Europe, Basel Committee’s risk weighted capital requirements for banks, is the kiss of death for your real economy.

Sir, Frédéric Oudéa, president of the European Banking Federation, writes: “The Basel Committee is targeting the degree of variability in how banks define the risks that ultimately determine their capital requirements. The highly technical nature of this topic should not divert attention from the fundamental question that lies behind the review: how, in the future, will European banks be able finance the economy and hence foster growth and raise employment?”, “New Basel banking rules’ impact on European economy” November 28.

But though Oudéa correctly argues that any review of current rules, “should not… disrupt the financing of the real economy”, he then does not tackle the “fundamental question”. That’s because be completely ignores, willfully or not, that the risk weighted capital requirements for banks seriously distorts the allocation of bank credit to the real economy.

In 1997 when getting some strange vibes about what was going on in the world of bank regulations I ended an Op-Ed with: “If we insist in maintaining a firm defeatist attitude which definitely does not represent a vision of growth for the future, we will most likely end up with the most reserved and solid banking sector in the world, adequately dressed in very conservative business suits, presiding over the funeral of the economy. I would much prefer their putting on some blue jeans and trying to get the economy moving.”

The risk weighting has added a dangerous layer of regulatory risk aversion that causes banks to no longer to finance the “riskier” future, only to refinance the “safer” past or present. Since risk taking is the oxygen of any development, these regulations, if continued, represent a kiss of death for Europe… and others

Now, anyone should be rightly concerned with that getting rid of the risk weighting would create such bank capital shortages that it would put a serious squeeze on bank credit. As a solution I have suggested grandfathering current capital requirements for all the banks current assets, and then apply a fixed percentage, like for instance 8%, on all new assets. That should of course include the public debt, since a 0% risk weight for the Sovereign and 100% for We the People, is a pure and unabridged unbearable statism.

Now, if regulators absolutely must distort, so as to think they earn their salaries, I suggest they use job-creation and environmental-sustainability ratings, instead of credit ratings that are anyhow being cleared for by banks.

@PerKurowski

What’s wrong with deregulating lousy regulations? Get rid of risk-weighted capital requirements for banks… but gently

Sir, Patrick Jenkins speculates on what Trump will do to bank regulations and regulators and how the latter would respond in America and in Europe. “Trump’s agenda on deregulation is as vital as his Nato policy” November 15.

I just know that with statist and distorting regulations, like the current risk weighted capital requirements, deregulation and getting rid of regulators, would be a good thing. But of course, that needs to be done with utter care, since you could otherwise easily make the cure worse than the disease.

The basic principle with respect to any changes in the capital requirements should be grandfathering, so that these only operate on the margin of the new, without shaking up the average of the old. Of course grandfathering should not be a tradable feature. If a European bank carries a low capital requirements mortgage on its book, and holds it that way until it runs out that is ok, but it should not be able to profit by selling low capital requirement’s mortgages to other more "needy" banks.

@PerKurowski

When will the Basel Committee define the purpose of our banks, and regulate accordingly?

Sir, Jim Brunsden writes of a “letter from the banking associations [that] calls on the Basel Committee on Banking Supervision to scrap plans for a floor limiting how far a bank can decrease its capital requirements by using internal risk models. “Lenders step up their fight against global capital reform.” September 2.

My immediate reaction could be to ask the bankers: When will you return to earning your returns on equity by doing banking and not by minimizing equity?

The current confusions about bank regulations all begin with that mindboggling fact that the regulator has not defined the purpose of banks. “A ship in harbor is safe, but that is not what ships are for.” John A Shedd, 1850-1926

When will the regulator understand that banks must finance the “riskier” future and not just refinance the “safer” past?

When will the regulator understand that what’s rated AAA is more dangerous to banks than what’s rated below BB-?

When will the regulator understand Voltaire’s “May God defend me from my friends. I can defend myself from my enemies”

When will the regulator understand that risk weighted capital requirements distorts the allocation of credit?

When will the regulator understand the full monstrosity of its risk weighted capital requirements for banks?

PS. Sir, from your steadfast silence on these issues I can only deduct your “Without fear and without favour” is pure BS. You are clearly beholden to banks and their regulators, caring very little for the real economy on Main Street.

@PerKurowski ©

Please help save us from regulators applying their standardized risk models to all banks… that would be the end

Sir, Martin Sandbu, in “Free Lunch: The bank, the fox and the henhouse”, June 13, discusses the issue that “Rules for banks’ capital cannot rely on their own models of risk”

Sandbu writes: “non-initiated may be surprised to know that [some] banks were [and are] permitted to decide how risky their assets were — which determines their capital requirements under rules that set safe capital thresholds as ratios of “risk-weighted assets”. To the extent banks perceive capital requirements as a burden, that creates an incentive for them to engineer risk assessments that minimize that burden.”

And so clearly when “The Basel Committee on Banking Supervision, which recommends global standards for national banking authorities, proposes to replace banks’ internal models of riskiness with external standardized models” this sounds very logic to many.

But the non initiated are not aware either of that, with Basel II, the regulators already gave a set of standardized risk weights to be used by all banks deemed not sophisticated (or big enough) to run their own risk models.

And Sir, it behooves us to fully understand what regulators did, before we dare to hand over to them one iota of more power.

Unbelievable, Basel II derived the risk weights, those that determine the capital requirements, from the ex ante perceived risk of the assets per se, and not from the risk these assets can pose to the banks or the bank system.

And therefore we have that assets rated below BB-, speculative and worse, those assets to which banks would never ever create excessive exposures to, got a risk weight of 150%, while assets rated AAA to AA, those to which banks could easily get to be dangerously exposed, these got a risk weight of only 20%.

So Sir, is there any good reason for us to welcome the same regulators to start working on a Basel IV?

As a minimum minimorum, before Basel IV work begins, we must require regulators to clearly specify what is the purpose of the banks, something they never did before they regulated. I say this because with the distortions produced with Basel I, Basel II and Basel III, they clearly evidenced, they do not give a damn about whether banks allocate credit efficiently to the real economy.

The only useful risk model is that which understands that bank capital is to be there against unexpected events, not against expected credit risks. For example, capital could be 8 percent against all assets.

But perhaps banks do need more capital, like 10 percent, because now we also have to guard them against the “unexpected” reality of regulators being capable of such an immense hubris, they can just push on without a clue about what they’re doing.

PS. To top it up... their risk-weights were portfolio invariant

@PerKurowski ©

A Leverage Ratio makes banks hold equity on all exposures, to cover specially for unexpected losses, like cyber attacks

Sir, I refer to the letter signed by financial sector representatives: “Leverage ratio threat to the cleared derivatives ecosystem” August 27.

What is argued, that segregated cash margins, held to guarantee the commitments of clients, should be deducted from a bank’s actual exposure, sounds quite reasonable since the current construct of the leverage ratio “fails to consider existing market regulations that mitigate…losses”.

But when it is said that: “The leverage ratio is designed to require banks to hold capital against actual exposures to loss”, that is wrong. The leverage ratio is there to cover for any exposures to losses, most importantly any unexpected losses.

It would for instance be easier for regulators to just state that the leverage ratio is to cover against cyber-attacks… so as to clear the air, while moving towards a completely different Basel IV.

@PerKurowski

If we are going to have a Basel IV that works for the economy, it cannot be built on principles of Basel I, II or III

Sir, Simon Samuels is half right when opining: “It is one thing to decide that tighter regulations are worth the cost. It is another to exacerbate that cost through delay and indecision” “Make up your mind on banking regulation” August 27.

Half right because much more than tighter regulations, we need better and less distorting regulations.

In his article Samuels, surely quite unwittingly, describes well how the risk-weighted capital requirements in Basel regulations distort the allocation of bank credit. When he writes: “a business that has a 17 per cent return on equity under Basel III might earn a paltry 3 or 4 per cent under Basel IV”, he should not ignore that a lot of lending that previously gave banks a decent return on equity, equally became bad business with the introduction of the risk-weighted capital requirements.

Before the introduction of credit risk weights, all borrowers competed with their risk-adjusted margins on equal terms for the access to bank credit. Now those who are perceived as safe, and which therefore generate lower capital requirements, are favored because their risk-adjusted margins can be leveraged many times more on bank equity than those of the “risky”. The problem of SMEs and entrepreneurs is that their voice is much less heard than that of the banks and of the AAArisktocracy.

I do understand that Samuel, as a bank consultant, shows much concern for the banks… but let me assure him that any delays and indecisions about correcting current bank regulations are hurting the real economy much more… and, implicitly, therefore also hurting the banks too.

Bankers, if good citizens, should know that making great returns on equity based on misallocations of credit to the real economy… hurts the future of which their kids are also a part.

@PerKurowski

Could an app which controls bank regulators’ natural sissy instincts, be the solution for our unemployed?

Sir I refer to Lisa Pollack’s “It’s only natural to seek an app for everything” of December 24.

It really shed lights on how we could perhaps obtain better bank regulations, not-withstanding regulators natural wishes to impose on our banks a so dangerous and distorting risk adverseness.

An app, that we could perhaps call Basel IV, would for starters reverse regulators automatic beliefs that what is perceived as risky is risky and what is perceived as safe is safe, for a much more correct: what is perceived as risky is actually quite safe, as it is what is perceived as absolutely safe that contains the greatest dangers.

Then since regulators seemingly cannot refrain from the meddling that distorts, this app would immediately convert all of their risk weighting into a neutral one and the same capital requirement for all bank assets.

And finally remembering what Mark Twain said about the bankers being those willing to lend you the umbrella when the sun shined, and wanting it back when it looked like it could rain, the Basel IV app would impose an extra capital requirement, whenever a bank had too much of its assets in AAA rated assets, housing and real estate finance, or loans to infallible sovereigns.

And so hopefully this Basel IV app would also neutralize bank regulators who are only concerned with the safety of the banks… as if shining and healthy banks could survive among the rubbles of a destroyed real economy.

Let us pray Santa brings us such an app a.s.a.p. That would bring our young ones what they most need now… namely better expectancies for finding good jobs.

Britain could be against bankers, bank lobbyist and bank regulators… but should never be versus its banks.

Sir I refer to Philip Augar’s “Britain versus the banks” July 19… what an unfortunate title.

Augar writing about Alex Brummer’s “Bad banks: Greed, incompetence and the Next Global Crisis” says the author poses the ultimate question for the authorities who have to decide “what sort of banking they actually want and the extent to which the market driven requirements of high returns through risk can be balanced with society´s desire for safe banking”.

What? “society’s desire for safe banking”? And what about all other society’s desires for banks… like helping to finance the creation of jobs?

Does Brummer for instance agree with that “market driven requirements of high returns [for banks]” and for which bank lobbyists convinced regulators to lower the capital requirements for banks when lending to what is perceived as safe, should trump the right of the “risky” small businesses and entrepreneurs of not being discriminated more than normal when accessing bank credit?

Sir, Just like Philip Augar starts by quoting JK Galbraith, so did I in my first article published in 1997 in the Daily Journal of Caracas, “Puritanism in banking”. In it I wrote:

“In his book “Money: Whence it came, where it went” (1975) [and of which the author signed a copy for me in 1978] John Kenneth Galbraith addresses the function of banks in the creation of wealth…

Galbraith speculates on the fact that one of the basic fundamentals of the accelerated growth experienced in the western and south-western parts of the United States during the past century was the existence of an aggressive banking sector working in a relatively unregulated environment. Banks opened and closed doors and bankruptcies were frequent, but as a consequence of agile and flexible credit policies, even the banks that failed left a wake of development in their passing.”

And clearly, the almost fanatic obsessions of current regulators with stopping banks from failing, impedes these from helping out in financing the development we need but that of course entails a lot of risk-taking. It also, with its minimalist capital requirements for anything that can dress up as "absolutely safe" guarantees the growth of the Too Big To Fail Banks.

And I also wrote “Galbraith refers to the banks’ function of democratization of capital as they allow entities with initiative, ideas, and will to work although they initially lack the resources to participate in the region’s economic activity. In this second case, Galbraith states that as the regulations affecting the activities of the banking sector are increased, the possibilities of this democratization of capital would decrease. There is obviously a risk in lending to the poor.”

And indeed few regulations can be argued to be as anti-democratic as the risk-weighted capital requirements for banks based on perceived risks… something which is amazingly ignored in these days when inequality is much discussed. 

Sir, let me finalize again by quoting Galbraith from the same “Money”. “It should be the simple truth in all economic and monetary matters that anyone who has explained failure has failed. We should be kind to those whose performance has been poor. But we must never be so gracious as to keep them in office”.

Indeed we should, perhaps, not tar and feather those who had anything to do with Basel II… but we should send them home, not promote them, and the least of it all… allow them to have anything to do with Basel IV… as they have already contaminated Basel III.

For Europe to reduce the horrors of its house of debt, it needs to allow its risky-risk-takers to get going.

Sir, Wolfgang Münchau writes about a “balance sheet recession: the notion that indebted households and corporations do not care about cheap interest rates but just want to offload debt. When that happens monetary policy becomes ineffective” and then, salt on the wound, he quotes Moritz Kramer of Standards & Poor’s saying “The Europeans have barely begun to deleverage”, “Europe faces the horrors of its own house of debt” June 16.

Has Münchau ever heard that “when the going gets tough the tough get going”? If so I would ask him who he thinks might be the real tough in Europe. And I would advance that would be all those with a spirit of initiative who are willing to risk either their good name or whatever little capital they have, in order to take on a business venture.

And, if you agree, then reflect on that these are precisely those who are now locked out from having a fair access to bank credit by the sissy bank regulators and their risk-weighted capital requirements.

And so, if Europe is going to have a chance to reduce “the horrors of its own house of debt”, it must start by inducing banks to allow the risky-risk-takers of Europe, wherever you can find them, to get going. 

Given the real and urgent needs of Europe, the risk-weight on loans to “risky” medium and small businesses, entrepreneurs and start-ups, should be lower than that of their “infallible sovereigns.”

Gillian Tett describes another reason for using a tangible equity to asset ratio as suggested by Thomas M. Hoenig of FDIC.

Sir, Gillian Tett is on the dot with her warnings in “Watch out for the interest rate hike hit to US banks”, July 14.

And so there we have it again, with regulators fixated with credit risk, while ignoring most of the other millions of risks that abound. Here banks, not only in the US but all over the world, could be holding long term and fixed rate assets classified as absolutely safe, and therefore allowed to be held against very little capital, all of which could be wiped out by some minor interest rates hike.

This is just another evidence for why one simple capital requirement, in my opinion between 8 and 10 percent of tangible equity to assets ratio, such as the one Thomas M. Hoenig of the FDIC is proposing would make so much more sense. In fact any other type of micromanagement would only constitute an expression of regulatory hubris.

I was so naïve, but I must insist on being so naïve, since I do not know any other way.

There I was, a small financial and corporate strategy consultant from a small developing country, completely, 100 percent sure, that the bank regulators of the developed countries were getting it completely, 100 percent, wrong. And so I decided to write letters about it to the Financial Times, hoping... no! absolutely certain that they would pick up and help divulge my arguments. 

But, little did I know, about how big weak egos could stand in my way.

How long will the media Gurus block the truths? Why do not old tired “Gurus” do like old soldiers, and just fade away?

A market distortion error is much worse than a model error

Sir, as you might guess from my hundreds of letters to you over the last 5 years and which were ignored, I completely agree with Pro Johan Lybeck that we should “Forget Basel III and head straight for Basel IV” February 2. I have though two differences with him. 

When he suggests “fixed risk-weight for all assets, so as to eliminate “model error”, I much prefer the same risk-weight for all assets, so as to eliminate the much worse non-transparent market distortion error. 

The second difference is that he suggests that the changes in capital requirements should be implemented now, even though that could mean banks could be partially owned by the state because they cannot raise new capital in time. My suggestion is to allow banks to keep the original capital requirements on any assets booked previously, since there is no need to cry over spilled milk, and allow the banks to use whatever new capital they can raise for the new business we so sorely need.