Europe, America, G20, don’t walk away from Basel Committee risk weighted bank capital regulations…you’d better run!

Sir, John Dizard writes about a “meeting of the Basel Committee on Banking Supervision on November 28 and 29… is scheduled to agree a “standardised approach for credit risk” and impose limits on the use of internal models. The idea is that banks in the G20 countries, a group of the world’s most powerful economies, will not engage in regulatory arbitrage, or international game playing that results in a lowering of credit standards.” “Basel’s background noise for the next crisis”, FTfm, November 7.

Of course, the Basel Committee should prohibit banks from using their own models to define their own capital requirements; allowing it, is like letting children use their own nutrition models to pick between chocolate cake, ice cream, broccoli or spinach.

But, to impose a regulators’ defined “standardised approach for credit risk”, is just as loony; it suffices to have a look at what the standardized risk weights included in previous Basel Committee regulations.

One example: Basel II, 2004, set the risk weight for an asset rated AAA to AA at 20% while that of an asset rated below BB- was set at 150%. Anyone believing that what is rated as highly speculative, almost bankrupt, below BB-, is more dangerous to the bank system than what is rated AAA to AA, must be smoking some weird stuff.

Sir, unfortunately Dizard, as most of you in FT, shows little understanding for the whole issue when he questions: “under the current version of the Basel “standardised approach”, unsecured lending to a non-public, below investment-grade corporate borrower requires the same bank capital commitment as project financing secured by assets, liens on equity and cash lockbox arrangements. Based on the past low loss rates for project lending, that is between two and three times as much capital as the risk should require.”

If that is so, should not the difference in risk reflect itself sufficiently in the interest rate and the size of exposures? Why should that same perceived risk also have to be reflected in the capital? Does Dizard (or you Sir) not know that any risk, even if perfectly perceived, leads to the wrong decision if excessively considered?

Sir, ask Dizard: “Why should a bank when lending to a below investment-grade corporate borrower have to hold more capital than when lending to “safe” projects? Will not the “risky” corporate anyhow get less credit and pay higher risk premiums than the “safe” project? 

Sir, again, for the umpteenth time, bank capital should not be required to cover for expected risks; it should be there to cover for the unexpected.

Sir, again, for the umpteenth time, the risk weighted capital requirements for banks have introduced absolutely insane distortions in the allocation of credit to the real economy. If Europe, America, G20, or the whole world do not run away from the regulators’ senseless doubling down on ex ante perceived risk, their economies are doomed to stall and fall.

@PerKurowski

Would adequate SIFIs’ designations have helped to avert the last crisis? Of course not!

Sir, I refer to Patrick Jenkin’s “MetLife ruling poses threat to drive towards global financial stability” April 5.

Jenkin sounds very much upset: “This is absurd. The FSOC — with its expert mandate and responsibility for “identifying risks and responding to emerging threats to financial stability” — is being torpedoed by an inexpert judge.”

Sir, you know I hold that the regulator, the Basel Committee and friends, was the real responsible for the crisis that errupted in 2007-08. Its risk weighted capital requirements for banks distorted the allocation of bank credit to the real economy, and allowed banks to leverage absurdly much on assets deemed, decreed or concocted as safe… and all this when history clearly shows that “safe” assets is precisely the stuff that big bank crises are made of.

Had the oversized exposures to AAA rated securities and sovereigns to Greece anything to do with what the regulators now tries to catch with their SIFI methodology? No is the simple answer.

In fact working on how to manage SIFI’s, keeps regulators from working on mending their own mistakes. And frankly I see no reason for Jenkins to deposit so much naïve faith in the expertise of FSOC or FSB or any other member of the regulatory logia.

He writes “The time may have come for the G20 to give the FSB proper statutory powers to ensure shortsighted political interests do not put the world on the road to financial ruin once more”

He should know that there is nothing as shortsighted as the risk weighted capital requirements. These have stopped the banks from financing the risky future and have them only refinancing the, for the very short term, safer past.

If anything Sir, I would wish for that “inexpert judge” to also look into whether the unauthorized discrimination against the access to bank credit of the “risky”, which is imbedded in that regulation, should really be allowed in the Home of the Brave.

It is high time the world starts to reflect on whether it really wants to allow an Ultra Important Regulator to introduce, as it wishes and thinks fit, dangerous systemic risks into the banking system.

The absolute minimum we must ask for is for the regulator to first give us its working definition of what is the purpose of our banks, so to see if we agree.

“A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926

@PerKurowski ©

The regulators’ search for financial stability has distorted the allocation of bank credit to the real economy.

Sir, you hold “G20 governments would do well to recognize that financial instability can rapidly translate into trouble for the real economy.” “Central banks alone cannot conjure growth” February 20

Sir, you should know by now the regulators’ search for financial stability, has already created much trouble for real economy.

You quote Zhou Xiaochuan, governor of the People’s Bank of China, with “The central bank is neither God nor a magician who can turn uncertainties into certainties.”

The correct reply to that would be: So why then do central banks, as regulators, act like God or magicians arrogantly imposing their besserwisser founded credit risk weighted capital requirements for banks?

If you allow banks to leverage more their equity (and the support they receive from society/taxpayers) with assets ex ante perceived as safe, than with assets perceived as risky; then what is perceived or deemed to be “safe” will produce higher risk adjusted returns on equity than what is “risky”.

And anyone who does not understand how that distorts the allocation of bank credit on Main Street, has never walked on Main Street; has never seen how difficult it is for SMEs and entrepreneurs to access bank credit even without the regulators making that harder for them.

And if you do not understand how useless such distortion is, because major bank crises never ever result from excessive exposures to something ex ante perceived as risky, then you have not read financial history.

Who authorized bank regulators to decide on the allocation of bank credit to the real economy?

Or is it really so bad that banks regulators are not even aware of that they distort the allocation of bank credit to the real economy?

PS. In 1999 in an Op-Ed I wrote: “The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause its collapse”

@PerKurowski ©

Who is to investigate how bank regulators manipulated markets in favor of US Treasury and similar sovereign debts?

In 1988, with the Basel Accord, bank regulators of the G20 countries decided that while the private sector should have a 100 percent risk weighing, their sovereigns, those represented by their bosses, the governments, were so safe so as to validate a zero percent risk weight.

That meant of course that, from that moment on, sovereigns have preferential access to bank credit… something that is of course paid by all those who do not count such preferential treatment.

Since de facto that also means regulators acted as if government bureaucrats could use bank credit more efficiently than the private sector, something that unless we are runaway statists or communists we know is absolutely false, the resulting distortion is also paid by future generations of unemployed.

And so, when compared to that manipulation, all the “potential manipulation of the US Treasury markets” referred to by Gina Chon and Martin Arnold” in “Probe into US Treasury markets” of September 10, is, excuse me, something like what is vulgarly known as chicken shit.

@PerKurowski

FT, be brave, confess, is it not that not so deep down in your heart you all carry a little statist agenda?

Sir, I refer to Elaine Moore’s “Sovereign borrowers fall behind on record sums of debt” September 6. Indeed, and as long as bank regulators insist in their pro-government borrowing bias, it is only going to get so much worse

Anyone who believes that with regulations such as those derived from the Basel Accord in 1988, which assigned a risk weight of zero to the sovereigns of G20 and a risk weight of 100 percent to the citizens of the G20, would not sooner or later result in much excessive sovereign borrowings, is ether blind, dumb, or pushing a statist agenda.

In a letter published by FT in October 2004 I wrote: “We wonder in how many Basel propositions it will take before they start realizing the damage they are doing by favoring so much bank lending to the public sector. In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits.”

And in a letter published by the Washington Post in December 2009 I wrote: “Your Dec. 20 Outlook compilation of the decade’s worst ideas did not include the one most to blame for the loss of most of the past decade’s growth: regulations that allowed banks to hold absolute minimums of capital as long as they lent to clients or invested in instruments rated AAA, for having no risk. This launched a frantic race to find AAA-rated investments wherever and finally took the markets over the cliff of the subprime mortgages.

The most horrific part is that it seems likely to endure because regulators can’t seem to let go of this utterly faulty regulatory paradigm. Let me remind you that banks are allowed to hold zero capital when lending to sovereign countries rated AAA and that there are already many reasons to think that the credit quality of many sovereign states has been more than a bit overrated.”

Sir, on the subject of the distortions produced by these regulations, since you published my letter in 2004, not only has the Greek tragedy taken place but you have also ignored way over a hundred letters I have written to you on it. Should I guess that is because not so deep down in your FT heart you all carry a little statist agenda?

@PerKurowski

With Portfolio Invariant Perceived Credit Risk Weighted Equity Requirements for Banks, Europe, the whole G20, is doomed.

Sir I refer to the reports and warning about Europe’s economy, November 13.

As long as regulators insist on using Portfolio Invariant Perceived Credit Risk Weighted Equity Requirements for Banks, Europe, in fact the whole G20, is doomed.

What more can I say that I have not already explained to you in more than a 1600 letters about what these regulations with their misguided credit risk aversion cause, and that you prefer to ignore?

Joe Hockey, as an impact assessment, just ask bank regulators some easy questions.

Sir, Jamie Smith, Sam Fleming and Gina Chon report that “The B20, a business lobby group has called on… the Basel Committee to investigate further the side effects of financial regulations”, “G20 split over call to assess impact of financial rules” September 18.

About time! I just hope this B20 also includes a god representation of those borrower who because they are perceived as risky are, by means of credit-risk-weighted capital requirements for banks, being denied fair access to bank credit.

I just came back from Toronto where I saw the play “Our Country's Good” advertised with “Thieves, murderers, prostitute, actors…this is what made Australia”. I sure hope Joe Hockey, Australia’s finance minister, now reflects on what would have become of Australia’s economy if its banks had needed to hold much much more capital (equity) when lending to its own “risky” outcasts, than what they needed to hold when lending to the “absolutely safe”, like to Greece. 

Frankly, before requiring any impact assessments I would be great if Joe Hockey, just asked bank regulators to answer some kindergarten level questions, and did not let go until he had an answer that a kindergartener would understand. Like the following:

Q. Why on earth should a lot of money lent at low interest rates to Mr. Safe be safer, or less risky for the bank, than little money lent at high rates to Mr. Risky?

Q. Is the truth not that the risk of banks have nothing to do with the credit risks of Mr. Safe or Mr. Risky, and all to do with how banks lend to Mr. Safe or Mr. Risky which, as they say in French, is pas la meme chose?

Q. Why on earth would bank regulators expect the bank to keep on lending to Mr. Risky if it cannot leverage its equity as much as it is allowed to do when lending to Mr. Safe?

Q. And if banks only lend to the Mr. Safe of this world and avoid all the Mr. Risky, what might become of the real economy… a safer or a riskier place?

The sad truth is that all current bank regulations have been written without first settling the issue of what is the purpose of banks.

Overly risk adverse regulators ignored that risk-taking is the most fundamental element needed for keeping an economy going forward, without stalling, and falling. “A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926

PS. Here a more complete definition of terms

PS. Sometimes when stress testing banks what is on their balance sheets is less important than what is not.

Mark Carney, FSB, to begin, stop giving the Too-Big-To-Fail banks growth hormones.

Sir I refer to Sam Fleming, Ben McLannahan and Gina Chon reporting “BoE chief leads push to break ‘too big to fail’ impasse at G20”, July 21.

There they report on the efforts of Mark Carney as the current chairman of the Financial Stability Board to try to clinch a deal on bailing in creditors of globally significant, cross border banks that get into trouble”.

Mark Carney, to begin with should start by stopping giving the growth hormones that minimalist capital requirements for what is officially perceived as absolutely safe, represents for the Too-Big-to-Fail banks.

And then I would also suggest they think a little bit more about the implications of the Contingent Convertibles. The CoCos, hard to manage even in the presence of solely a leverage ratio rule, are mindboggling difficult when the capital requirements for banks are risk-weighted.

Perhaps Mr. Carney should read what George Banks had to say about CoCos when asked by his Board of Directors at theDawes Tomes Mousley Grubbs Fidelity Fiduciary Bank

“A plan to finish fixing the global financial system”, or will it just finish it off?

Sir, in “A plan to finish fixing the global financial system” September 10, if his then quite an arrogant title, Mark Carney, the governor of the Bank of England and the current chairman of the Financial Stability Board writes “supervisors need to make good the pledge to G20 leaders… to tackle large differences in risk weights across banks”. I would ask him the following.

Why do you not tackle the supervisors’ own criteria of allowing large differences in risk weights to determine the effective capital requirement for banks?

Do you not understand that allowing for much much lower capital requirements on exposures to the “Infallible Sovereign”, to houses, or to the AAAristocracy, than for “The Risky”, like the medium and small businesses, entrepreneurs and start-upscauses the banks to be able to earn much much higher risk adjusted returns on equity when lending to the former than when lending to the latter.

Do you not understand that causes serious misallocations of bank credit in the real economy, and is by itself a source of immense systemic risk for the banking system?

Now if Mr. Carney would not understand what I am talking about, then I guess I would humbly have to recommend him taking a Finance 101 refreshment.

Carney also states “The G20s aim is to turn shadow banking from a source of risk to a source of resilience”. If that is going to happen by the Basel Committee and the Financial Stability Board, with excessive hubris continuing to believing themselves to be the risk managers of the world, and thereby distorting the global financial system… then, God help us! That would only finish it off.

Capital requirements for banks based on job creation, makes more sense than those based on risk of default.

Sir and there they are, the G20, in South Korea, lost for words, but yet babbling.

If I were to be given one minute of voice there, I would ask all of them to throw away the capital requirements based on the risk of default, because the risk of default is already being priced in the interest rates of the market, so there’s no need to discriminate through bank regulations against the unrated small businesses and other “risky” elements.

And, if the government official could just not resist meddling with the markets, then I would suggest them to impose capital requirements for banks based on the job creation potential of the borrower… more jobs less capital less jobs more capital… I mean, is not to help create job a primary function of banks?

But, of course, history has recently taught us that we need to be very careful with the job-creation-rating-agencies we empower.

It’s the risk-weights, stupid!

Sir what detonated this crisis? The fact that because of the risk-weights the banks needed only to hold 20% of the basic capital requirements when investing in triple-A rated securities backed by the lousily awarded mortgages to the subprime sector. Would it have happened if the risk-weight for those investments had been 100%? Of course not!

In this respect when one, on September 17, 2010, more than two years after the crisis exploded, reads the chairman of the Financial Stability Board Mario Draghy covering in “Next steps on the road to financial stability” about everything under the sun, except for the risk-weights, one feels, no matter how impolite, an urgent need to shout “It’s the risk-weights, stupid!”

Eerie!

Sir Just on word comes to mind when reading your pre G20 summit reports April 2... Eerie!

It feels like sitting in a cellar waiting for the hurricane to come or pass knowing that your cellar is utterly inappropriate for such an event.

A bit of navel-gazing, haven’t we?

Sir Paul Keating is absolutely right in saying that “Global financial confidence, once destroyed, requires myriad positive events and a heavy convergence of them to counter ambient pessimism and gloom”, “A chance to remake the global financial system”, March 5.

But then Keating lists issues, like better IMF governance, which is of course a very laudable thing to do, I support it completely, that in my opinion are almost irrelevant to the confidence of markets and perhaps even to most of the official actors.

For example when he mentions “the government of China has no intention of dealing with its surpluses by letting its real exchange rate redirect national resources, especially when such action risks putting it into the hand of the IMF” I would argue that the voting rights at the IMF, at this particular moment, is one of the very last real concerns of China.

Also whether the G20 structure “is truly dynamic” or the old Breton Woods arrangements are reformed sounds currently as some pure and unashamed navel-gazing.

Since it was the G10 that by means of endorsing the concoctions of the Basel Committee empowered the credit rating agencies so much that the whole world followed their AAA signs over the subprime precipice, I cannot honestly see how the markets would regain confidence in any sustainable way from a concentration of bureaucratic powers in a G20.

Does Keaton really believe a G20 success spells recovery? Is he long or short on G20 derivatives?

But would they listen?

Martin Wolf suggests “What Obama should tell the leaders of the Group of 20”, February 25 and it all sounds so extremely intelligent and rational. Problem is though that the chances of obtaining a rational responses to rational requests are very slim in a world where there has been so little capacity to respond to any threat of something that could occur more than a week ahead, and in a world where so many promises, like that of .7% of GNP to foreign assistance are continuously and shamelessly broken by most.

In this respect if I was Obama, which I am of course not, lucky you, I would start by asking... how can we make sure that the upcoming summit will not be a waste of time since we clearly have no time to waste?

As a bare minimum, before flying over the pond, I would request the Europeans to deposit at least half of their voting rights in the International Monetary Fund, in the same escrow account where I on behalf of the US would also be depositing its own half of the voting rights, also before flying over the pond, and so as to be able to proceed down the road of international cooperation in a much more credible and expedient way. Wasting even a second of the summit on the voting right issue should just not be an option.

Also if I was Obama, and Martin Wolf, I would stop from dividing the world between surplus and deficit countries since that division helps very little when trying to foment a spirit of international cooperation when clearly all the countries are hurting.

Whatever, don’t forget the tax bill will be in the mail, quite soon.

A thirty year mortgage of 300.000 dollars at 11 percent rate to the subprime sector will, if made part of a security that because it has a prime rating is discounted at 6 percent, be worth 510.000 dollars. The difference of 210.000 dollars in financial air, pocketed as profit by an intermediary, will most probably be lost completely, no matter what happens to the housing sector. And so, if by any chance these are the kind of loses the governments are helping out with, they will not recover a single cent from it, and the taxpayer will have to make up for it, or it all breaks down in more inflation or in, gulp! … sovereign defaults.

This is why I agree and commend FT on starting to beat the drums on “Austerity must follow a stimulus”. November 13. Let us hope now that the G20 meetings do not take the form of an electoral campaign where only fiscal stimulus and tax rebates are offered and no one even speaks about the tax bill that must follow.

If it would not be for its very tragic implication it would be outright comic to see so many neo-Reaganites preaching the benediction of the Laffer curve, promising less taxes and more fiscal income… and even bail-out profits. What an amazing irresponsibility!

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.