The Basel Committee jammed banks’ gearboxes… not only in India

Amy Kazmin reporting on India quotes Rajeev Malik, founder of Singapore-based Macroshanti, in that “A well-oiled, well-functioning financial system is the gearbox of the economy”, “Financial system is ‘like a truck with a messed-up gearbox’” September 23.

The financial system’s gearbox got truly messed up when regulators decided that banks could leverage differently their capital based on perceived risk… more risk more capital, less risk less capital… as if what is perceived as risky is more dangerous to bank systems than what is perceived as safe.

And Kazmin writes: “The financial companies that had provided much of India’s credit growth in recent years are now struggling with access to funding themselves after the shocking collapse of AAA-rated infrastructure lender, IL&FS, last year.”

Could that have something to do with the fact that since 2004 Basel II regulations banks needed to hold only 1.6% in capital when human fallible credit rating agencies assigned an AAA to AA rating to a corporation?

And Kazmin writes: “With its own voracious appetite for funds to finance its fiscal deficit, New Delhi is now mopping up much of the country’s household savings through a clutch of small schemes such as post office savings that offer higher rates than commercial banks.”

Could that have something to do with the fact that since 1988 Basel I regulations, banks need to no capital at all against loans to the government of India… but 8% when lending to Indian entrepreneurs.

Sir, risk taking is the oxygen of any development so, with such a dysfunctional gearbox, how is India going to make it? None of the richer countries would ever have developed the same with Basel Committee’s bank regulations… and all their bank crises, those that always result from something safe turning risky, would have all been so much worse, as these failed exposures would have been held against especially little capital. 

Here is a document titled “Are the bank regulations coming from Basel good for development?” It was presented in October 2007 at the High-level Dialogue on Financing for Developing at the United Nations. It was also reproduced in 2008 in The Icfai University Journal of Banking Law. 

@PerKurowski

In banking, the worst worse case scenario by far, is something perceived as very safe turning out to be very risky

Sir, Tim Harford writes “We don’t think about worst-case scenarios in the right way.” “To help us think sensibly about it, Gary Klein has argued for conducting ‘pre-mortems’ — or hypothetical postmortems. Before embarking on a project, imagine receiving a message from the future: the project failed, and spectacularly. Now ask yourself: why? Risks and snares will quickly suggest themselves — often risks that can be anticipated and prevented.” “We need to be better at predicting bad outcomes” September 21.

Indeed and what would that pre-mortem suggest as the worst-case scenario for banks regulated by means of risk weighted bank capital requirements?

1. That what was perceived as risky turned out to be risky? No bankers already knew it was risky and, if they anyhow took a chance on it, that would be with a small exposure and a high risk-adjusted interest rate.

2. That what was perceived as risky turned out to be safe? Of course not! What great news, perhaps the bank had helped a successful entrepreneur.

3. That what was perceived as safe turned out to be safe? Of course not!

4. That what was perceived as safe turned out to be risky? Holy Moly! Like those AAA rated securities.

So since that “hypothetical postmortem” was not done, the risk weighted bank capital requirements, besides seriously distorting the allocation of credit to the real economy, also produce especially large exposures to what’s perceived or decreed as especially safe, and is held against especially little capital, risking thereby especially big crises… Good job regulators!

My 2019 letter to the Financial Stability Board

@PerKurowski

For capitalism to refunction, first get rid of the risk weighted bank capital requirements.

Sir, Martin Wolf quotes HL Mencken with “For every complex problem, there is an answer that is clear, simple and wrong.” “Saving capitalism from the rentiers” September 18.

Indeed, and the most populist, simplistic and wrong answer to how our banks should function, are the risk weighted bank capital requirements. These are naively based on that what’s perceived as risky is more dangerous to our bank systems than what’s perceived as safe; and, with risk weights of 0% the sovereign and 100% the citizens, de facto also based on that bureaucrats know better what to do with credit they are not personally responsible for, than for instance entrepreneurs.

And so when that what’s “super-safe”, like AAA rated securities backed with mortgages to the subprime U.S. sector exploded in 2008, this distorted bank credit mechanism, wasted away the immense amount of liquidity that were injected, creating asset bubbles, morphing houses from being homes into being investments assets, paying dividends and buying back shares.

“Tall trees deprive saplings of the light they need to grow. So, too, may giant companies”? Yes Mr Wolf, but so too does these stupid bank regulations.

“A capitalism rigged to favour a small elite” Yes Mr Wolf, but that small elite is not all private sector. The difference between the free market interest rates on sovereign debt that would exist absent regulatory subsidies and central bank purchases, and current ultra low or even negative rates, is just a non-transparent statist tax, paid by those who invest in such debt.

“We need a dynamic capitalist economy that gives everybody a justified belief that they can share in the benefits.” Yes Mr Wolf, but that should start by getting rid of the risk weighted bank capital requirements, so that banks ask savvy loan officers to return, in order to substitute for the current equity minimizing financial engineers.

“Corporate lobbying overwhelms the interests of ordinary citizens” Yes Mr Wolf, but silencing the criticism of current bank regulations could also be the result of some journalists having been effectively lobbied. Or not?

"Capitalism"? No Mr. Wolf, what we really have is Crony Statism

My 2019 letter to the Financial Stability Board
My 2019 letter to the IMF

@PerKurowski

Warning! Big Tech might be drawn into a too close too dangerous for us relation with Big Brother.

Sir, Ms. Rana Foroohar writes: “Whatever their size, the winning companies will be those that are profitable. That may sound obvious, but it hasn’t been for the past decade, as easy money has dulled investor senses.” “Activist’s critique of M&A is right” September 16.

But where did that “easy money” come from? Was it not central banks injecting immense amounts of money, and which effects were much distorted by the risk weighted bank capital requirements, which low capital requirements allowed that liquidity to multiply manifold? Has Ms. Foroohar tried to put the breaks on such easy money, or the contrary has she not been egging it on? 

And Ms. Foroohar concludes: “Meanwhile their Big Tech competitors are already being circled by regulators… Attorneys-general from 50 US states and territories in the US have launched an antitrust investigation into Google’s dominance of search and advertising, while New York is leading a probe of Facebook’s monopoly power… in Europe, the EU competition commissioner Margrethe Vestager… has been given a broader remit that includes digital policy.”

Should we cheer that? Absolutely not! For two reasons:

First that it might lead to Big Tech entering into too close too dangerous relation with Big Brother.

Second we, whose personal data is being exploited by Google, Facebook and similar, should be compensated long before redistribution profiteers and neo-ambulance chasers… for instance by having 50% of their ad-revenues to help fund an unconditional universal basic income.

@PerKurowski

Expert technocrats, like those in the Basel Committee, can be shameless and dangerous populists too.

Sir, Takeshi Niinami writes “Japan’s populism leads to mounting government debt and short-term solutions for immediate issues without a clear long-term vision for recovery. This is not unique to Japan. I believe that the US and EU will begin taking quite a similar path” “Japan has a unique form of populism” September 16.

1988’s Basel Accord gave officially birth to the risk weighted bank capital requirements. This regulation, with its much lower decreed risk weight of sovereign debt than of private debt, set all who applied it on a firm course to too much debt and too little growth. 

Just its denomination “risk weighted”, as if the real risks could be known, is of course just another sort of shameless populism. That the world fell for it, is clearly because the world wanted it so much to be true, that it never found in itself the sufficient will to question its basic fallacy; that it considered that which ex ante is perceived as risky to be more dangerous ex post to our bank systems than what is perceived as safe, something which obviously is not so, as all major bank crises in history evidence. 

As I so often have said, that faulty regulation imposed a de facto reverse mortgage on the economy, which extracted the value it already contained, as banks focused more on refinancing the safer past than the riskier future. By refusing those coming after us the risk-taking that brought us here, the intergenerational holy bond that Edmund Burke wrote about was violently violated.

@PerKurowski

Any populism your populist can do mine can do better; mine can do populism much better than yours.

Sir, Gillian Tett, when discussing populism and populists writes, “Nor is it obvious that Mr Trump will lose in 2020. If you look at recent opinion polls, these offer as much reason for alarm as for cheer.” “Is the populist wave in the west here to stay?” September 14.

Clearly populism is in the eye of the beholder. For instance, if Hugo Chavez had hosted “The Populist Apprentice” he might very well have told President Donald Trump. “You’re fired!” 

As for me Sir, you know very well I opine that one of the worst and most destructive populism ever, was when the expert bank regulators in the Basel Committee told us that with their risk weighted bank capital requirements, our banks would be safer… not caring one iota about how that would distort the allocation of credit to the real economy and, to top it up, base these on that loony idea that what's perceived as risky is more dangerous to our bank system than what's perceived as safe 

@PerKurowski

What a pity Martin Weitzman did not chair the Basel Committee for Banking Supervision. If he had we would surely not have suffered the 2008 crisis.

Sir, Tim Harford when referring to an economic paper by Martin Weitzman on climate change classifies it as a “this changes everything” paper, leading him to conclude “extreme scenarios matter. What we don’t know about climate change is more important, and more dangerous, than what we do”, “How this economist rocked my world” September 14.

So I must ask why is it possible to understand that and yet so hard to understand the mistakes of bank regulations based on that what’s perceived as risky being much more dangerous to our bank systems, than what might be lurking behind that which is perceived as safe?

“The truly eye-opening contribution” — for Tim Harford — “was Weitzman’s explanation that the worst-case scenarios should rightly loom large in rational calculations.”

In January 2003 you published a letter in which I said, “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds. Friends, please consider that the world is tough enough as it is”. 

Sir was it not clear I was warning about big crises resulting from some human fallible credit rating agencies assigning a very safe rating to something very risky? Like that in 2008 caused by the AAA to AA rated securities backed with mortgages to the subprime sector? European banks and US investment banks, loaded up with because with those credit ratings they were allowed according to Basel II, to leverage their capital a mind-blowing 62.5 times.

Ten years later, when it comes to bank regulations, Martin Weitzman’s wisdom about “worst case scenarios”, is still blithely ignored.

PS. In April 2003, as an Executive Director of the World Bank, in a formal statement I wrote "Nowadays, when information is just too voluminous and fast to handle, market or authorities have decided to delegate the evaluation of it into the hands of much fewer players such as the credit rating agencies. This will, almost by definition, introduce systemic risks in the market"

PS. My 2019 letter to the Financial Stability Board

PS. My 2019 letter to the IMF

@PerKurowski

Two regulations will turn the beautiful dream of the European Union into a nightmare.

Sir, Ignazio Angeloni writing that “The ECB houses hundreds of experienced, dedicated [bank] supervisor” blames “fundamental weakness in the underlying laws and the “resolution” framework for dealing with ailing banks” for many of EU’s bank troubles. “A common thread runs through diverse EU financial misfortunes” September 13.

The lack of a good resolution framework is a problem when trying to solve difficulties but much worse is that which causes the problems, in this case two regulations that are endangering Europe and the euro. Seemingly none of EC’s experts were capable of doing anything about it.

First, something that also affects most other economies, the Basel Committee’s risk weighted bank capital requirements. These seriously distort the allocation of credit, and, to top it up, are stupidly based on that what’s ex ante perceived as risky is more dangerous ex post to our bank systems than what’s perceived as safe. 

And second, in this case only a homemade EU concoction, the lunacy of all times of having assigned a 0% risk weight to all Eurozone sovereigns’ debts, even though all that debt is not denominated in  their local/printable/fiat currency.

@PerKurowski

Ms. Gillian Tett, what is that we really have, capitalism or statism?

Sir, Gillian Tett lectures us interestingly with “If you want to understand what is at stake in this debate, it pays to consider the original meaning of the word ‘company’”... “a society, friendship, intimacy; body of soldiers”, “one who eats bread with you” “in other words initially synonymous with social ties”. “Capitalism — a new dawn?” September 7.

Yet, over the years I cannot rememer Ms. Tett saying a word about that our banks are regulated exclusively so as to be safe mattresses in which to put away our savings, without one single consideration given to their vital social purpose of allocating bank credit efficiently to the real economy. “A ship in harbor is safe, but that is not what ships are for”, John A Shedd.

And Ms. Tett also writes “the 2008 financial crisis had undermined faith in unfettered free markets.” What? Like those “unfettered free markets” with Basel II regulations that when in order to borrow from banks, borrowers would have to remunerate an amount of bank capital of 0% if sovereigns, 1.6% if AAA rated, 2.8% if residential mortgages and 8% if unrated entrepreneurs?

http://subprimeregulations.blogspot.com/2019/07/risk-weights-are-to-access-to-credit.html

@PerKurowski

Regulators instructed banks to compete with small savers and insurance companies for whatever was perceived as safe.

Sir, Michael Mackenzie writes “the concern that investors will extend their embrace of riskier assets and of private markets that are far less liquid and transparent, in an effort to boost returns over time.” “Contrarians gain confidence amid fog of future predictions” September 7.

Of course, how can it not be? Small savers and insurance companies face huge new competition for what’s perceived as safe as a consequence of regulators, with risk weighted capital requirements, telling banks to stay away from what’s perceived as “risky”, and to maximize their risk adjusted returns on equity with what’s perceived, or decreed, or concocted, as “safe”. 

Out went the savvy loan officers, in came the equity minimizing financial engineers.

So what’s the threat now? A new crisis resulting from excessive exposures to “the safe”, like some 0% risk weighted Eurozone sovereigns deciding it cannot pay back debt that is not denominated in its own printable currency, or regulators waking up to the fact that what is really dangerous to our bank systems is that which bankers might perceive as safe.

Sir, when in 1988 bank regulators assigned America’s public debt a 0.00% risk weight, its debt was about $2.6 trillion, now it is around $22 trillion and still has a 0.00% risk weight. When do you think it should increase to 0.01%? 

http://subprimeregulations.blogspot.com/2019/07/risk-weights-are-to-access-to-credit.html

@PerKurowski