To save us from “calm waters” and recover economic dynamism, get rid of risk weighted capital requirements for banks

Sir, Tim Harford writes: “economic dynamism is at risk… John Haltiwanger has charted a fall since the early 1980s in the rate of start-ups, business exits, job creation and job destruction…Calm waters eventually stagnate. It is time to agitate the real economy…But how? …support for small-business finance, would all add much needed fizz to the economic system.” “Eerie quiet marks Black Monday’s anniversary” October 22.

That “how?” must include getting rid of the absolutely insane risk weighted capital requirements for banks

Sir, as a member of the Civil Society, during the Annual Meetings of World Bank and IMF, and for the umpteenth time during such occasions, I asked the following question:

“As the world’s premier development bank the World Bank must know that risk-taking is the oxygen of any development. So why is it still not speaking out against the risk-weighted capital requirements for banks that put a brake on risk-taking, like on the lending to SMEs small and medium sized enterprises…even though never ever has a major bank crisis erupted because of excessive exposures to something ex ante perceived as risky.”

After Jim Yong Kim gave a very valid answer, but not one that directly addressed my concerns, IMF’s Christine Lagarde jumped in with:

“I am actually tempted to address also this question, is that okay?

Because I think it is an important point and one that has very complex ramifications. It has complex ramifications in the banking regulations business, in the banking supervision business, and in the accounting business.

And then it is at the very junction of between sorts of self-established model by the banks versus models established by the supervisors. 

I think we both would agree that methods that would actually encourage the lending by banks and by insurance companies and by pension fund to SMEs, you know with the risk associated with it, should actually be very much in order.

At the moment the risk weighing methods and the models that are being used are discouraging from actually investing and taking risk to benefit the small and medium sized enterprises 

And that’s not necessarily the best avenue to support the economy and to support entrepreneurs who want to have access to financing.”

Sir, as you can see the IMF is finally opening up its eyes to the distortions in the allocation of bank credit that are produced by current bank regulations… those which FT has been so steadfastly silent on… even though I have over the years sent you about a thousand letters on this specific issue.

FT, when will you be fearless and without favour enough to take up this issue?

Here is a transcript of my question and the answers received during AM2017.

And here is an old homemade YouTube in which I try to give an explanation as simple as possible of what is so wrong with the risk weighting.

God make us daring!

PS. By the way are you not at all curious how regulators, in their standardized risk weights of Basel II, came up with only a 20% for those so dangerous AAA rated, and a whopping 150% for the so innocuous below BB- rated, those that bankers do not touch even with a ten feet pole?

@PerKurowski

When restructuring the World Bank you might want to start even higher than its presidency.

Sir, I refer to your editorial “Restructuring hell at the World Bank”, April 10.

You end it stating “If there is a silver lining to the bank’s turmoil, it is this: the Bretton Woods Institutions belong to the world. From now on, they must be headed by the best people available”

Not so fast! When presenting my book Voice and Noise, May 2006, in which I reflected on my experiences as an Executive Director of the World Bank, 2002-2004 this is what I said:

“Although we proudly name ourselves the World Bank, the fact is that we are more of a “Pieces of the World Bank”, with 24 Executive Director representing parochial interests. As a consequence I sadly had to conclude in that the World itself, call it Mother earth if you want, in these times of globalization, is in fact the Bank’s most underrepresented constituency.

This needs to be fixed, urgently, as we need to be able to stimulate a profoundly shared ownership for the long-term needs of our planet; that is if we want to survive as a truly civilized society worthy of the term civilization. As I see it, adding a couple of truly independent seven-year-term Executive Directors, whose role would be to think about the world of our grandchildren, way beyond the 2015 of the Millennium Development Goals—could be what the World Bank most needs now.”

And Sir, I still stand by that. 

The way the World Bank’s Executive Directors are nominated by ministries, does not guarantee the existence of sufficient intellectual and independent diversity at the Board. And that is the number one condition that needs to be satisfied in order for any international finance institution, to become something more than a well intended mutual admiration club, run by an also well intended management in natural pursuit of their own and perhaps even more parochial objectives.

PS. I have been asked by a representative of the civil society, whatever that now means, to add some additional straight to the point explanations of what I mean, and so here it is:

1. I guarantee that if one Joe the Plumber or one Nancy the Nurse, selected through lottery from 25 plumbers or 25 nurses, substituted for one of the 25 current executive directors, chosen also by lottery, we would have a 75% chance of ending up with a more commonsense and wise Board of Executive Directors at the World Bank, and less than a 1% chance to end up with something meaningfully worse.

2. If the Basel Committee for Banking Supervision (or perhaps the IMF) had counted with one biologist or an expert in the contagion of diseases, they would never ever have introduced something as dumb as the risk-weighted capital requirements for banks which, besides distorting the allocation of bank credit, amplify dramatically the consequences of any insufficient or any excessive ex ante perception of risk. And the world would have been saved from the current crisis. The ongoing intellectual incest is so bad that even 7 years after the outburst of the crisis they still do not realize what they have done.”

3. With reference to William Easterly’s 'The tyranny of experts', the real nightmare is to be in the hands of a group of similar experts on the same subject.

4. One of the best ways to control for the dangers of group-think, is to subject the group to the authority of some who is guaranteed not to belong to the group, and has no reason for wanting to belong to the group.

PS. Whenever you click on to social media, say this little prayer: “Please God, save me from becoming a victim of intellectual incest”

What the World Bank most needs to do in order to end poverty.

Sir, I refer to Robin Harding´s article on the restructuring program of the World Bank that is currently being executed by its president Jim Yong Kim, “Man on a mission”, April 8.

I do not know much of the program but, as a former Executive Director of the World Bank, 2002-2004, I do know that whatever it contains, much more important for the bank’s quest of ending poverty, would be for it to speak out loud and clear against the risk based capital requirements for banks that have invaded current regulations.

The net effect of those capital requirements is to allow banks to earn much more risk-adjusted return on their equity on exposures deemed as “absolutely safe”, than on exposures deemed as “risky”. And as you can understand this is something which dramatically distorts the allocation of bank credit in the real economy.

By in that way favoring the access to bank credit of the “infallible”, these capital requirements add a new layer of discrimination against “the risky” poor developing countries, the World Bank´s most important constituency… and, within all countries alike, against “the risky” medium and small businesses, entrepreneurs and start-ups.

In short the world´s premier development bank needs to remind regulators of the fact that risk-taking is the oxygen of any development… and that there is in fact no chance whatsoever to fight poverty, or even to sustain an economy, in a risk free way.

And the World Bank, in its quest, should also be able to enlist the help of their neighbor the IMF, by reminding the world´s premier financial stability watchdog of the fact that major bank crises never result because of excessive bank exposures to what is perceived as “risky”, these always result, no exceptions, from excessive exposures to assets which were ex ante perceived as “absolutely safe”, but turned out not to be.

PS. This is not new. In April 2003, as an Executive Director, in a formal written comment on the World Bank‘s strategic framework 2004-06 I stated:

"Basel dictates norms for the banking industry that might be of extreme importance for the world’s economic development. In Basel’s drive to impose more supervision and reduce vulnerabilities, there is a clear need for an external observer of stature to assure that there is an adequate equilibrium between risk-avoidance and the risk-taking needed to sustain growth. Once again, the World Bank seems to be the only suitable existing organization to assume such a role."

PS. Also, though I am not a banker or a regulator, the following which I formally stated at the Board in October 2004, should serve as evidence that I might know something of what I am talking about:

“Phrases such as “absolute risk-free arbitrage income opportunities” should be banned in our Knowledge Bank. I believe that much of the world’s financial markets are currently being dangerously overstretched though an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions.”