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

If Draghi is the European Central Bank’s sharpest tool I pity Europe

Sir, Ralp Atkins holds that “Draghi’s resolve is European Central Bank’s sharpest tool” October 31. 

To me Mario Draghi is one of those utterly failed regulators who believed for instance that banks should be allowed to leverage their equity 62.5 to 1 when lending to those officially perceived as “The Infallible”, for instance Greece, but kept strictly to 12.5 to 1 leverage when lending The Risky, like European small businesses and entrepreneurs. And so, in this respect, if Draghi is the sharpest tool, I can only pity Europe, that tool can only keep on cutting it into pieces. 

As I have said so many times, if little me had anything to do about helping the eurozone or Europe out (or the US too) , the first thing I would do is to make certain that those most capable of saving the economy had access to bank credit in the best of terms. And that would mean that while bank equity remains so scarce, I would dramatically lower the capital requirements for banks when lending to “The Risky”, and slowly increasing these for all, until that odious and stupid regulatory discrimination in favor of “The Infallible” has been completely eliminated. 

To inject funds in any way shape or form before the distortions on how those funds will flow through the economy has been eliminated, all that is achieved is wasting away extremely scarce fiscal and monetary policy space.


PS. For those who do not know Mario Draghi was since April 2006, until 2011, the Chairman of the Financial Stability Forum, later the Financial Stability Board. And this is something I had to say about the FSF in 2008.