Bank regulators never considered the unexpected, like a pandemic

Sir, Angela Merkel, Justin Trudeau and Erna Solberg opine: “The Covid-19 pandemic has taught us that the costs of prevention and early response are small compared with the consequences of under-investment.” “G7 should pay lion’s share of costs to help end the pandemic” FT June 10.

That’s correct but it should not have taken a pandemic to understand that banks need also to have sufficient capital so as to be able to respond to unexpected events. Unfortunately, instead of basing their bank capital requirements on such possibilities, or on that of misperceived credit risks e.g., 2008’s AAA rated mortgage-backed securities, bank regulators, the Basel Committee, doubled down on perceived credit risks, those which were already being cleared for by banks. 

The result? Though so many don’t want the innocent child to be heard, the banks now stand there naked.

Sir, again, if what’s perceived as safe is safe, and what’s perceived as risky is risky, would banks need capital. Not much. 

Bank regulations need a complete overhaul, meaning going back to the humbling reality of risks being hard to measure; instead of digging us down even deeper in the hole with Basel IV, Basel V and so on.

PS. July 12, 2012 Martin Wolf wrote: “Per Kurowski, a former executive director of the World Bank, reminds me regularly, crises occur when what was thought to be low risk turns out to be very high risk.” Martin Wolf clearly heard me, but he did not listen.

@PerKurowski

Long term growth, development, in India and elsewhere, requires getting rid of Basel's regulatory risk aversion.

Sir, Eswar Prasad writes: “the real question for policymakers in India is not about how they can boost growth temporarily but how to create the environment to elicit private investment. Without that, durable longterm expansion will remain a mirage”, “Long-term growth in India depends on serious reform” October 17.

It is now ten years since at the High-level Dialogue on Financing for Developing at the United Nations, I presented a document titled: “Are the Basel bank regulations good for development?”

Its first paragraph states: “It is very sad when a developed nation decides making risk-adverseness the primary goal of their banking system and places itself voluntarily on a downward slope, since risk taking is an integral part of its economic vitality, but it is a real tragedy when developing countries copycats that and falls into the trap of calling it quits.”

And from what I have seen, in terms of Basel’s banking regulations, India is proceeding as if just as papist as the Pope.

The risk weighted capital requirements; those that dangerously distort the allocation of bank credit in favour of what is perceived decreed or concocted as safe, and against what is perceived as risky, like SMEs and entrepreneurs, are still going strong there.

That is the danger of empowering technocrats that are more interested in showing off to colleagues what’s fashionable in Basel than wearing what they should wear back home.

PS. The document referred to was also reproduced in India, in October 2008, in The Icfai University Journal of Banking Law Vol. VI No.4

@PerKurowski

Lord Adonis, as your National Commissioner, could do more for UK’s infrastructure by going to Brussels and Basel than staying in London.

Sir, I refer to your “A commission for firing up Britain’s bulldozers” October 7.

You write: “In economic terms, more infrastructure ticks every box. It enhances productivity, while building it also creates jobs. With interest rates near to all-time lows, the financing costs are nothing to fear. Should prudence or ideology demand the use of private instead of public money, there are pension funds crying out for a stable return, if the state bears the construction risk.”

Not so fast! In infrastructure, what could and how it will be financed, in the UK, depends a lot on what the financial regulators think; as they express in their capital requirements for banks and insurance companies. These regulators are in so many ways the real Great Disrupters. 

In fact, your Lord Adonis would be well advised to take a little study trip to Brussels and Basel to learn about all this. In fact you’re your Lord Adonis could well be doing UK’s infrastructure sector much more favors staying there, helping to eliminate the distortions to infrastructure finance that regulators create, than what he could achieve by remaining in London leading the National Infrastructure Commission.

Per Kurowski

@PerKurowski ©  J

Poor rich Oprah Winfrey should get herself a buyer-power-rating, issued by one of few big agencies.

Sir, I refer to James Shotter´s “Swiss image suffers after asylum row and Winfrey furore” August 10.

Poor rich Oprah Winfrey considers herself discriminated against because of how a certainly much poorer sales assistant in an upmarket Zurich boutique, dared to express the opinion that a ludicrous expensive handbag was too expensive, instead of perhaps increasing its price 50 percent as any much more able vendor would have done.

Frankly, this whole affair is so incredibly petty when I compare it to that other official discrimination which also originates in Switzerland, through the Basel Committee. That one establishes that even though “The Infallible” borrowers are already much favored in the markets, and “The Risky” much disfavored, that banks are allowed to hold much less capital when lending to the former, and thereby earn a much higher expected risk-adjusted return on its equity, than when lending to the latter.

I guess that if these bank regulators were asked, they would suggest that Oprah Winfrey equips herself with an AAA buyer power rating, issued by one of few formidable buyer-power-rating agencies.

Of course, the instinct of any normal ludicrous expensive handbags store owner, upon seeing an AAA buying-power-rating, would be to increase the listed price of the handbag, but I am sure that our Basel Committee regulators could also come up with a way of favoring these ultra rich buyers, and thereby discriminate against those who, immensely poorer, just want to feel like an Oprah Winter holding that completely unaffordable handbag in their hands for some seconds.

It is truly amazing how much we can hear about any discrimination based on color or other factor, when compared how little the officially sanctioned discrimination based on perceived risks are not even debated. Could it be because we are ashamed of having to admit to ourselves that we have changed from being risk-taking into risk-adverse nations?

In the name of my constituency, my granddaughter, I protest though: “Damn you Basel Committee… for having castrated our banks”

The “risky” are the European untouchables.

Sir, John Plender is absolutely correct when he identifies the officially “risky”, the emerging economies of eastern Europe and small and medium sized businesses, already penalized by the Basel capital regime, as the biggest victims of the ongoing deleverage, “Europe faces vicious circle of disorderly bank deleveraging” April 25. 

The World Bank and the IMF during their recent spring meetings were all dressed up in signs that asked about “reducing gaps”. And indeed, one gap that surely needs to be closed, and where the World Bank and the IMF should be at the forefront, is the one odiously increased by senseless bank regulators, between those perceived ex-ante as “not-risky” and those similarly perceived as “risky”. 

Unfortunately no one made a big point of this during these spring meetings as they were all busy talking about the scarcity and the need of “safe-assets”. Clearly, those perceived by the regulators ex ante as “risky”, in Europe, are a new class of untouchables.

The bank crisis and the Basel Committee banking regulations explained to a golfer

Once there was a golf Club with a somewhat narrow golf course and where, even though the members were very careful, sometimes the hooking or slicing of the golf balls into adjacent holes, caused some serious accidents.

The Club’s Board was ordered to find a solution. To that effect the elected members of the Board consulted with some Experts and asked for recommendations. The Experts told the Board “most of the slicing and hooking is the product of bad players and so, if you want to solve this problem, you need to get rid of them”. Knowing this idea would not be received with much enthusiasm, and could in fact pose a direct threat to their reelection as members of the Board, they all decided to immediately delegate the “how” to a Committee of Experts.

The Committee of Experts decided that they needed to appoint some Golf-Player Rating Agencies (GPRAs) to rate the real quality of the players and thereafter created a parallel handicap adjustment requirement that effectively eliminated the bad players… without these even noticing it. According to their ratings, the AAA rated players had their normal handicap increased by 5 strokes, while the players rated B- or worse had their normal handicaps officially reduced by 5 strokes.

It worked! Though, just initially… Since having to play with a very low handicap was pure hell for a bad player, most of the bad players rapidly decided to change clubs and, as a result, the Club gained immense recognition for having the best players and being the safest club in the country… and the Committee of Experts was wildly acclaimed for having true experts. We will never ever have more accidents in our Club… was the Board’s self congratulatory message at the year’s end… four years ago.

But life is life, even among golfers, even in a golf club… and so the membership of the Club started changing. For instance, many great golfing has-beens around the country were attracted by a system that so clearly could help to pro-cyclically prolong their golf-life, just like many never-able-to-be-good players were also attracted by the possibility of joining a club renowned for having exclusively good golf players… and so they all started to read up and converse with the GPRAs about what was necessary in order to be conveniently rated.

There was such an avalanche of enquiries that the GPRAs got confused and overworked and started to make mistakes… to such an extent that the Club rapidly became overcrowded with dubiously rated golf-players. This would, of course, not have meant anything in the old days, but, since everyone had been duly informed that the accidents had been forever eliminated and that therefore there was no need for being careful… the accident rate shot up and rapidly turned, three years ago, into a pandemic disaster that threatens even the survival of the Club… and aggravated by the fact that the beginners and the decent-bad players, those who really are the heart and soul and economical support of a golf club, want nothing to do with a club that has a handicap system that so harshly discriminates against them, and have therefore joined other clubs.

But, golfing friends, the saddest part of this story is that since the logic of “getting rid of bad players and allowing only good players” sounds so very attractive and so very logical, the Board has not even today understood what they did wrong and so they insist on using exactly the same Committee of Experts to come up with better solutions. And the Committee of Experts is currently studying only refinements of their original handicap adjustment requirement formulas because, as “experts”, they cannot under any circumstances acknowledge that they were so fundamentally wrong.

And, unfortunately, the local media is not sufficiently "without fear and without favour" to dare to really fundamentally question the wisdom of the local Club´s Board or of the Committee of Experts.

With their “Risk-Weights” it is the regulator who is taking the load off the books of the banks.

Sir, in reference to all being written about that “distasteful” behavior of banks of putting much of their exposure off the books, you should perhaps consider the following:

When the regulators used (and use) a risk-weight of only 20% to reflect the risk-weighted value on the books of banks of for instance lousily awarded mortgages to the subprime sector that manage to hustle up a triple-A rating, it was (is) the regulator who is taking 80% off the balance sheet(books)of the banks.

When the regulators used (and use) a risk-weight of only 0% to reflect the risk-weighted value on the books of banks of loans to a sovereign rated triple-A, like the US or UK, it was (is) the regulator who is taking 100% off the balance sheet(books)of the banks.

Sincerely, I doubt the banks could have managed that kind of disappearance acts on their own.

They´re just plain dumb

Sir Arvind Subramanian is absolutely right when in “Greek deal lets banks profit from immoral hazards” May 7, states the case that there has to be a debt restructuring that includes a lot of hair-cutting to turn Greece´s economy into something reasonably viable, something reasonably livable.

But then he goes into a lot of convolutions trying to explain why the parties in charge do not understand it, but leaves out the most simple and the most normal human possibility, that of them being plain dumb.

I mean anyone who has allowed banks to stock up on Greek and alike debt by authorizing them a 62.5 times to one leverage can´t be anything but plain dumb… and we the dumber allowing them to do so.

Right battlefield, wrong combatants!

Sir John Plender in “Rules will decide the New York vs London Battle”, April 7, considers that one reasonable safe bet is that a new Basel agreement… will provide the basis for a level playing field on capital and liquidity” though “where the balance will fall between the two financial centres on all this is anyone’s guess”. Are we going to fall again for the same trick? It was with the excuse of reducing regulatory arbitration between banking centres that Basel created the regulations that served as growth hormones for the big banks. It is not about New York against London, Basel might be the battlefield, but the combatants are the too-big-to-fail banks and the underdogs, the too-small-to-matter-to-the-regulators banks.

What we need is to face up to the shattered myth of a rational regulator!

Sir here we stand before the ruins of a financial regulatory system that limited its purpose to avoid defaults and put too much trust in credit rating agencies allowing for minuscule capital requirements whenever AAAs were present… and mostly discuss the myth of a rational market? What about the myth of a rational regulator?

Justin Fox commences to hint at what we really need arguing in that “Cultural change is key to banking reform” March 26. I support a drive to simplify regulation and not to complicate them even further as is evidenced by the reforms currently suggested by the Basel Committee and the Financial Stability Board.

Justin Fox, though also supporting simplification, argues this might not be enough, as shown by Lehman Brothers´ faking the balance which is evidence of “ways to subvert even the clearest of the rules”. He is right but let us not forget that Lehman Brothers´ what they were up to was hiding and trying to redistribute the losses while the regulators, pushing so much toward supposedly risk-free land, were creating losses… and that is no doubt a lot worse.

Yes we need regulatory dynamism... in the right direction of course

Sir I much appreciate Tony Jackson’s call “Let’s get some dynamism into dynamic provisioning” March 22. He is absolutely right, as I have been arguing for more than two years, now is the time to lower the capital requirements for banks, at least for those small businesses and entrepreneurs and though they caused the largest regulatory capital needs had nothing to do with causing this crisis.

What two years? I have been on this much longer

http://teawithft.blogspot.com/2004/08/towards-counter-cyclical-basel.html

Default risk-weights and purpose-weights are used to establish capital requirements for banks in Venezuela.

Sir on July 29, in Venezuela, the financial regulator, Sudeban, issued a normative by which the risk weights used to establish the capital requirements of the banks were lowered to 50%, when banks lend to agriculture, micro-credits, manufacturing, tourism and housing. As far as I know this is the first time when these default risk-weights and which resulted from the Basel Committee regulations, are also weighted by the purpose of the loan.

The way it is done Venezuela seems to lack a lot of transparency and it could further confuse the risk allocation mechanism of the markets (though in Venezuela that mechanism has already almost been extinguished) but, clearly, a more direct connection between risk and purpose in lending is urgently needed.

In this respect the Venezuelan regulator is indeed poking a finger in the eye of the Basel regulator who does not care one iota about the purpose of the banks and only worry about default risks and, to top it up, have now little to show for all his concerns.

I can indeed visualize a system where the finance ministry issues “purpose-weights” and the financial regulator “risk-weights” and then the final weight applicable to the capital requirements of the banks are a resultant of the previous two.

Does this all sound like interfering too much? Absolutely, but since this already happens when applying arbitrary “risk weights” you could also look at this as a correction of the current interference.

The investors know very well what is going on.

Sir Gillian Tett in “Investors are floundering in post-traumatic syndrome” July 24, writes that “the number fretting about inflation is similar to those concerned about deflation – with almost no one sitting on the fence”. No wonder, to be sitting on the fence presupposes governments know what they are doing and if they did why are we in this crisis to begin with?

Personally I am convinced we will fall over to the inflation side because the public debt will become unsustainable; there are other bottlenecks like oil out there; and I do not see sufficient political will to stop the printing press from working overtime.

What I do not agree is when Gillian Tett says that “investors lack the intellectual framework to make sense of what is going on”, they know perfectly well that it is the governments and the regulators who lack the intellectual framework to make sense of what is going on, as evidenced by the lack of efforts to ascertain we will not have a new cull of subprime financial regulators in Basel.

The same Basel induced temptations keep plaguing the banks

Sir since it was the extremely low capital requirements that were authorized for banks whenever the risk perceived by the credit rating agencies was non-existent that started the stampede into subprime land, John Plender is absolutely right when he writes “Banks let off the hook as flawed model is preserved” July 15. It does not matter much if you increase the minimum capital requirement averages if, on the margin, you keep on interfering in the same arbitrary way in the risk allocation mechanisms of the market.

Today, the banks are still authorized to leverage themselves 62.5 to 1 on the loans they give to corporate borrowers rated AAA to AA- or need to capital requirements at all when lending to sovereigns rated AAA to AA- and so, today, all the temptations to head off in the wrong direction are still there.

Since it was an excessive risk-aversion that caused the crisis there is nothing wrong with a little more of risk-taking.

Sir the commissioner of Japan’s Financial Services Agency Takafumi Sato warns that “Tightening capital rules could increase risk-taking” July 1. Given that the current minimum capital requirements concocted in Basel authorize a marginal leverage of bank equity of 62.5 to 1 if the borrower has an AAA to an AA- rating it is hard to even comprehend what increased risk taking he refers to.

Excessive risk taking was not the problem. It was the excessive risk-aversion of the regulators that created an amazing regulatory bias in favour of what was perceived as being of little risk which brought this crisis upon us. In this respect we might in fact need some increased risk-taking.

This crisis did not originate from risky Argentinean railway projects but from investing in the safest assets, houses, in the safest country, the US, in securities rated AAA. Do you call that excessive risk taking?

Madoff got a sentence of 54.900 days. Should not the regulators spend one day in the slammer just for the sake of justice, just to help us restore some minimum accountability?

And what about the midgets of finance?

Sir you list with photos “The fallen giants of finance” December 23. But, what about all those midgets of finance in Basel, namely the financial regulators who thought they could exorcise risks from banks for ever with their utterly silly minimum capital requirements and the appointment of the credit rating agencies as risk overseers and got us into this mess? Should we not publish their names and photos too?

Law, yes, interference, no

Sir Gideon Rachman quotes Jacques Attali, an advisor to President Sarkozy of France saying “the core of the financial markets is that we have global markets and no global rule of law”, “And now for a world government” December 9.

Yes surely we need more global rule of law but while legislating for the globe let us be very clear on the differences between law and interference. The current financial crisis was caused primarily by the financial regulators in Basel interfering with the markets by giving unlimited siren powers to the credit rating agencies without tying us all up to the mast or plugging our ears with beeswax, regulators included.

Don’t count on the Dr Strangeloves in Basel.

Sir Peter Montagno in “Danger of pressing nuclear button on a rating agency” November 21, holds that “a bloodbath in the markets” could happen “if and when the authorities decide to withdraw an agency’s registration”. What on earth does Mr Montagno call what is currently happening in the markets?

Instead of pinning our hope on some Dr Strangeloves in Basel figuring out how to better control the credit rating agencies we should just proceed and disarm their nuclear heads, taking away the powers of influencing so much the markets that have been vested into them by the same scientists in financial regulations.

Governments, whatever, do no more harm... you’ve done quite enough as is!

Sir in “Finding a way out of the global crisis”, November 2, you hold that “With goodwill and imagination, the G20 leaders can commit themselves to a co-ordinated, co-operative solution to the financial crisis” when they now meet in Washington on November 15.

As someone convinced that the seed of our current systemic financial crisis lies in the bank regulations that emanated from the risk-adverseness extremists sitting in The Basel Committee, I cannot but feel apprehension when thinking about the possibility of governments, once again, unleashing their good-willed imagination on the market.

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.