Show steel and lower the capital requirements for banks when lending to the risky, or the economy will collapse

Sir I refer to Avinash Persaud’s “Show steel and raise rates or the financial system will fracture” August 25.

Though I do not disagree with what Persaud writes, I would argue that before the rates are increased, we should get rid of the credit risk weighted capital requirements for banks. These artificially lower the interest rates on what is perceived as safe, and artificially increase the relative interest rates paid by those perceived as risky... like SMEs and entrepreneurs.

By getting such distortions out of the way, it would be so much easier for the real economy to adjust to any interest rate adjustment. By leaving these in place, the distortions in bank credit allocation could be dramatically amplified when adjusting the rates.

I hear you: “Kurowski are you crazy? Lowering the capital requirements for banks on risky assets?”

Why not? “Risky” assets present much less risks of unexpected losses than those perceived as absolutely safe… and are not unexpected losses the prime reason for which banks are required to hold equity?

@PerKurowski

The next crisis will have the same origin as the last, too much bank exposure to what is blessed as safe by regulators.

Sir, Avinash Persaud writes: “Exotic assets, and the crippling losses that big and indispensable financial institutions suffered after buying too many of them, bore much of the blame for the last financial crisis. The next one might have a more paradoxical cause. Instead of being overexposed to assets of dubious provenance, many of the same institutions may be buying too many of the assets that the authorities deem safe.”, “The assets made combustible when regulators call them ‘safe’” June 2.

What “Exotic assets that bore much of the blame for the last financial crisis” is Persaud talking about? Where has he been? Was it not AAA rated securities, loans to Greece, any assets backed by default guarantees issued by an AAA rated like AIG, loans to the real estate sector in Spain, and similar “safe assets” that caused the crisis? Every single one of these problematic assets had one thing in common, namely that bank were allowed to hold very little equity against these because these were perceived as safe.

But Avinash Persaud is absolutely correct when he ends stating: “In the popular narrative, the financial crisis was caused by the willful wrongdoing of the banks. Regulators should know better. In financial markets, risky behavior is less often born of recklessness than of a false sense of safety.”

I wonder though if he will dare to honestly extrapolate from what he is saying… and understand that current capital requirements for banks should perhaps be higher for what is perceived as safe than for what is perceived as risky? And then dare to state that current bank regulators have been 180 degrees wrong?

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?

Some disagreements with Professor Persaud´s excellent comments on bank bail-ins and contingent convertible notes, Cocos.

Sir, Avinash Persaud deserves much praise for the clarity of his “Bank bail-ins are no better than fool´s gold” October 22. I do hope the regulators take notice and try sincerely to understand it, though I have many reasons to doubt they will. In the mutual admiration club of the Basel Committee and the Financial Stability Board, they only listen to the members.

That said there are though three issues on which I differ much with Professor Persaud.

The first is when he states “Financial crises are the result of market failure”. This is not always so. The current crisis was produced by regulatory failures present in the loony capital requirements for banks based on, ex ante, perceived risk. These made banks go, excessively, with very little capital, into areas deemed as “absolutely safe” and which we all know, or should know, are precisely those areas capable of creating big financial crises, when, as always happens, some of the perceptions turn out to be wrong, ex post.

The second is when he writes about “the failed philosophy at the heart of the 2004 Basel II global banking rules, which made the market pricing of risk the frontline defence against financial crises.” Where on earth does he get that from? The frontline of Basel II, its only pillar, were the capital requirements I just mentioned… and its implied frontline defence was allowing banks to earn much much higher risk-adjusted returns on their equity on assets deemed as “infallible” than on assets deemed as “risky”. And that is why banks now are not financing the future but only refinancing the past.

The third is when, with respect to Basel II, he mentions “a throwback” and which seems to imply he believes that Basel III is fundamentally different. That is not the case. Where it really matters, on the margins of banks' credit allocation decisions, regulatory risk-weighting is still in full force… and so the distortions of the real economy will keep on occurring… and keep on producing larger and larger crises… to be paid by all, especially by the young.

If all the bright students went to Wall Street… who became the regulators?

Sir Avinash Persaud declares “risk is a chameleon” and then describes many absolutely perfect reasons why no one should build a bank regulatory system centered around capital requirements based on perceived risks; all this reasons perfectly ignored by the regulators, “Boomtime politicians will never rein in the bankers” November 27.

Having often in serious jest forwarded the idea that perhaps bank capital requirements need to be higher for what is perceived as risky since that perception could introduce pro-cyclicality and carelessness into the system I fully agree with Persaud’s comments on risk.

Persaud also asks “why the universities and press, falling over themselves to kick bankers today, did not play a more effective counterveiling force” hindering the bankers from capturing the regulators. To phrase that question one has to assume the expert PhDs and expert reporters really knew what was going on, but seeing that so many of them are still not capable to free themselves from the paradigms they bought and wake up to the real facts, that might not really be the case; which is of course even more unfortunate for us all. They say that all the bright students went to Wall Street… if that’s true, then who stayed at the universities, who went to the press and who became the regulators?

Better putting some sand in the wheels than building channels that deviates the flow of capital.

Sir perhaps if there was a tax on responding an email during the first ten minutes of receiving it many unnecessary embarrassments could have been avoided. And that is primarily the role of a Tobin type like tax proposal, to slow things down, to give us a little more time, to put a lid on the trading of any small arbitrage opportunity becoming a purpose and not a tool. And, of course, in this I agree with Avinash Persaud’s “Time to put sand in the wheels of the market” August 28. Also, when you are allowed to put huge taxes on so many other goods and services, why should a minuscule tax of this nature be the source of much more dangerous inefficiencies?

But, having said that, let me point out the irony with so much being discussed about what a Tobin tax, with its little sands in the wheels of the market could do, compared to how little discussion, or none at all, there has been about the construction of the huge channel that the current capital requirements for banks made in Basel signifies, and that deviates trillions from what is perceived as risky to what is perceived as less risky. That is indeed a humongous tax, that is indeed a source of crazy structural inefficiencies, and that is what we are now paying for with the current financial crisis. Compared to that a Tobin tax is only a footnote

I will gladly trade you one Basel Committee for a hundred of offshore financial centres.

Sir Avinash Persaud is absolutely right when he writes “Look for onshore, not offshore scapegoats”. The damage produced by the onshore enclave we know as the Basel Committee and all its regulatory derivatives, has caused hundredfold more misery than all offshore financial centres put together.

This does of course not imply that I would not like to trade away the financial centres too.

What we need to make sure is that any financial crisis results at least from something worthwhile.

Sir John Eatwell and Avinash Persaud, in “Fannie and Freddie, damned by a Faustian bargain” July 18, write the following: “The main cheerleaders for the marketisation of banking were the gnomes of Basel – the centre of international bank regulation. Many regulators thought the “marketization” of banking represented a brave new world, where grizzled, idiosyncratic lending officers were replaced with best-of-breed credit models, policed by third party rating agencies and, where risk was digitised, spread across a large number of investor and traded. But it was a Faustian bargain…. We need to redraw the lines of financial regulation. A critical objective should be to preserve diversity, not create artificial homogeneity in the blind pursuit of common practice.”

Of course as I have been writing and fighting along those lines for over a decade I totally agree with them on this. But when they suggest that regulators need to focus more on the risk capacity of the institutions, primarily their funding structure, there I lose them. The first think we need to focus on is what the real purpose of our financial system should be since currently it seems limited to avoid any type of crisis and that, besides being unrealistic, sounds like a truly pitiful objective.

Since a financial crisis is natural and will happen no matter what, we need to make sure that any financial crisis at least results from something worthwhile.

Free the banks from the chaperones and get the party going!

Sir Charles Goodhart´s and Avinash Persaud´s “A party popper’s guide to financial stability” June 5 reads like the desperation of a garage fixer to fix something with whatever epoxy he can lay his hand on.

I have myself often proposed a progressive tax on banks, based on the-bigger-you-are-the-more-it-will-hurt-if-you-fall-on-me principle but, what on earth do they mean by taxing the growth rate of bank assets, which is what raising capital requirements mean? That slow growing banks can just sit back and trade growth allotments, like if bank assets were carbon type contaminants?

No instead of worrying so much about the possible hangovers why do they not worry more about making the party better. The current risk adverseness implied in the minimum capital requirements based on risk and as measured by the credit rating agencies, have the markets playing boring and unproductive minuets, like consumer finance dressed up as “risk free” securitizations.

The world is clamouring for decent jobs, and if the banks are to help us create them, they need to be given more freedom and responsibility. In that sense, set the capital requirements for banks at a fixed percentage of assets and get the chaperones out of their hair, so that we can get more of that risky salsa that when if times comes for a hangover, makes it at least more bearable... since the party was great!

At least let us guarantee some cyclicality in the bonuses!

Sir Prof Avinash D. Persaud in his letter “Bumper bank bonuses and banditry in the boom” suggests new regulatory capital requirements for the banks so as to get rid of a system that “adds to pro-cyclicality”. I could not agree more, especially since that would also help to reduce the “pro-cyclicality” produced by the credit rating agencies which is something I have been arguing since the Basel Accord started to be applied globally.

Though I also agree that the above is a much better way to take care of the salaries and bonuses of bankers than having regulators act directly on it, I would like to remind about the importance of fully restoring the powers of shareholders, in banking and in all other activities because as long as management have so much influence over their own bonuses there is not even cyclicality.

Do not blame the messenger!

Sir, Avinash Persaud in “Hold tight: a bumpy credit ride is only just beginning” August 16, speaks nostalgically about those days “before securitization” and indeed he is right in so many ways especially on that part of the banks not any longer carrying and nurturing the credits on their own books. But he should not blame it on securitization as such, that is just a very valuable tool, if used correctly. He should blame instead those bank regulators that arrogantly thought they could drive banking risks out of banking without any consequences and that empowered a couple of credit rating agencies to do the impossible task of correctly rating credits without introducing systemic risks.