Why is it not obvious that what bankers perceive as safe must, by definition, be more dangerous to our bank systems than what they perceive as risky?

Sir, Jonathan Ford writes, correctly, “One concern with using risk-weighted assets is that bank bosses can influence the calculation by tweaking the asset number”, “Money to burn at the banks? It all depends on how you count it” December 3.

But you really do not have to go there to be very concerned, it suffices to ask yourself: What is more dangerous to our bank systems, that which bankers perceive as risky, or that which bankers perceive as safe?

And then you do not have to use bankers models, it suffices to know that in the standardized risk weights of Basel II, the regulators themselves assigned a meager 20% risk weight to the rated AAA to AA, that which really could be dangerous (like in 2008) and a whopping 150% weight to the innocous below BB- rated, that which bankers won’t like to touch even with a ten feet pole.

I agree with those wanting a straight equity requirement for banks, a leverage ratio, like Mervin Kings’ 10% or Professor Anat Admati’s 15%, but much more than for the safety of our banks, I want that so as not distort the allocation of bank credit to the real economy. 

Sir, I am convinced that, a 0% bank capital requirement, with no supervision of banks, with no deposit guarantees to its depositors, would be much better for our real economies, and much safer for our banks systems, than the current dangerous regulatory nonsense… which only guarantees especially big crisis, resulting from especially big exposures, to something perceived as especially safe, against especially little bank capital.

Unfortunately, you seem to believe our bank regulators really know what they’re doing… or is your motto “Without fear and without favour” just a marketing ploy?

http://subprimeregulations.blogspot.com/2018/08/risk-weighted-capital-requirements-for.html

@PerKurowski

Tier one capital ratios is a game invented by regulators for banks to play.

Sir, Jonathan Ford mentions “An average tier one capital ratio of 8 per cent —. An accounting measure of their soundness, it meant banks could lose that proportion of the value of their risk-weighted assets before their loss-absorbing capital was spent.” “Financial fragility lurks behind a confident façade” September 17.

No, not really-really so. Let us, just for the example suppose that a bank carries only very “safe” corporate assets rated AAA to AA assigned by the regulators a risk weight of 20%. Based on the Basel II basic capital requirement of 8%, that meant it needed to hold only 1.6% in capital against those assets. That would give the bank a tier one ratio of 8%... but how much could it afford to lose on its assets that had been risk weighted before its capital was completely gone? Not 8%, but 1.6%.

The risk-weighted assets only give a correct indication if the perceived risk reflected are correct and if bankers will manage those perceived risks correctly. What are the chances of that? Quite slim, especially when banks have all the incentives to minimize equity they are holding, something that makes it easier for them to maximize the return on equity to their shareholder (and of course the bankers’ own bonuses)

In other words, the Basel Committee tier-one bank capital ratio, based on risk-weighted assets, as if risks were known, is just devious and dangerous false information that feeds a false sense of security. Nothing of what accountancy can misreport beats that. Worse, by distorting the allocation of credit, much more than concealing realities, it changes realities… on a global scale.

PS. Here is an aide memoire on the mistakes in the risk weighted capital requirements for banks.

@PerKurowski

Optimally the utilities’ long-term views should result from their local connections.

Sir, Jonathan Ford describes in very clear terms why “private equity firms shouldn’t own regulated utilities, full stop. In very long-term businesses providing essential services, investors should have time horizons to match.” “Why private equity investors and utilities should not mix” June 17.

But there is more to this issue. In 2000, Electricidad de Caracas, EdC, the electrical utility of Caracas, Venezuela, that had been founded and managed by a local family for 105 years, was sold off to a big time international player, AES. I was in shock, and so I wrote in several Op-Eds. 

Not only would we lose the natural accountability of the management that exists when these are your neighbors and suffer the same service failings that you do; but it would also take that company out of the hands of electrical engineers and place it into the hands of financial engineers. 

Yes, the new owners proceeded to sell assets, repurchase shares, take up new loans and pay out dividends, leveraging the company up to the tilt… and many needed investments were delayed.

While EdC was being negotiated I wrote: "From my local electrical distributor, what I'm interested in seeing are good engineers with colorful helmets, accompanied by competent accountants with simple calculators, which only serve to add and subtract. I do not like to observe the presence of lawyers, financiers, brokers, publicists and other professionals little or nothing related to bring me the light home…. I get very scared when I hear terms like ‘unfriendly takeovers’ ‘poison pills’ and ‘golden parachutes’.”

To that I should have added “And I absolutely want my neighbors to hold management control and a clear majority of shares in that company.”

PS. The EdC story had an even sadder ending. In 2007, after trying to negotiate tariffs with a loony government, AES withdrew. Unfortunately, the Local that stood up to forcibly repurchase it, was Pdvsa… and you probably know what happens to anything that is in the hands of the current Pdvsa.

@PerKurowski

In terms of a short-termism that harms the long run, few are as guilty as current bank regulators.

Sir, Jonathan Ford quote US academic Lynn Stout with “The pressure to keep share prices high drives public companies to adopt strategies that harm long-term returns: hollowing out their workforce; cutting back on product support and on research and development; taking on excessive risks and excessive leverage; selling vital assets and even engaging in wholesale fraud.” “Shareholder primacy lies at heart of modern governance problem” March 5.

Indeed, but I hold that low investments and poor productivity is also the result of regulators’ risk weighted capital requirements for banks based on ex ante perceived risks. These focuses on making the banks safe today, at the price of making it all worse off tomorrow, ex post. How? Because they dangerously push banks to overpopulate, against especially little capital, those safe havens that have always been the main threats to our banking systems; and because they keep banks from exploring those risky bays, those with entrepreneurs and SMEs, those that could give us the growth and the jobs of tomorrow.

@PerKurowski

Bank regulators could derive valuable lessons from pension scheme difficulties.

Sir, Jonathan Ford while discussing Carillion’s pension schemes writes: “deficit repair should reasonably leave space for the company to foster future growth, and thus preserve the ongoing viability of the sponsor.” “Carillion’s pension crisis defies any magic legal cure” February 26.

Absolutely. But does that not apply to bank regulations too? As is the risk weighted capital requirements give banks huge incentives to stay away from financing the “riskier” future, like entrepreneurs, in order to refinance the safer present, like houses.

And Ford adds: The worst outcome would be one that simply encouraged trustees to “de-risk” schemes further by purchasing highly priced gilts to protect themselves against mechanical increases in short-term liabilities caused by falling market yields — a pro-cyclical practice known as “liability-driven investment”.

In essence that is what the risk-weighted capital requirements do. They doom banks to end up gasping for oxygen in dangerously overpopulated safe-havens against especially little capital, leaving the riskier but perhaps more profitable bays unexplored.

Ford argues: “It’s not clear though what any “tough new” rules could have done to help this messy situation.”

I know too little about Carillion but, what I do know, is that pension funds in general, government’s included, have been way too optimistic when estimating potential real rates of return in the order of 5% to 7%. 3% would be more than enough of an optimistic real rate of return, given the so many unknown factors out there.

@PerKurowski

Our dear George Banks, having anteceded the Basel Committee, would never have dreamt about current bank bonuses

Sir, Jonathan Ford writes: “As Andy Haldane of the Bank of England points out, there are few ways for banks to bolster their returns to shareholders. One is to loosen underwriting standards and so increase the riskiness of assets they invest in. The other is to squeeze the amount of regulatory capital they set against the investments they make.” “Banking bonuses ought to be dead and buried by now” August 14.

Haldane is wrong about the increase of riskiness of assets, to improve the return on equity that is of little and doubtful sustainable value (bankers have even been fired for that); but he is absolutely correct about the regulatory capital.

When current bank regulators were taken for a ride by bankers and convinced, like for instance with Basel II of 2004, to set the capital requirements against something rated AAA to AA at only 1.6%, meaning an authorized leverage of equity of 62.5, they allowed bankers to earn returns on equity beyond their shareholders’ wildest dreams, and this even after keeping for themselves huge eye-watering bonuses.

Place a 10% capital requirement on all bank assets and those bonuses would immediately begin to vanish in the air as a result of shareholders becoming again important to banks.

As a huge bonus for the rest of the economy, that would also eliminate the current odious distortion of bank credit in favor of “the safe”, sovereigns, AAArisktocracy and houses, and against the risky, SMEs and entrepreneurs.

PS. Here is a letter from George Banks III, after having been called a bankster.

George Banks (the first)

@PerKurowski

To restore real accountability in finance we must start with the bank regulators

Sir, Jonathan Ford writes: “Since the financial crisis, bank shareholders have borne pretty much the whole cost of cleaning up the reputational and legal damage done to the sector... the case must be focused on individuals simply to restore a sense of personal responsibility to finance. Bankers have escaped prosecution partly because of the law itself. There was nothing on the statute book to prohibit the mismanagement of big financial institutions.” “Restoring individual accountability in finance is worthy goal” June 26.

One reason for why that so necessary holding to account has not happened, might be the fact that the bankers “herded into the dock to face the music” could argue the following:

“Your Honor! Our regulators, those who explicitly or implicitly support us, those who tell governments and citizens they have everything under control, with Basel II in 2004, explicitly authorized us to leverage our capital 62.5 times or more whenever an AAA to AA rating was present, like the case of the securities backed with mortgages to the subprime sector, and to leverage even more with sovereign debt, like Greece.”

Sir, if there ever was a need to shame some in relation to the 2007/08 financial crisis, that would be its instigators, namely the Basel Committee and their bank regulating colleagues. Instead, like Mario Draghi, they were promoted.

@PerKurowski

We must learn how to keep all the profiteers of all the worthy social causes and fights at bay.

Sir, Jonathan Ford is on a very right track with his “How subsidy culture keeps Britain’s green industry in the black” October 31.

Of course we all want more jobs, a better and more sustainable environment, more equality in the world (at least most of us), and many other good things. But, in order to afford helping that to happen, we must learn how to keep the profiteers of those causes and fights at bay.

That, we do much better by providing the right economic signals, than by having some few deciding on how to allot among some other few, our contributions to the cause.

For instance, instead of capital requirements for banks based on perceived risks, credit ratings, and that only help to increase inequalities, we would all be better if regulators used some based on job creation and environmental sustainability ratings. Some lower capital requirements when financing those social goods would allow them to earn higher expected risk adjusted returns on equity.

And we should also use specific taxes that send the right economic signals, without causing too much pain or generating direct distortions. For instance a huge carbon tax, which revenues are all poured back to the economy by means of a Universal Basic (variable) Income, would be a great help, for the environment, for the economy, and therefore for jobs.

Sir, the problem though is that there we have to go up against the re-distribution profiteers, and as you know they are very very strong, since most of them are so firmly entrenched as do-gooders’ in the public sector.

@PerKurowski ©

Could it be current bank regulators are not held accountable because their mistakes are just too big to fathom?

Sir, Jonathan Ford with respect to Wells Fargo’s “misdemeanors” asks “why supposedly competent managers failed to join the dots”; and correctly states that “one reason why public confidence in Wall Street remains so low… [is that the] bosses are not held accountable” “If no bank is ‘too big to jail’, Wells Fargo bosses must face the music” October 17.

Now with respect to banks, their purpose and their stability, there are two very clear dots:

1. If you allow banks to leverage their equity, or the support they receive from society, more with some assets than with other, then you will distort the allocation of credit to the real economy.

2. What is dangerous for bank systems, is never what is ex ante perceived as risky, but always either some unexpected event, or the build-up of dangerous excessive exposures to something that ex ante was perceived as safe but that ex post turned out not to be.

So, if regulators impose capital requirements that allow banks to leverage more with assets ex ante perceived as safe, then I would hold that is clear evidence of them not being able to connect even the most basic dots. Should they not be held accountable? Of course they should, but they aren’t.

I fully agree with Ford’s opinion that even though “little money was taken” in Wells Fargo’s “misdeeds” being discussed “that doesn’t diminish the bank’s culpability”

But could it be though that some mistakes, like those committed by current bank regulators, are just so big they can’t even be discussed? If so, we, and foremost the next generations, are doomed.

@PerKurowski ©

High interests do not solve any retirement problems, if there is no real economic growth to pay for these

Sir, Jonathan Ford writes of how “The Bank of England’s decision to cut interest rates and resume quantitative easing” is creating all sort of expected deficits in retirement plans, and specifically to “UK’s 6,000 still existing defined benefits schemes” “Real change in attitude is needed to solve the issue of fund deficits” August 22.

Ford also mentions the responsibility of the “existing generation…to strive to provide for the obligations to workers they have inherited”. That is very correct, but the possibilities of it will also very much depend on the health of the real economy.

If there were no low or even negatives interest rates, but only high positive interest rates, in order for these to translate into real positive rates, the interests would, in the medium and long term anyhow, have to be paid by real economic gains.

And that is why, once again, I insist that the most egregious thing that is happening to that future economy on which we all will depend, is the risk aversion that has been introduced into the allocation of bank credit by means of the risk weighted capital requirements for banks.

It is just amazing this is not even being discussed.

@PerKurowski ©

In terms of capital requirements for banks, when travelling towards 20 or 30 percent, how do we survive the journey?

Sir, Jonathan Ford writes Alan Greenspan exhibited both candor and clarity in an article for the Financial Times in which he called for banks to raise substantially more capital “Higher capital is a less painful way to fix banks” August 26.

First, in that article Greenspan compared the evolution of traditional bank capital levels, with the much newer risk-weighted capital requirements concocted by the Basel Committee. They cannot be compared and so in doing Greenspan clearly evidence why he should take his retirement more serious, and better do like soldiers, just fade away.

And then, in terms of what capital requirements he has in mind, Greenspan writes about “20 or even 30 per cent of assets (instead of the recent levels of 10 to 11 per cent)”. Not mentioning whether he refers to risk-weighted assets or not, something which has implications not to be frowned at. For instance, with current risk weights of 100 percent when lending to unrated SMEs and entrepreneurs, banks could be required to hold 30 per cent in capital, while allowed to hold zero capital when lending to the zero risk weighted sovereigns… Is that what we need? And how do we get from here to there, without dying during the journey? Can you imagine the initial bank credit austerity that could ensue? 

Greenspan argued: “if history is any guide, a gradual rise in regulatory capital requirements as a percentage of assets (in the context of a continued stable rate of return on equity capital) will not suppress phased-in earnings since bank net income as a percentage of assets will be competitively pressed higher, as it has been in the past, just enough to offset the costs of higher equity requirements. Loan-to-deposit interest rate spreads will widen and/or non-interest earnings will increase.”

And I would just ask Greenspan: If you were thinking of buying bank shares… and heard about “a gradual rise in regulatory capital”, would you buy those shares now, or would you prefer to postpone that decision to when the increase in regulatory capital seems closer to being completed?

@PerKurowski

FT, when have you lately heard a regulator state that allocating credit efficiently is a bank’s most important purpose?

Sir, Jonathan Ford writes “the banking lobby has been relentless in its opposition to reform, seeking to present it in terms of false choices — between growth and safer banks, or between regulation and a successful financial system.” “Relief for banks as Britain puts a leash on its financial watchdog” July 20.

Of course these are false choices… but the fact is that regulators pursuing safer banks are negatively affecting growth. Their credit risk weighted capital requirements for banks distort immensely the allocation of bank credit to the real economy.

And clearly, from what Ford describes, Martin Wheatley of the Financial Conduct Authority saw more his role as an bank inquisitor, and had no concern whatsoever about credit allocation.

Let us hope his successor is willing to include a hefty dose of regulatory mea culpa, and does not just follow in the political convenient track of only holding “bankers publicly accountable for their actions”.

@PerKurowski

What about 15% of ad revenues to the content provider and the mobile operator, each one, and 70% to me?

Sir, Jonathan Ford seems to agree with “mobile operators… offering customers control over how they use their data allowance online” but is a bit suspicious of their intentions since operators also “want content providers to hand over more of their revenues from advertising”, “Mobile ad-blocking risks becoming a barrier to innovation” May 18.

There is no question that there is a lot of fighting about the value to access us consumers, and if we do not find efficient ways to block ads, we will drown in these, and de facto become incommunicado.

We users, we must fight back for our rights.

If I am going to use my limited attention span, and my data allowances, to look at ads that are directed to me only because my own preferences and lifestyle is known as a result of being on social media or otherwise surfing the web… then it is really I who should be paid.

And I would gladly pay the content providers, for providing advertisers the information they need about me, and the operators a commission for providing me a collection service. How about a generous 15 percent to each one of them? And 70 percent to me :-)​

@PerKurowski

How can you call the mother of all bank credit distortions an “opiate of ‘light touch’ regulation”?

Sir, Jonathan Ford refers to an “opiate of ‘light touch’ regulation before the financial crisis” “The right balance of banking regulation is still some way off” March 2.

He has no idea. How on earth can you call a regulation which restrict banks to leveraging their equity 12 times to 1 in the presence of something perceived as risky, but allows a 60 and even higher leverage for something perceived as absolutely safe, “light touch”?

Ford speaks about power passing to regulators after 2008. Wrong! Already with Basel I regulators gamed the equity requirements for banks in favor of the sovereigns, meaning the governments, meaning their bosses.

Yes Mr. Ford there is “the risk of starving some parts of bank’s business that, while costly to run and consumptive of capital, are of high social value”. But who decided the rates of capital (equity) consumption, the regulators with their “light touch”?

PS. Mr. Ford, give us one single bank crisis resulting from an excessive exposure to something that was perceived as risky, when banks placed that asset on their balance sheet.

No! The real “masters of the universe”, those self-appointed, those full of hubris, are the bank regulators.

Sir, Jonathan Ford refers to the bosses of hedge funds who manage about 10 percent of investment funds worldwide as and that in reference to these “it is hard to avoid the impression that hubris is a factor”, “The master of the universe are playing a loser´s game", August 25. 

Forget it! If there are some who can be defined as masters of the universe full of hubris, that is the bank regulators who play risk managers for the world, and on their own, without consulting with anyone, dole out the risk-weights which determine the capital requirements for the banks. 

In doing so, the regulatory nannies have caused obese and dangerous bank exposures to whatever was considered officially as absolutely “not-risky”, and anorexic bank lending to whatever was considered officially as “risky” like unrated small businesses and entrepreneurs. 

If hedge fund bosses do wrong, their clients lose, but when bank regulators do wrong, massively, and on a massive global scale, as they have done, then everyone loses, starting with those who as a result will become unemployed and those who might never ever get an employment. 

PS. “The Challenge”