There will not be any normalization of bank credit in Europe until regulators do a 180 degrees volte-face.

Sir, Sarah Gordon writes that “While the region’s [highly credit rated] groups have gorged on cheap credit, its multitude of smaller companies have had to deal with a scarcity of funding”, “Poor corporate credit is holding back Europe’s recovery”, January 31.

Of course, how could it be otherwise, when regulators, especially in times of scarce bank capital, require banks to hold much more capital when lending to those who are perceived as having higher expected losses than to those who possess a high credit rating.

Gordon mentions that because companies are “now driven by the desire to invest. This will inevitably, result in normalization of credit at some point.” Forget it! There will be no normalization of credit until regulators realize that capital requirements for banks should have very little to do with expected losses, and a lot to do with unexpected losses, and therefore get rid of the current system of risk-weighting.

When regulators exorcised primal risk-taking from the banks, they doomed our economies to decadence.

Sir, Edmund Phelps writes that “Nations with once-dynamic economies will be helpless to recover their prosperity as long as they misunderstand what causes economic progress”, "Free innovators from the state’s deadening hand”, January 31.

Indeed before it is realized that primal risk-taking is what leads to innovations and start-ups, and which is what keeps the economy sturdy muscular. Any economic growth based on risk-aversion leads only to economic obesity. Unfortunately, bank regulators, with their loony capital requirements based on ex ante perceived expected losses exorcised such risk taking from the banks.

And Edmund Phelps also correctly states “The state is no better suited to take a big role in the technical innovation than in artistic creation”. But Phelps might not be aware of how bank regulations are stacked in favor of the state assuming such role. Currently when a bank gives a loan to a “risky” innovator, let’s for example call it a Solyndra; it is required to have much much more capital than when lending it to the “infallible sovereign”, and so that instead a bureaucrat can relend that money to an innovator, like a Solyndra.

Sir, don’t you recognize insanity when you see it?

Tobias Buck reports on how “banks from countries such as Spain and Italy borrow money cheaply from the European Central Bank to buy high-yielding sovereign debt from their own governments”, “Spain’s lenders reap profit on Madrid bonds”, January 30. And that the banks can do, because they need to hold no capital against these “infallible sovereigns”.

Frankly, Sir, don’t you recognize insanity when you see it? This is what the banks are doing in countries where the unemployment rates, especially those of the youth, want to make you cry. How on earth are the banks to help these countries to get out of what seems to be a death spiral?

And all because bank regulators do not care an iota about asking themselves what is the purpose of banks before regulating these… and therefore allow themselves to come up with loony risk-weighted capital requirements based on perceived risk of expected losses and which directly discriminates against the access to bank credit of the “risky” medium and small businesses, entrepreneurs and start-ups.

How could Europe have allowed itself to fall in the hands of regulators who do not care about the real economy? And how can FT keep quite on this?

Risk weighted capital requirements for banks means some will receive too much credit, too cheap, others too little, too expensive.

Sir, John Plender in “How to spend $2.8tn of corporate cash” FTfm January 27, writes “The financial sector is there to intermediate between those with surplus funds and those who wish to invest. It can be relied to do so”

Not so fast Mr Plender. The most important financial intermediaries, the banks, are kept from efficiently allocating credit in the real economy, as a result capital requirements based on perceived risk. In fact, since banks can lend to “the infallible” against very little capital, the lending to “the risky”, which requires much more capital, is coming to a halt.

But seemingly the regulators are blissfully unaware of that it is them who are distorting. I say this because Christopher Thompson writes “Non-financial corporate loans in have fallen… creating a headache for regulators keen to encourage lending,, especially to small and medium sized businesses, which provide the bulk of Europe´s employment” “Balance sheets hint at EU bank confidence”, also January 27.

A “headache for regulators”, Europe has indeed fallen in the hands of a real inept bunch of bank regulators. What about the pain of the unemployed?

Real banking reform will only happen when regulators understand and acknowledge what they did wrong, and correct it.

Sir, Martin Arnold writes “Regulators are forcing banks to hold much more capital and to reduce their leverage, which is making some areas of business unprofitable. This is pushing some banks to quit those areas”, “Bankers assess once-in-generation reform” January 24.

That is indeed one way to word it, but since the truth is that the profitability of these areas was artificial in that it was based on the fact that they required much less capital than other, there should hopefully be other areas which could regain competitive profitability… like lending to medium and small businesses, entrepreneurs and startups.

The real reforms of banking will, sooner or later, only come when regulators understand and acknowledge the following:

You can´t have capital requirements for banks that are “portfolio invariant”, namely those which do not consider the benefits from a diversification of assets in “the risky” category, or the dangers of excessive concentration of assets to “the infallible”.

The fact that an asset is deemed risky because it has high "expected losses", does not mean one iota that it has the potential of more “unexpected losses”, which is what capital is there for, than what is perceived as “absolutely safe”.

That the efficient allocation of bank credit to the real economy is, medium and long term, of much more significance for the real safety of banks, than what can be achieved by any distorting risk management carried out by regulators-

Unfortunately, before the above is fully realized, things could get much worse.

The distortive risk weighted capital requirements for banks will haunt Ben Bernanke and Martin Wolf

Sir, Martin Wolf writes that contemporary “banks are constrained not by reserves but by their perception of risk and rewards of additional lending”, “Model of a modern central banker” January 22.

That is indeed so, but Wolf forgot to include that banks are also constrained by capital requirements, and by how the regulators’ perceptions of risks are transmitted by means of the risk-weighting of these.

When Wolf comments “An active an enterprising financial system creates risk, often by raising leverage dramatically in good times” he is ignoring the fact that the extreme high bank leverages of now, are actually leverages that were and are authorized by the regulators… and since banking itself is much about leveraging, banks must go to where they can earn the highest-risk adjusted returns on equity… which is usually where the capital requirements are the smallest.

And that created the distortions which not only produced the crisis when allowing investment banks and European banks to leverage immensely on AAA rated securities, and “infallible sovereigns”, but it also hindered the liquidity provided by for instance quantitative easing from reaching those who could do the most with it… like the medium and small businesses, entrepreneurs and start-ups. 

Ben Bernanke has most certainly done good things as a central banker, and Martin Wolf has definitely written great pieces as a journalist, but I do believe that history will hold their silence about this source of distortion seriously against them… and this even if they plead ignorance about it.

PS. Sir, just to let you know, I am not copying Martin Wolf with this, as he has asked me not to send him any more comments related to the capital requirements for banks, as he understands it all… at least so he thinks.

Excessive exposures to what is “absolutely safe” by regulated banks could be much more dangerous than whatever lurks in the shadows.

Sir Tracy Alloway writes “Shadow banks, we are told, are unregulated institutions that lurk in the dark corners of the financial system – away from the supervised activities of run-of-the-mill commercial banks”, “Competition for banking business lurks in the shadows” January 18.

But perhaps we should keep in mind that those unregulated shadow institutions are not able to leverage remotely as much as the banks who operate in sunlight… so the question of safety is sort of relative.

And Alloway also comments “that there is perhaps an underappreciated danger: that non bank lenders will encourage riskier behavior at larger banks that find themselves compelled to try to compete with the shadows”. But that would only happen if banks are able to dress up that riskier behavior in such as way that it is perceived as “absolutely safe” so that they do not need to hold much capital.

As is, the real risky behavior of banks is building up excessive and dangerous exposures to what is perceived as “absolutely safe”… all a consequence of capital requirements which are portfolio invariant.

Alloway hopes that these “shadow lenders serve a purpose” satisfying “the needs of the real economy”. Indeed let us hope and pray it is so, because as is, the supervised banks, with the risk aversion imposed on them, are kept from doing so.

What contains “expected losses” can also contain the “unexpected profits” we need for increased productivity.

Sir, in “Two challenges for the global economy”, January 18, with respect to a decline in economic productivity, you mention: “The solution lies in structural reforms aimed at allowing the most innovative sectors to expand”. That is correct. What is not correct is to believe that you can so easily, so besserwisser, identify what are the most innovative sectors… and so the market needs to be free to collaborate doing that.

But regulators currently impose on banks risk-weighted capital requirements, which wrongly, and stupidly, assumes that what is perceived to risk more expected losses, also risks more unexpected losses. And that is monumentally wrong. Not only does history show us that the worst “unexpected losses” most often derive from what was considered to have the smallest expected losses… but it also implicitly assumes that what risks a lot of expected losses, cannot contain huge unexpected profits, and that more than pay for any losses incurred.

And that double consideration for perceived risk discriminates all what is perceived as risky from fair access to bank credit… and impedes the markets invisible hand to operate freely.

While that regulatory mistake stays in place, our chances to produce the unexpected profits needed to change the current gloomy productivity outlook are indeed slim.

How on earth can regulators be so daft so as to believe that our future lies in the hands of banks playing it safe?

How on earth can regulators be so daft so as to ignore that asking our banks to play it excessively safe is truly dangerous for the economy and for the banks?

OCC, before asking banks to raise their standards of risk management, should stop regulators' distorting parallel risk managing

Sir, Tom Braithwaite and Camilla Hall report that “The Office of the Comptroller of the Currency said it plan to raise the standards it expected for risk management at the largest banks”. “Goldman and City wreck Wall St hopes for escaping doldrums”, January 17.

Before doing that OCC should first consider the distortions the risk-weighted capital requirements for banks cause.

As OCC should know, bankers clear sufficiently well for perceived risks, by means of interest rates, size of exposures and contract terms. But current capital requirements those which the regulators order banks to hold primarily as a buffer against some “unexpected losses”, are based on the same perceptions of “expected losses”.

And so the system now considers twice the “expected losses” and none the “unexpected losses”. And as a result, the regulators have introduced a distortion that makes any high standard risk management that serves a societal purpose absolutely impossible.

And this is especially wrong when the capital requirements are portfolio invariant, because that ignores the benefits of diversification for what is perceived as “risky”, and the dangers of excessive concentration for what is perceived as “safe”.

OCC should understand that it has no problem if banks manage their risks well, only if they don’t, and so it makes absolutely no sense to base the capital requirements for banks, on the same perceptions of risk used by the banks.

OCC should understand that those who most represent “no-expected-losses” are in fact those most liable to produce the largest and most dangerous unexpected losses.

OCC, do the world a favor, throw out the risk-weights a simple straight leverage ratio and allow the bank to be banks again… not credit distributors in accordance with what the risk-weighting which produces different capital requirement tells them.

Sincerely it surprises me that, in the “home of the brave”, with a market that prides itself to be free and to give equal opportunities, OCC allows for capital requirements which allow banks to earn much higher risk-adjusted returns on equity when lending to The Infallible than when lending to The Risky.

The implied discrimination does not seem to be compatible with the Equal Credit Opportunity Act (Regulation B).

Kid! If you eat your spinach you must eat your broccoli too.

Sir I refer to Henny Sender’s “Distress appears across Asian funding markets” January 15. In it Sender describes that banks are not in great shape and are too risk adverse to lend to lower rated companies… [aggravated] by regulatory changes which require more capital for anything other than investing in sovereign debt”.

Indeed, but the main constraint to lending to “the risky” is not risk-aversion but the risk adverse capital requirements. It is like telling children who don’t like spinach that if they eat it, they have to eat broccoli too.

And let us be frank… who but communists could believe that a bank system becomes safer by lending to the “infallible sovereign” and not lending to the “risky citizen”?

Of course it is all crazy… and it all derives from the fact that regulators, instead of setting the capital requirements for banks based on “unexpected losses”, as they should, based these on the “expected losses”, those which were already being cleared for by banks by means of interest rates, size of exposure and other terms. 

Recently on a blog when asking why regulators were not asked about this mistake, someone replied“there comes a point where the hypocrisy of the situation becomes so intense that it can no longer be addressed”.

Does that apply to you FT?

FT and Martin Wolf are also part of the failing elites who threaten our future.

Sir, Martin Wolf writes “the economic, financial, intellectual and political elites…lulled by fantasies of self-stabilizing financial markets…failed to appreciate the incentives at work and, above all, the risks of a systemic breakdown”, “Failing elites threaten our future” January 15.

That is wrong! That is the Greenspan version. The truth is that regulators interfered with the financial markets by imposing risk-weighted capital requirements for banks based on perceived risk of expected losses, those risks which were already being cleared for by bankers, and not based on the risks of unexpected losses.

Wolf is absolutely right though when he writes that the “divorce between accountability and power strikes at the heart of any notion of democratic government”. A proof of that is how those responsible for the failed Basel II went on to work on Basel III, without missing a beat, without really having to explain themselves, and without changing the basic manuscript. Frankly a self-stabilizing movie industry, would never ever dream of following up a box-office flop like Basel II in that way.

But you Sir, and Martin Wolf, have for many years stubbornly ignored my arguments about the huge mistake, which considering twice same perceived risks represents. And so, when now Wolf writes “If elites continue to fail...The elites need to do better”, may I just remind you that, in my book at least, you and him are part of that elite who are dangerously silencing the mistakes of some favored elites.

PS. Sir, just to let you know, I am not copying Martin Wolf with this, as he has asked me not to send him any more comments related to the capital requirements for banks, as he understands it all… at least so he thinks.

If some tiny tapering creates much hullabaloo, can you imagine if the Fed would try to soak QEs up?

Sir, Avinash Persaud argues “central bankers need… a better understanding of what their bond-buying has achieved”, “An expensive way to speak truth to financial markets” January 14.

Absolutely! From all what we read central bankers do not understand yet that those “Cash balances… trapped in a broken system”, are a direct consequence of capital requirements for banks which do not allow for liquidity to go to where it is most needed in the real economy, namely to finance “risky” medium and small businesses, entrepreneurs and start ups.

I fully agree with Persaud in that the first QE could be explained, and even justified, based on the need “to unfreeze markets that were close to seizing up”… but, from there on, no way Jose!

If the distortion produced by the current risk-weighting of bank regulations is not eliminated, so that the invisible hand of the market can resume operations, can you imagine what would happen if the Fed would even try to soak QEs up, I mean with so much hullabaloo already resulting from some tiny tapering?

Banks’ RoRWAs is like allowing kids to grade themselves. Shareholders could, at their own risk do so. Regulators should not!

Sir, The Lex Column makes several statements about banks’ RoRWA, the return on risk-weighted bank assets, January 13.

In essence RoRWA is like allowing kids to grade themselves, and their parents, as their shareholders, believing it. And though it does not sound very wise, that is ok since parents, at their own risk, are absolutely free to do so.

But, when teachers, or bank regulators, start using the kids’ own grading system, or the banks’ own risk-weights, then something is bound to go wrong. More sooner than later the whole system will overdoses on the kids and bankers biased perceptions, as these all have a lot of vested interest in having good grades or good RoRWA.

Risk weighted capital requirements for banks should be based on unexpected losses. They are not!

Sir, a bank should be free to calculate his own capital requirements in any which way he likes, and these will be almost entirely be based on expected losses. But a regulator should set the capital requirements based on the “unexpected losses” as these are those that should really be of his concern, but they do not.

Explicitly, for reasons of simplicity, the Basel Committee sets the capital requirements for banks that are there to cover for unexpected losses based on the same risk perceptions used to estimate the expected losses. And, to top it up, these capital requirements are also, explicitly, portfolio invariant… which means that the benefits of diversification is not accounted for, nor are the dangers of any asset concentration.

What a miserable state of affair of our bank regulatory system, if the implications of simple facts like that, cannot even be discussed.

In “Banks win concessions from Basel on leverage” January 13, Sam Fleming and Gina Chon report that if relying on a non-risk weighted capital requirement, such as the leverage ratio, that would tempt banks “to take on riskier loans to earn higher returns”. But again there is no discussion about the wisdom of allowing banks, by means of risk-weights to be able to earn higher risk-adjusted returns on safer loans, and which leaves hanging in the air the question of… who is then going to finance “the risky” medium and small businesses entrepreneurs and start ups?

That one can allow a Mario Draghi to mention “The leverage ratio is an important backstop to the risk-based capital regime”, without anyone asking him, the European Central Bank President, about the distortions in the allocation of bank credit to the real economy risk-weighting produces, is clear evidence that something is rotten in the Union of Europe.

Instead of labor and capital struggling against each other, perhaps they should discuss what to do with their intermediaries

“The real disaster lies in youth unemployment” writes John Plender in “Recession has revived labour´s struggle against capital” January 11.

And there is no doubt he is right about it and there is no doubt we have no chance of solving it while we have bank regulators who insist on that “unexpected losses”, those for which they require banks to have capital, are higher for the “risky” than for the “safe”.

Because, by means of Basel´s risk-weights, this translates into the banks being able to earn much higher risk-adjusted returns on equity when they lend to the “safe”, than when they lend to the “risky”.

And that translates of course into that banks will not any longer lend to finance the “riskier” future as much as previous generations of banks did.

And Plender writes: “The real driver of income inequality over the past decade has been top pay – specifically, of chief executives and bankers” and I ask. Could the bonuses of bankers have been as high as they were if bank capital has been required to be as much as it used to be pre-risk weighting days? No way!

And so instead of labour and capital struggling against each other, perhaps they should discuss what to do with the intermediaries… whether these are executives, regulators or politicians.

I mean, do not those who receive low salaries have a lot in common with those who receive low interest rates on their savings?

Current bank fines seem to be neo-medieval indulgences, not paid by the sinners

Sir, in “The regulatory cost of being JPMorgan” you hold “Fines – however large seem an ineffective stick with which to beat miscreants”, January 11.

Absolutely! These bank fines seem to be medieval indulgences, in this case not even paid by the sinners, but by shareholders, tax savings and less credit to the real economy.

No Mr. Ralph Atkins. We know precisely that the next financial polar vortex is going to hit… where it always hits!

Sir, Ralph Atkins writes that “six years after the eruption of the financial crisis… we know remarkably little about where the next ice storm might break”, “Investors hunt for the financial polar vortex", January 10.

He is wrong. We know exactly that the next financial polar vortex is going to break out where these always do, namely in a haven that has been perceived as “absolutely safe”, but has become dangerously overpopulated.

And the damages will be worse than ever, because of the manmade fact that, when it hits, just like when the last 2007-08 hit, our banks will have little capital to cover up with, as a direct consequence of those nonsensical risk-weighted capital requirements the Basel Committee concocted.

If only an “intellectual vacuum”, but, sadly, it is worse than that Professor Michael Ignatieff.

Sir, Michael Ignatieff writes about “the waning power of ideas” and begs “Free polarized politics from its intellectual vacuum”, January 10. Although, as a self described “radical of the middle”, or “extremist of the center”, I do agree with most of what he writes, I must still confess feeling that the absence of ideas would at least be better that the presence of some really bad ideas.

And a truly bad idea currently present, are the risk-weighted capital requirements for banks, and which allow these to earn much higher risk adjusted returns on equity on exposures deemed as “absolutely safe”, than on exposures deemed as “risky”.

And that makes it of course impossible for banks to allocate credit efficiently to the real economy. And that guarantees that the chances of any major bank crisis, those usually caused by dangerously overpopulating some safe-haven, have been exponentially increased.

Technically the mistake is explained by the fact that regulators estimate the “unexpected losses”, those for which you mainly require banks to hold capital, based on the same perceptions used by the banks to estimate “expected losses”.

And here we have all the free market believers not complaining about that horrible interference with the market that risk-weighting causes … and here we have all progressives not saying a word about the odious discrimination in favor of the AAAristocracy and against the “risky” that risk-weighting causes.

And meanwhile the chances for our youth to find employment in their lifetime are evaporating, thanks to this nonsense of banishing risk-taking from our banks.

If bank liquidity will by design not be able to flow where it is needed in Europe, why more of it?

Sir, in “Europe must avoid false optimism” January 9, you recommend: “Mr Draghi should show more urgency, extending for example new liquidity to the banking sector via a fixed-rate longer-term refinancing operation”. For what purpose Sir?

You must know that given the scarcity of capital in the European banking sector, and the risk-weighting of capital requirements, that liquidity would not flow to where it is most needed, and would therefore only worsen the imbalances, like even strengthening “the lethal embrace between sovereigns and lenders”.

Professor Thomas Piketty: “Don't be so defeatist, it is so middle class.”

Sir, Robin Harding holds that “Inheritance should not be an alternative to hard work” January 6.

The setting is: “The lower the rate of growth, the smaller the percentage of society’s wealth created by those who are alive today, and thus, by definition, the larger the percentage that is passed on from previous generations… higher inheritances certainly exacerbate inequality.”

And that is derived from Thomas Piketty’s “eagerly awaited” “Capital in the Twenty First Century”. The book includes: “if the after tax return on capital is higher than the rate of growth in the economy, then all the heir and heiress need to do is save enough of the income from their inheritance… and their share of society’s wealth will rise”… ergo we must redistribute, and so we need “wealth taxes on a global scale”.

I do not agree with its general premise. An after tax rate of return on capital which is higher than the rate of growth in the economy, is something not really sustainable… unless other factors are in play. And, in this respect, I would just ask Mr. Piketty about what he believes would have happened to after tax returns on capital, without Tarps, QEs and all Fiscal Stimulus since 2007?

And also, what a horrendous vision it implies! That we should now only adapt to a shrinking economy, and give up all illusions about making it stronger and better, and just concern ourselves with that the last tree on our Easter Island we cut down is equitably shared? I can hear Downton Abbey’s Violet Crawley admonishing “Don't be so defeatist, it is so middle class.”

But of course I agree with Robin Harding in that developed (and developing) societies should “opt for the free-flowing meritocracy of the last century, not a return to the dynastic wealth of the one that preceded it.

But that, as I see it, has less to do with inheritance taxes and, at least currently, much more to do with bank regulations. You see the Basel regulators, with their risk-weighted capital requirements, do not want banks to take the risks which come with any “free-flowing meritocracy”, and instead to concentrate their exposures to the illusions of safeness of the “dynastic wealth”.

And by the way, anyone who thinks that the presence of after tax returns on capital higher than the rate of growth in the economy, would be sufficient to keep the value of an individual inheritance… has little knowledge about real life and about capitalism. Oh no! To waste an inheritance is very easy, but to keep the real value of an inheritance is, and should always be, hard work, no matter what the average interest rates are.

I wish more would concentrate more on the causes of inequality, than on the resulting inequalities. If not, and if we tax more all of the wealthy, all we will get is few oligarchs getting even more wealthy, not because of capitalism but because of crony capitalism.

Did the baby-boomers’ parents’ not take risks, or use reverse mortgages in order to extract everything for themselves?

Sir, Janan Ganesh writes “Bad luck, not policy, is the scourge of the young” January 7. What is this? I’ve seen a photo of him in FT, and so is he here just working for the baby-boomer establishment?

Of course “There is no law of the universe that says each generation most be more prosperous than the last”, but that should not diminish one iota the moral obligation of each generation from trying that to be so.

Currently grey-haired bank regulators base the capital requirement for banks which should take care of the unexpected losses, on the perceptions of expected losses. And with that they have introduced a distortion that guarantees banks will finance mostly what is perceived “safer”, like the known past, and keep out from what is perceived “risky”, like the future.

And does that mean that the young will at least inherit a safer banking sector? Of course not! The risk-weights which determine the capital requirements are portfolio invariant. That means these do not take account of the added risks of asset concentrations, or the dissipation of risks by means of asset diversification. And that means that the risk of the banking system might be increasing exponentially, even while it is being reported as safer.

Yes “Baby boomers enjoyed almost miraculously circumstances” but, to attribute that to luck and not to the daring risk-taking of previous generations is ungrateful, to say the least.

Just look at the financial products offered to baby-boomers. “Reverse mortgages” which allow parents to extract all equity possible from their houses, for their own consumption, and thereby leaving much less for their heirs. Did the baby-boomers’ parents do such things?

If the young would only look up from their virtual world, and react to what is happening in reality, then Paris of May 1968 might just seem in comparison to have been just another hip peaceful gathering of premature baby-boomers.

PS. There is not a day in which I do not thank all my antecessors for all their risk-taking, and not a day I do not fret I am not capable of taking enough risks for my successors.

God make us daring!

For markets to make the global economy safer, we must allow markets to decide, not the regulators.

Sir, I can of course understand insurers like Henry de Castries and Eric Chaney wishing and praying for some safe and liquid assets comparable to US treasuries, and with which they sincerely believe it would be easier for them to responsibly fulfill their undertakings, “How markets can make the global economy safer” January 7.

But, safe assets are not something you just pull out of a hat, and on top of that, safe assets are also something which can turn into very risky assets, with a blink of an eye.

But, if we really want to allow markets to make the global economy safer, we need to stop interfering and distorting these.

For instance when the authors write “On the positive side, financial regulations has been strengthened” they are wrong. That is only repeating what regulators say of their own work. The sad truth is that financial regulations have been even further weakened with the introduction of even more layers that make it even harder to understand what their consequences are. And the risk-weighting of the capital requirements for banks, the mother of all distortions of the allocation of bank credit in the real economy, is still very much alive and kicking.

And when the authors write “The twin sovereign and banking crisis in the eurozone have forced leader to embrace serious reforms” I really do not know what they refer to. In that respect I just know that the embrace between banks and sovereigns is, because of the fact that banks need little or no capital when holding exposure to sovereigns, getting tighter by the hour and soon, if left alone, it will just mean they strangle each other to death.

The authors end asking for “a rebalancing solution based on a pragmatic fusion of policy and markets”… but, might our real problem be an excess of pragmatic fusions?

Gideon Rachman, on our current front of bank regulations in Basel, neither Sarajevo nor Munich mentalities will do.

Sir I refer to Gideon Rachman’s “Time to think more about Sarajevo, less about Munich” January 7.

Right now our banking systems are heading towards a meltdown, caused by excessive and dangerous exposures to what is perceived as safe assets and which therefore allow banks to hold less capital… and, consequentially, our real economy is not capable of helping us out, as its more “risky” participants, are not provided with the bank credits they need for some of them to turn into the saviors of tomorrow.

Rachman quotes Margaret MacMillan in “The War the Ended Peace” lamenting that “none of the key players in 1914 were great an imaginative leaders who had the courage to stand out against the pressures building for war”; and writes that “In 1914 national leaders were so keen to appear strong and to protect their ‘credibility’, that they were unable to step back from the brink of conflict.”

In contrast, in 1938, I guess the problem was that leaders held that everything was fine and dandy.

So Rachman what shall we do? Trust the Sarajevo regulators who arrogantly hold they can fight any bank risks which come up, or trust the Munich regulators who tell us that Basel III has repaired Basel II.

As I see it, neither one will do.

If the visible banks are not rationally regulated, there is no choice for the real economy than to run for the shadows.

Sir, the risk weight function which determines the current capital requirements for banks are based on two monumental mistakes.

The first mistake is that for reasons of simplification the Basel Committee oversimplified and decided that the expected unexpected losses of those perceived as safe will be much less than the expected unexpected losses of those perceived as “risky”. And that means that the perceptions of risks will either reward or punish… twice.

The second mistake is that the risk weights are “portfolio invariant” and which means these do not take account of the added risks of asset concentration, or the dissipation of risks by means of diversification. And that means that the risk of the banking system might be increasing exponentially, even while being reported as safer.

And all this leads to banks then earning higher risk-adjusted returns on equity when lending to the “safe” than when lending to the “risky”.

And the direct result is that those perceived as “safe” will have a subsidized access to bank credit, paid by negating the same to those perceived as “risky”.

And that guarantees banks will not be able to assist in helping the economy to get out of a secular stagnation, as alerted by Lawrence Summers in “Washington must not settle for secular stagnation”, or to avoid that weak destabilizing growth to which Edward Luce refers to in “Anglo-Saxon trumpeting will strike a hollow note” January 6.

And, while these regulatory discrimination against medium and small businesses, entrepreneurs and start ups remain in force, then Italy, instead of becoming more like Germany in order to prosper, as Wolfgang Münchau proposes in “What eurocrisis watchers should look for in 2014”, would do well becoming even more Italy and run into the shadows of its economía, finanza e banca sommersa.

Though Lady Luck can still work without interference, the invisible hand cannot!

Sir, Tim Harford extracts similarities to the real economy from Natasha Dow’s “Addiction by Design”, “Casino’s worrying knack for consumer manipulation” January 3. What an extraordinarily interesting and, at least for me, brand new concept.

But when Harford writes “It is hard for a free market-enthusiast like me to look unblinkingly at Las Vegas… and not feel that the invisible hand has slipped”… I must confess a slightly different vision.

For instance, when I look at a roulette table, I see that all bets, though some take you out faster than others, have exactly the same expected value, in Vegas -$0.053 for every $1… and so I conclude that there Lady Luck can work without any interference, after the commissions of the house of course.

But, when I look at banks and see how regulators have set different capital requirements based on ex ante perceived risks, which leads to assets returning different risk-adjusted returns on equity, I am absolutely convinced that the invisible hand is not given the slightest chance to operate its magic.

A philosopher’s questions to the Basel Committee on capital requirements for banks and unexpected-losses.

Sir, Alain de Botton makes "The good case for putting philosophers into company boardrooms”. January 2.

In that respect I would hold that philosophers are also urgently needed elsewhere, like in the Basel Committee for Banking Supervision. Let me explain.

In “An Explanatory Note on the Basel II Internal Rating Based (IRB) Risk Weight Functions” July 2005 we read:

“The model [is] portfolio invariant and so the capital required for any given loan does only depend on the risk of that loan and must not depend on the portfolio it is added to.”

And the explicit reason for that simplification is:

“This characteristic has been deemed vital in order to make the new IRB framework applicable to a wider range of countries and institutions. Taking into account the actual portfolio composition when determining capital for each loan - as is done in more advanced credit portfolio models - would have been a too complex task for most banks and supervisors alike.”

And this leads to:

“In the context of regulatory capital allocation, portfolio invariant allocation schemes are also called ratings-based. This notion stems from the fact that, by portfolio invariance, obligor specific attributes like probability of default, loss given default and exposure at default suffice to determine the capital charges of credit instruments. If banks apply such a model type, they use exactly the same risk parameters for expected losses (EL) and unexpected losses (UL), namely probability of default (PD), loss given default (LGD) and exposure at default (EAD).”

And so, if the Basel Committee had included a philosopher in their team, he might very well have asked the following disturbing and possibly game-changing question.

“Friends, I read here you have decided, primary for reasons of expediency, to make the capital requirements for banks, those that should cover for “unexpected losses”, dependent on the same risk perceptions used to estimate the “expected losses”.

Does that not signify that banks could overdose on perceptions about expected risks, without you regulators doing what you should do about considering the unexpected losses?”

Does that not signify you would be discriminating against “The Risky” those who are already discriminated against because of expected losses, by making them also bear the largest regulatory burden for unexpected losses?