Europe, if you spoil your kids too much they will not grow strong. That goes for banks too.

Sir, Patrick Jenkins analyzes several concerns expressed about European banks when policymakers gathered to mark the retirement of Danièle Nouy from ECB’s Single Supervisory Mechanism (SSM); who is to be succeeded by Andrea Enria as the Eurozone’s chief banking regulator. “As European banks regulator retires, six big challenges remain” December 11.

The former Grand-Chair of the Federal Reserve, Paul Volcker, in his recent book “Keeping at it”, co-written with Christine Harper, recounts the following when, in 1986, the G10 central banking group tried to establish an international consensus on bank regulations and capital requirements:

“The US practice had been to asses capital adequacy by using a simple “leverage ratio”-in other words, the bank’s total assets based compared with the margin of capital available to absorb any losses on those assets. (Historically, before, the 1931 banking collapse, a ten percent ratio was considered normal)

The Europeans, as a group, firmly insisted upon a “risk-based” approach, seemingly more sophisticated because it calculated assets based on how risky they seemed to be. They felt it was common sense that certain kind of assets –certainly including domestic government bonds but also home mortgages and other sovereign debt- shouldn’t require much if any capital. Commercial loans, by contrast, would have strict and high capital requirements, whatever the credit rating might be.”

Sir, even though the Basel Accord was signed in 1988 and further developed in 2004 with Basel II, and with which the European risk weighting was adopted, I am sure we can trace the differences between US and Europe banks to these original differences on capital requirements. The US has been much more strict on capital than Europe. In fact the problems with American banks during the 2008 crisis were mostly restricted to those investment banks, which supervised by the SEC, had been allowed in 2004 to adopt Basel II criteria.

In Europe meanwhile banks could do with much less capital, which meant that much more was left over for bankers’ bonuses. In essence, Europe’s banks were dangerously spoiled. The challenge these now faces is having to substitute their equity minimizing financial engineers with good old time loan officers; and convince the capital markets of that. Good luck!

@PerKurowski

For transparency, all candidates to chair ECB’s Single Supervisory Mechanism, should publicly answer one question.

Sir, I refer to Claire Jones and Rachel Sanderson reporting on the selection by the European Central Bank, of the person to substitute for Danièle Nouy as the chair of the Single Supervisory Mechanism. “ECB banking watchdog seeks new chief” July 17.

A major turning point for our Western world liberal order, in truth for our whole civilization, was when regulators, surprisingly, 1988, with no one questioning them, decided that what is perceived as risky is more dangerous to our bank system than what is perceived as safe, and proceeded to apply such nonsense with their risk weighted capital requirements for banks.

We have already paid dearly for their stupidity, which excessively boosted bank exposures to AAA rated securities, house mortgages and sovereigns (like Greece), and has made it harder for SMEs and entrepreneurs to access bank credit.

Therefore, in the name of that transparency we all deserve, which of course includes all at the Financial Times, all candidates to chair ECB’s Single Supervisory Mechanism should give their public and reasoned answer to the following question: 

What is more dangerous to our bank system, that which is perceived as risky, or that which is perceived as safe?

Will those involved in the selection process, and who might clearly have a vested interest in it remaining a question that shall not be asked, dare to ask it?

Here an aide memoire on the major mistakes of the RWCR

@PerKurowski