John Reed, competing on equal terms with equal capital requirements, traditional and investment bankers can be friends

Sir, John Reed writes that combining traditional banking and investment banking into a universal banking is inherently unstable and an unworkable model “Our universal banking mistake”, November 12. 

Reed argues: “Mixing incompatible cultures… make the entire finance industry more fragile…Traditional bankers tend to be extroverts, sociable people who are focused on longer term relationships. They are, in many important respects, risk averse. Investment bankers and their traders are more short termist. They are comfortable with, and many even seek out, risk and are more focused on immediate reward. In addition, investment banking organisations tend to organise and focus on products rather than customers. This creates fundamental differences in values.”

Reed might have a point, but, in my opinion, the main reason for the system being fragile is because regulators treat the different activities differently. With the credit-risk weighted capital requirements for banks, some are allowed to leverage their activities much more on equity than others. That introduces distortions that are impossible to clear for.

Apply one single capital requirement for all assets, for instance 8 percent, and the leveling of the internal playing field would strengthen the system and help to drive out many of those cultural differences. 

PS. Could farmers and the cowboys be friends, if treated so differently?

@PerKurowski ©

Paul Volcker and John Reed, our jobless young, more than a safer, need a more functional financial system

I cannot fully agree with Paul Volcker and John Reed about having a 6% cross the board capital requirement “standard alongside a robust system of risk weights” unless there is more clarity about what risk are to be weighted, “A safer financial system is now within our grasp”, December 12.

I say this because the problem with the current risk weighting used is that it weighs that risk of the assets which is already weighted, by means of interest rates, size of exposure, duration and other terms. And so, re-clearing for the same risk in the capital, causes banks to earn much higher risk adjusted returns on equity for assets perceived as “absolutely safe” than for assets perceived as “risky”; and this makes it therefore impossible for banks to allocate bank credit efficiently in the real economy. 

At this moment, when a generation of young people without jobs risk becoming a lost generation, the limited objective of a safer financial system needs urgently to be superseded by the much more comprehensive objective of banks becoming more functional.

Some are waking up to the colossal failings of Basel bank regulations... when will FT?

Sir, Shahien Nasiripour and Tom Braithwaite report “US regulators urged to outdo Basel III rules” October 5. In it they mention that “some like Jeremiah Norton, a director on the FDIC´s five man board, have voiced doubts about the proposed risk-weighting scheme, which links capital levels to assets risk”. Might he have tried to answer some of my wicked questions on bank regulations? Like: 

1st: When do banks most need capital, when the risky turn out risky, or when the “not-risky” turn out risky? 

2nd: If bankers do as Mark Twain says, namely “lend you the umbrella when the sun shines and wanting it back when it rains”; and all bank crisis ever have result from excessive lending to what was perceived as “not risky”; and the perceptions of risk have already been cleared for in the interest rates and the amounts of the loans, then what is the logic behind allowing banks to hold less capital requirements when they engage in what is perceived as “not risky”, as current bank regulations do? 

3rd: What economists can be so dumb not understanding that if you allow banks to leverage 60 times or more their bank equity for some assets and only 12 times for other, producing thereby vastly different returns on equity, you will drastically distort the economic efficient resource allocation that banks are supposed to perform? 

More sooner than later, everyone is going to wake up to the fact that our current bank regulations are built upon absolutely insane foundations. And then of course, the silence of the Financial Times on this issue is going to be a source of immense embarrassment for the paper and especially for those responsible of, notwithstanding its motto, ordering its silence on it, during so many years.

How come the real flaw of Basel bank regulations is not even discussed?

Sir, Karel Lannoo, in “Rulemakers in Europe must flex muscles on Basel III”, January 31, gives a good description of many of the particular problems derived from the current capital requirements for banks, but is yet incapable of pinpointing the true core of what´s wrong with these… namely that regulators add their risk discrimination on top of the risk discrimination that already occurs in the market. But, of course, it is not only Mr. Lannoo, who fails to see that.

Recently John Reed, a former Chairman and CEO of Citicorp, a former Chairman of the New York Stock Exchange and currently the Chairman of the Massachusetts Institute of Technology's Office of Corporation, during an interview in a program of Bill Moyer titled “How Big Banks are rewriting the rules of our economy” said the following:

“It does not take a genius to see what happened … the presumption that you can capture risk by looking at historical volatility…. As soon as you say something appears not to be risky you get an overinvestment in it because the capital requirements are less, and then if something does go wrong the hurt is all the more because you do not have the capital to cover that risk”

But what does obviously not take a genius to see, even I saw it, and about which I have written hundreds of letter to FT, is something still totally ignored in the debate, and in the rewriting of the next Basel version. The useless and so dangerous capital requirements for banks based on perceived risks remain the main pillar of the Basel bank regulations. How come?

Ref: 17:40 to 18:15

http://billmoyers.com/episode/full-show-how-big-banks-are-rewriting-the-rules-of-our-economy/