What do we all have left to counter any major new round of debt-failures with?

Sir, Jonathan Wheatley reports that according to the Institute of International Finance “Total debt owed by households, governments, and financial and non-financial corporations were $247.2 tn at the end of March 2018 and, relative to gross domestic product, exceeded 318 per cent” “EM exposure Surging debt puts pressure on global financial system” July 12.

Emerging markets? What about all of us?

Households count on their income and worth of assets, basically houses, to pay back their debt… and their increased debt, anticipated demand, means they cannot help each other as much as they used to.

Non-financial corporates, which have become much more leveraged, count on business remaining healthy, though indebted households and governments will find it harder to keep up the demand they need.

Governments depend mostly on tax revenues, and these will depend on how it goes for households and non-financial corporations.

Financial corporates depend on deriving some profitability intermediating for the other three sectors, and on In God We Trust 

Looking at the harrowing figures three questions come to my mind.

The first, where would we all be if we in 2007-2008 had gone for the hard landing I suggested in 2006, instead of pushing the crisis can forward?

The second, where would our banks and all our debts be if banks had needed to hold for instance 10% in capital against all assets?

The third, WTF do we all have left to counter any major new round of debt-failures with?

@PerKurowski

IIF confesses the distortions in the allocation of bank credit caused by Basel’s risk weighted capital requirements

Sir, Laura Noonan writes “The Institute of International Finance has denounced regulators’ proposals to give banks less freedom to use their own models to decide how much capital they need to support their loan books.”, “Risk warning over change to lenders’ safety measures”, June 7. It contains the following fascinating information.

“A low quality borrower with a risky BB- credit rating. Right now…generates a return on capital of just 7.7 per cent today. At the other end of the credit spectrum, a bank’s return on equity for an A+ rated borrower could fall from 13.9 percent today”.

So here IIF confesses that because of the risk weighted capital requirements, an A+ rated borrower (50% risk weight) currently generates about twice the return on equity for the bank than a BB- rated one (100% risk weight). Sir, do you think banks in such a case would lend to those BB- rated? Of course not! But are there not many BB- rated who should have access to bank credit, even if in small amounts? Of course there are. Can’t they get credit? Of course they can, but only if they pay much higher interest rates, so as to overcome the regulatory discrimination against them. 

Sir, that bankers, those who are supposed to be able to evaluate credit risks, should now earn a higher risk-adjusted return on equity on what is perceived as safe than on what is perceived as risky, sounds to me like the regulators have made bankers’ wet dreams come true.

And IFF then states that “a bank using the new rules could earn a return on capital of 11.4 percent on a low quality borrower with a risky BB- credit rating [but], a bank’s return on equity for an A+ rated borrower could fall to 4.6 percent under the new regime.”

Does that mean the A+ rated borrowers would not have access to bank credit any more? Of course not! It is only that they would have to pay slightly higher interest rates since they would not count with as much regulatory subsidies.

Sir, I have soon written a thousand of letters to you all in FT on how the risk weighted capital requirements dangerously distort the allocation of bank credit to the real economy. You have ignored all of these. Now here you are getting a clear and loud confirmation of that distortion from the horse’s mouth, will you still ignore it?

How should it be? Those rated A+ and those rated BB-, and all other, should compete on equal footing for bank credit, by means of offering different risk premiums, and the bank should assign the credit in an appropriate amount to whom has offered to provide it with the highest risk adjusted return on equity. And that can only happen if the capital required for lending to an A+ or to a BB- is exactly the same.

PS. An “appropriate amount” is that which guarantees a good diversification of the banks’ portfolios. The current risk weighted capital requirements are, to top it up, portfolio invariant.

@PerKurowski ©

Timothy Geithner should start by increasing the capital requirements for banks when lending to the government.

Sir Krishna Guha in “Bankers´ pleas on rules rebuffed , October 5, reports that Timothy Geithner said of the banks “These are the institutions that told the world and told the shareholders and told their creditors and told their customers they knew how to manage risk and that they were better at this than their supervisors were ever going to be”.

Does Mr. Geithner really believe that the supervisors will ever be better at managing risks than the banks? Is he suffering from amnesia? Has he already forgotten that it was the minimal capital requirements which the regulators authorized the banks to have whenever the regulator´s own outsourced credit risk supervisors, the credit rating agencies, awarded their AAAs which detonated the crisis?

Of course regulatory overkill is a risk for a recovery which urgently needs risk-taking to awaken. Nonetheless if Mr. Geithner needs to show himself off as a real regulatory macho man why does he not increase the capital requirement for banks when lending to his own government?… it is currently zero!

Or does Mr Geithner also believe that public bureaucrats are better at taking investment decisions than their private counterparts?