´s answer minute 55:20 and Mr. Zoellick´s on 1.04:15

http://www.imf.org/external/am/2011/mmedia/view.aspx?vid=1176766541001

From both answers you can deduct what I have always and most loudly criticized about the Basel Committee, namely that they have regulated the banks without defining or even considering what is the purpose of the entities they regulate… How on earth can you regulate something well without defining its purpose?

The Basel Committee watchdog, is now to probe how banks measure assets? You´ve got to be kidding!

The following is from a statement of Stefan Walter, secretary general of the Basel Committee on Banking Supervision, on September 20 

"If risk-weighted assets are not calculated in the correct way then the integrity of the (capital rules) is compromised" …. “The Basel Committee of international banking regulators is to launch a study into how banks measure assets for meeting capital safety rules… will focus on how banks determine risk-weighted assets under existing rules, not on whether the regime itself should change.” 

It looks like the Basel Committee is beginning to understand the horrible dimension of its mistakes, but, what an amazing lack of fortitude! …now it wants to blame the banks… without referencing its own madness when determining the risk-weights of Basel II and how these are used. 

Basel Committee Members, You tell us! You who determined that capital requirements for banks when lending to a triple-A rated sovereign should be zero, and to sovereigns like Greece only 1.6 percent; you who assigned a risk-weight of only 20 percent for anything private sector related to a triple-A rating and therefore allowed the banks to have only 1.6 percent in capital and leverage up 62.5 to 1 when investing in securities collateralized with lousy awarded mortgages to the subprime sector …. How do you think banks should determine risk-weighted assets under existing rules? 

You should not need a study for that… just ask yourselves! For heaven´s sake, you ARE the regulators!

“That used to be us” misses completely that us used to be risk-takers.

Thomas L. Friedman and Michael Mandelbaum recently authored the book “That used to be us: How America Fell Behind in the World It Invented and How We Can Come Back” 

From the comments I have heard, I have not read the book yet, the authors, like most other thinkers, fail to understand the most fundamental cause the US, as well as the Western World, is falling behind, namely a growing risk-adverseness, and which is represented most clearly in the current bank regulations. 

Even though banks already take consideration of the risks of default they perceive when they set their risk-adjusted interest rates, and amounts the lend, the regulators ordered the banks to have higher capital when lending to those perceived as “risky” than when lending to those perceived as “not-risky”. 

Suffices to say, that translates into a subsidy to bank lending to those already favored by the market, like “good” sovereigns and the triple-A rated, and into a tax on bank lending to those already disfavored by the market, like the small businesses and entrepreneurs. 

Those regulations are inexplicable since whatever is perceived as “risky” does not carry in it the potential to cause a systemic crisis, only what is perceived as “not risky” can. 

Those regulations have been designed without a single word being stated about what the purpose of our banks should be, and much less with respect to how much risk they should take to fulfill their vital capital allocation role. 

One of the reasons the truth has not come out, is because the world has been caught into a linguistic trap. Most experts attribute the crisis to excessive risk-taking, but which considering that all the significant losses originated in what was ex-ante perceived as “not-risky”, must clearly be wrong. 

The US, and the Western Word, became what they are because of risk-taking, and without it the US, and the Western World, will stall and fall. 

With respect to this odious wall of regulatory discrimination against risk-taking, that needs to disappear if we are going to have a chance to Come Back, we can only shout out: “Mr. Regulator. Tear down that wall” 

PS. Here´s a short video that explains the current regulatory madness it in an apolitical red and blue! http://bit.ly/mQIHoi

The lending to Solyndra LLC conundrum

If banks lend to Solyndra LLC, directly, that solar panel maker which after given a $535 million federal loan guarantee recently filed bankruptcy, they need to hold 8 percent in capital, but, if they lend to the US government so that it can relend those funds to Solyndra LLC, the banks need no capital at all… Is this really the way you want it to be? 

Mr. Regulator. Tear down this Basel wall! 

PS. A video explaining current regulatory madness it in an apolitical red and blue! http://bit.ly/mQIHoi

Basel bank regulations are un-American, un-European and un-Western World

I do indeed think that current regulations are un-American, but I guess my reasons are not exactly those of Jamie Dimon.

Yes! It is un-American, because by allowing banks to leverage more their capital when earning the risk-adjusted-interest-rate from those perceived as “not-risky” than when earning the same rate from those perceived as “risky”, Basel regulations have introduced a silly and unproductive risk-adverseness that is not compatible with a “ the land of the brave”

Yes! It is un-American, because allowing banks to leverage immensely more their capital when lending to the government than when lending to their small businesses and entrepreneurs, is stealth communism, absolutely not compatible with “the home of the brave”

Yes! It is becoming even more un-American, because allowing some banks to be named Systemically Important Financial Institutions, SIFIs, against a token additional 2.5 percent equity paid over many years, and thereby awarding them a “Too-big-to-fail” franchise, and relegating de facto all other banks to the group of Systemically Un-Important Institutions, SUFIs, is, or should be, an un-American discrimination

PS. Here´s a video that explains a small part of the craziness of our bank regulations, in an apolitical red and blue! http://bit.ly/mQIHoi

Bank regulations and 9-11

It might be because I am a bit too risk-adverse that I have always felt that as long as the Western World remains brave, and willing to take risks, it will survive any threat, no matter how big these are, but, if it becomes coward and risk-adverse, then any minor cold could signify its demise. In this respect, with anguish, I must alert about the damages that the regulators are doing to our banks, the frontline financiers of our risk-takers. 

The banks have always discriminated based on what they perceive as the risk of default, which of course includes the information provided by the credit ratings. That they do by means of: the higher interest rates charged, the lower amounts lent, the shorter length of the loans, more collaterals required, the longer time allotted to investigate the credit worthiness of the borrowers, and of course the bankers´ own personal risk-adverseness... never heard about the banker lending the umbrella when the sun shines and taking it back when it rains? 

Therefore, when the bank regulators, the Basel Committee for Banking Supervision and friends, imposed capital requirements for banks based on the perceived risks of default, which allowed for much lower bank capital when the perceived risk of default was low as to what was required when the perceived risks were high, the regulators added a new, very arbitrary and dangerous, layer of risk adverseness. 

Those capital requirements discrimination signified that the risk-adjusted premiums for lending to what was perceived as not risky could be leveraged on bank capital much more that what the risk-adjusted premiums for lending to those perceived as risky could be. 

The immediate result was to generate a stampede of bank lending to the “not-risky”, like “approved” sovereigns and risk-free AAAs, which created the current crisis … and to provoke a withdrawal from lending to the “risky”, like the job creating small businesses and entrepreneurs, which keeps us from getting out of our current crisis. 

The saddest part of it all is that, more than three years into the crisis, the problem here mentioned is not even discussed and much less a part of the reforms of our bank regulations. Basel III still has the bank regulators acting as risk-adverse global risk managers…in other words diggings us deeper in the hole. 

In these days when we are remembering the horrors of 9-11, we need then to be aware that the bank regulators, unwittingly, are engaging in regulatory terrorism that will weaken the Western World much more than other better known forms of terrorism. 

Risk-taking is the oxygen of any development and movement forward… and, if you don’t move forward you fall…and so what’s it going to be Western World?

Ps. A video that explains a small part of the craziness of our bank regulation in an apolitical red and blue! http://bit.ly/mQIHoi

"No ordinary man could be such a fool"

My daughter Alexandra, an art fanatic, on hearing my explanation about the mistake of the Basel Committee, pointed me to “The forger’s spell”, a book by Edward Dolnick about the falsification of Vermeer paintings. Boy was she right! 

In that book Dolnick makes a reference to having heard Francis Fukuyama in a TV program saying that Daniel Moynihan opined “There are some mistakes it takes a Ph.D. to make”. And he also speculates, in the footnotes, that perhaps Fukuyama had in mind George Orwell’s comment, in “Notes on Nationalism”, that “one has to belong to the intelligentsia to believe things like that: no ordinary man could be such a fool.” 

And that comprises about the most appropriate explanation I have yet seen so as to understand why our bank regulators were able to commit their huge mistake that got us into this financial and economic crisis that threatens the Western World, namely to base their risk weighted capital requirements on the expected and not on the unexpected.

No “ordinary man” would have told his children to beware about what he knew his children were afraid of, and stimulated them to go more where they already wanted to go as it seemed safe to them… which is precisely what the current risk weighted capital requirements for banks do. They cause too large bank exposures whenever the perceived risk of default of the borrower is low, and too small or even nonexistent exposures whenever the perceived risk of default is high. 

And then, just like to force it down our throats, Dolnick writes “Experts have little choice but to put enormous faith in their own opinions. Inevitably, that opens the way to error, sometimes to spectacular error.”

Dolnick also mentions that the psychologist Leon Festinger once marveled: “A man with conviction is a hard man to change. Tell him you disagree and he turns away. Show him facts or figures and he questions your sources. Appeal to logic and he fails to see your point”. 

All of which also leaves me with the problem that seemingly no ordinary financial reporters, like those in FT, can really come to grips with believing, or even daring to believe, that experts could be such fools.

PS. And of course, John Kenneth Galbraith and Upton Sinclair Jr added explanations

PS. No matter how insightful Francis Fukuyama seems to be, with his "End of History", he shows he did not see the statism introduced in the Western world in 1988 by bank regulators, with their Basel Accord

PS. Alexandra Kurowski 2016, M.A. in Modern and Contemporary Art and the Market, Christie’s Education New York,

PS. Here is a memo on the abundant lunacy contained by the risk weighted capital requirements for banks

I bet you’d all be better bank regulators than those in the scandaliciously dumb Basel Committee!

Of course we would all like and benefit from the credit ratings providing us with more accurate results… but that is not really the issue.

If you were a responsible regulator, what would make you toss and turn at night, that the credit ratings are correct or the possibility they are wrong?

If your answer, as expected, is the second, then try to explain the current capital requirements for banks that allow for extremely little bank equity when the credit ratings determine there is very little or no default risk at all, and which therefore are betting it all on the credit rating always providing correct risk information. Loony eh!

As a result of this regulatory silliness, the current crisis left our banks with no capital, simply because they were not required to have any capital against what was ex-ante rated as “not-risky” but that “ex-post” could turn out to be very risky.

Would you have not been a better regulator asking instead for capital requirements for banks that covered the case of the credit ratings being wrong? I bet you would!

One of the biggest challenges we now face is finding a way to accept and internalize that the “expert” regulators appointed to such vital places as the Basel Committee for Banking Supervision, the global bank regulator, could really come up with so unbelievably unbelievable dumb regulations… Truly scandalicious!

PS. Loony bank regulations explained in an apolitical red and blue!

Did the Basel Committee outsource the drafting of Basel I-II-III to Fidel Castro in Cuba?

Something like that must have happened because regulations that order banks to hold much much more capital when lending to small businesses and entrepreneurs, than when lending to the government, can only be described in terms of a communistic ruled access to bank credit.

SEE THE VIDEO. Loony bank regulations explained in an apolitical red and blue! http://bit.ly/mQIHoi

The vicious communistic styled bank-regulatory circle that nationalized our bank savings

“I, the Government, commit to give the credit rating agencies strong evidences that I will support you, the big banks, so that you, the big banks, can get good ratings and raise funds cheaply. 

And I, the Regulator, commit to set zero or very low risk-weights so that you, the banks, do not need to hold capital when lending to the government… of course for as long as you allow us to keep our jobs. 

And you, the big banks, you just do as the incentives and the disincentives tell you to do. 

And so we, the Government, the big banks and the regulators will live forever happy… until the scheme collapses and citizens and taxpayers find out what we have been up to.”

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.