Expert technocrats, like those in the Basel Committee, can be shameless and dangerous populists too.

Sir, Takeshi Niinami writes “Japan’s populism leads to mounting government debt and short-term solutions for immediate issues without a clear long-term vision for recovery. This is not unique to Japan. I believe that the US and EU will begin taking quite a similar path” “Japan has a unique form of populism” September 16.

1988’s Basel Accord gave officially birth to the risk weighted bank capital requirements. This regulation, with its much lower decreed risk weight of sovereign debt than of private debt, set all who applied it on a firm course to too much debt and too little growth. 

Just its denomination “risk weighted”, as if the real risks could be known, is of course just another sort of shameless populism. That the world fell for it, is clearly because the world wanted it so much to be true, that it never found in itself the sufficient will to question its basic fallacy; that it considered that which ex ante is perceived as risky to be more dangerous ex post to our bank systems than what is perceived as safe, something which obviously is not so, as all major bank crises in history evidence. 

As I so often have said, that faulty regulation imposed a de facto reverse mortgage on the economy, which extracted the value it already contained, as banks focused more on refinancing the safer past than the riskier future. By refusing those coming after us the risk-taking that brought us here, the intergenerational holy bond that Edmund Burke wrote about was violently violated.

@PerKurowski

Central banks and regulators are wittingly or unwittingly imposing communism by stealth, at least in Japan.

Sir, you refer to that Bank of Japan’s holdings of government bonds are already at more than 40 per cent of the outstanding stock… and to “massive equity purchases” [by means of buying into the ETF market], and to“the government is the biggest beneficiary of the BoJ’s low interest rate policy” “BoJ risks falling out of sync on global easing” August 7.

Add to that the lower capital requirements for banks when lending to the government than when lending to citizens, and it all adds up to a huge gamble on that government bureaucrats know better what to do with credit/money than private enterprises. It sure sounds too much like communism by stealth for my liking. 

In 1988 the Basel Accord assigned 0% risk weight to sovereigns and 100% to citizens and we all believed that when in 1989 the Berlin Wall fell we had gotten rid of communism for good. How can the world have been so naïve? It will of course end badly.

@PerKurowski

Require banks to hold capital against the unexpected, making sure those not able to manage perceived risks fail, fast

Sir, Nobuchika Mori, commissioner of Japan’s Financial Services Agency writes: “Regulators have made the global financial system more resilient by major regulatory reforms. Banks now have much bigger capital and liquidity buffers. Resolution frameworks have been strengthened. Derivatives markets are being made safer, while toxic forms of shadow banking have been detoxified.” “A holistic approach to future-proofing the financial system” May 26.

Holy moly! How come bank regulators have not been nominated for a Nobel Prize? I mean, if Bob Dylan and Juan Manuel Santos could each get one, and if what the author says is true, these also sound to be worthy one or two.

But no! Nobuchika Mori then goes on describing some pending issues that would not make them worthy of a prize, on the contrary, more worthy of being sacked.

He writes: “It is possible that funds are not being allocated in ways that foster economic growth. Credit should be provided in ways that enhance productivity, revitalise industry, foster innovations and create new businesses.”

Indeed! But should not the purpose of the banks have been defined before regulating these?

He writes: “We need supervision to establish whether regulation offers perverse incentives to banks to accumulate excessive risks.”

More than supervision what is needed are regulators that understand that with their current capital requirements, banks will accumulate too large exposures against what is ex ante perceived as safe (but that ex post could be risky) and too little exposures to what is perceived as risky, like those “small and medium-size enterprises” those who according to the author could “help to revitalise local communities”

“An Explanatory Note on the Basel II IRB (internal ratings-based) Risk Weight Functions” expresses: 

“The model [is] portfolio invariant and so the capital required for any given loan does only depend on the risk of that loan and must not depend on the portfolio it is added to.”

The explicit reason for that mindboggling simplification was: 

“This characteristic has been deemed vital in order to make the new IRB framework applicable to a wider range of countries and institutions. Taking into account the actual portfolio composition when determining capital for each loan - as is done in more advanced credit portfolio models - would have been a too complex task for most banks and supervisors alike.”

But here Nobuchika Mori wants the supervisors to take on even a more active and complex role. That would not be helpful. That implies assigning the supervisors too much capability and, explicitly, too much power.

Much better it is to get rid of all risk weighting setting a reasonable leverage ratio, like 10% capital for all assets (sovereigns included), to cover in part for what is unexpected… all in the knowledge that the faster banks that cannot manage perceived risks fail, the better for all.

The Questions!

@PerKurowski

Regulators make banks earn higher risk adjusted ROE’s lending out the umbrella to those in the sun than to those in the rain

Sir, in 2003 as an Executive Director of the World Bank, in a formal statement I wrote: “The financial sector’s role, the reason why it is granted a license to operate, is to assist society in promoting economic growth by stimulating savings, efficiently allocating financial resources satisfying credit needs and creating opportunities for wealth distribution. Similarly, the role of the assessor –in this case, the Bank– is to fight poverty, and development is a task where risks need to be taken.

From this perspective the Financial Assessment Program Report might revolve too much around issues such as risk avoidance, vulnerabilities, stress tests and compliance with international regulations, without referring sufficiently to how the sector is performing its social commitments.

We all know that risk aversion comes at a cost - a cost that might be acceptable for developed and industrialized countries but that might be too high for poor and developing ones. In this respect the Bank has the responsibility of helping developing countries to strike the right balance between risks and growth possibilities.

In this respect let us not forget that the other side of the Basel [Committee’s regulatory] coin might be many, many developing opportunities in credit foregone.”

And I had started this fight against senseless credit-risk aversion already in 1997 with the first Op-Ed I had ever published “Puritanism in banking” 

And in 2009, in Martin Wolf’s Economist Forum, I prayed “Free us from imprudent risk aversion”

So you can imagine how much I agree with Nobuchika Mori when he, as Japan’s regulator of financial markets and institutions now writes: “too much emphasis on stability can be harmful, especially in the long run. It may prolong and even perpetuate stagnation. Based on this experience, a shift to supporting finance for growth is needed now”, “Too much 'medicine' could make the system sicker” December 15.

Think of it. Mark Twain is quoted with saying “Bankers want to lend you the umbrella when the sun is out and take it back when it rains”. With credit risk weighted capital requirements, the regulators now also give our banks higher risk adjusted returns on equity when lending out the umbrella to those in the sun than when lending it to those in the rain.

@PerKurowski ©

Accepting credit-risk weighted equity requirements for banks, is accepting the economy going into early retirement.

Sir I refer to Yoichi Takita’s “Split emerge between central bank and policy makers”, your special report on Japan, March 30.

Takita writes “ The government is working hard to ensure investment and employment growth will lead to an economic upswing.”… and for that Mr. Abe will try “eliminating disincentives such as high corporate tax rates, big electricity bills and excessive economic rules”.

I do not know enough about Japan to evaluate how much that could help, but, if it was for instance Europe, which depends so much on bank credit, then that would not suffice. That is because any country that tells its banks to go and leverage much their equity, and the implicit support they receive from taxpayers, on what is “absolutely safe”, and to stay away from “the risky”, is a country that has placed itself, unwittingly or voluntarily, in an early retirement mode not compatible with any sturdy and sustainable economic growth.

@PerKurowski

Poor Shinzo Abe. Has no one told him Japan as a member of G10 also signed up on Basel II’s risk-aversion?

Sir, Shinzo Abe, Japan’s prime minister with respect to the goal of achieving economic growth in Japan writes: “We are restoring Japan’s venture spirit, creating opportunities for start-ups to bid for government contracts, opening markets and promoting new entrants in areas including energy agriculture and medical services”, “My ‘third arrow’ will fell Japan’s economic demons” June 30.

I almost feel sorry for him. Has no one told him that Japan, as part of the G10, signed up on Basel II, those bank regulations that has it as its pillar, that all who are perceived as risky, like start-ups and new entrants usually are perceived, shall NOT have fair access to bank credit, because this is believed to promote the stability of the financial system?

With such an opposition, there is little Shinzo Abe, or anyone else for that matter can do, no matter how good the intentions.

The world (Japan) does not need inflationary expectations it urgently needs more rational bank regulations

While the banks, by means of minuscule capital requirements for what is perceived as absolutely safe, are reigned in from taking on exposures to what is perceived as risky, at the same time central banks allow themselves to run extremely risky monetary experiments. Something is way wrong!

Sir, in “Japan embraces monetary change”, April 5, you hold that though “an impressive package of quantitative easing… may have adverse consequences… there was no alternative.

Wrong! More than anything Japan, UK and all other Basel Committee subjects too, need to rid themselves from silly bank regulations which favor “The Infallible” and therefore discriminate against “The Risky”. Get a grip on yourselves! In the real economy, what is absolutely absent is what is “absolutely safe”.

Any quantitative easing, keeping these regulations in place, only doom the banks to dangerously overpopulate whatever is perceived as “safe havens”, holding too little capital, and thereby making the world a much more riskier place.

Banks earning higher risk-adjusted returns on equity lending to “The Infallible” than lending to “The Risky” is plain crazy.

Sir, William H. Saito, in “Embrace failure to nurture entrepreneurs”, in your “Japan Technology & Innovation Special Report” December 4, writes “The opposite of success isn’t failure, it’s not doing anything. Fear of failure is stifling entrepreneurship”.

This is precisely what I have been arguing with you in relation to current bank regulation, but that you in FT seem incapable to comprehend. The opposite of safe banking is not taking risks with “The Risky”, but lending only to “The Infallible”. In trying to make the banks avoid lending to “The Risky” allowing them in that case lower capital requirements, bank regulators doom our banks and our economies to suffocate because of lack of the oxygen of risk-taking on the shores on some supposedly very safe and shallow beaches.

Just as Saito wants a Japan that needs “to embrace weakness and failure” Europe and America once again must want to embrace risk-taking, “God make us daring!”, and put an end to that utter nonsense of allowing banks to earn much higher risk-adjusted returns on equity when lending to “The Infallible” than when lending to “The Risky”

The banks are made to jump from one huge pro-cyclicality to another.

Sir, Ben McLannahan reports, “IMF sounds alarm on Japanese lenders”, October 11, and this as a result of “domestic bank holdings of government bonds in the country could rise to a third of their total assets within five years now”.

I do not get it! Is it not what they wanted? They must obviously have understood that this would be only the natural consequence of allowing the banks to hold basically no capital at all against exposures to “The Infallible”, while at the same time requiring them to hold around 8 percent in capital when lending to “The Risky”, like the small businesses and entrepreneurs.

But, I am indeed worried, because it means that precisely at the moment the public sector might be hit by higher borrowing cost, will be precisely the moment they will need to bail out the banks because of their losses on public bonds. 

The article also states “Japan’s interest rates have been kept low in recent years by strong support from the banks”, but that must be a typo. I guess they meant “strong support from the bank regulators”. 

Indeed it would seem like the regulators are intent on having our banks jumping from one huge pro-cyclicality to another.

Sounds like a lot of butterfly wing flapping!

Sir Marc Chandler in his “This is the rainy day Japan’s reserves are meant for” February 22 suggests that Japan should give $242bn of their reserves to the Japanese so as to boost the internal demand. Great idea! Pity though that bringing home $242bn while the sun is not really shining on the US economy sounds a fraction more than a butterfly flapping its wings and will cause some other effects to the economy of the world.

How to get someone else’s grandson to take care of you when you are old?

Sir, Michiyo Nakamoto reports “Japan requires age-old wisdom on problems of productivity” April 23, on how a country of saver “who have long been happy to keep the bulk of their wealth in bank deposits” now have to start looking for improved returns on their money in order to make ends meet in an ageing society with declining workforce.

This is just the beginning of some truly important intra-generational transfer challenges that have been surprisingly little studied, and planned for, and simply accepting more risks in order to get better returns does not really cut it as a sustainable solution to this problem. For instance the Japanese society might need to take an urgent look at issues such as the saving propensity of the coming generations in Japan and the rest of the world, since if those generations do not want to save as much as theirs, then with whom are they in the future to barter with their investments and savings against the cash they need. Could it even be that they could be better off by simply cashing in their investments today and holding the cash?

Needless to say this is a question that affects many countries and I can already see a young generation of nurses in developed countries asking and getting six figure incomes… or even much more if they restrict the competition with foreign nurses.

The world needs the cleansing and energizing forces of volatility

Sir, Tim Young in his letter on “How Japan’s investment was paralyzed”, April 16, asks the very relevant question “whether the cumulative loss of output [of following a conventional low interest rate policy] is less than might have been suffered if macroeconomic policy had allowed the asset price bubble to pop rather than deflate slowly.”

I certainly believe the losses of letting a problem fizzle out are in the long run, in average, always larger than having the bang and getting on with it, and so do you, for instance when in employment policies you commend the American styled labour flexibility that allows for easier firing so that resources can be better and faster reallocated. Sir, if you can lose your job, on the dot, because it is good for the economy, what would make losing 30% of the value of your house any different? What is better, keeping the high value of your houses or allowing your kids to afford a house?

It is time the world starts to think again about the cleansing and energizing forces of volatility and remembers that the absence of tremors could just mean a bigger earthquake in the making.