The Basel Committee stupidly made banks substitute savvy loan officers with equity minimizing financial engineers

Sir, John Plender, reviewing Philip Augar’s “The Bank That Lived a Little” writes: Not so long ago banking was a relatively simple business whose main focus was on deposit-taking and lending. Then in the 1980s everything changed as a powerful tide of deregulation swept through the industry… courtesy of Ronald Reagan and Margaret Thatcher”, “Head rush”, July 7.

Was it “deregulation” or plain missregulation? The main change that was introduced in banking, in 1988, with the Basel Accord, was the risk weighted capital requirements for banks. 

That meant that from there on, the risk-adjusted returns on bank equity were not to be maximized by savvy loan officers, but by equity minimizing financial engineers.

And clearly “increasing amounts of risk in relation to dwindling cushions of capital” allowed the bonuses of bankers to be so much higher.

Has banking “turned into an ethics-free zone”? Yes, but blame the regulators for much of that. Now, 30 years later, I would think there is no room to put the blame on Ronald Reagan or Margaret Thatcher. 

Frankly, since FT has not dared to ask regulators why banks have to hold more capital against what is dangerous perceived as safe than against what is made innocous by being perceived as risky, as I see it, FT is so much more responsible for all this mess.

@PerKurowski

Philip Augar, the ‘banking crisis of 2008’ did not dent at all Milton Friedman’s ideas that “sowed the seed of shareholder value”

Sir, Philip Augar quotes Milton Friedman with: “that business is not concerned ‘merely’ with profit but also with promoting desirable ‘social’ ends . . . They are — or would be if they or anyone else took them seriously — preaching pure and unadulterated socialism….” “to make as much money as possible” for the owners, “while conforming to the basic rules of society”, “A call for boards to overturn the status quo” January 4.

And he follows up with “This sowed the seed of shareholder value... It took the banking crisis of 2008 and the ripple effect of financial disaster to expose the flaws of the theory”

What is Augar talking about? Banks, in order to make the highest risk adjusted profits, just followed the “basic rules of society”, in this case set by their regulators who, with their risk weighted capital requirements for banks told them: “Go out and make your biggest risk adjusted profits on what is perceived or decreed as safe”

And that is precisely what banks did, initially making huge profits, but also creating dangerously excessive exposures to “the safe” like AAA rated securities and loans to sovereigns who had been assigned a 0% risk weight, like Greece; which exploded.

I cannot understand how Augar can argue that has dented Milton Friedman’s thesis. If anything it clearly demonstrates the dangers of having some very few define and impose “the basic rules of society”.

He opines “boards need to develop a mindset that challenges rather than seeks to justify the status quo” That is correct, but does that not include papers like the Financial Times too?

Sir, why has FT not dared to challenge the status quo by for instance demanding regulators to give a straight simple answer, not disguised in incomprehensible technicalities, to the question of “Why do you want banks to hold more capital against what has been made innocous by being perceived risky, than against what is dangerous because it is perceived safe”?

http://perkurowski.blogspot.com/2016/04/here-are-17-reasons-for-why-i-believe.html

@PerKurowski

Timely accurate information is good, but you’ve got to keep markets guessing too.

Sir, I refer to Philip Augar’s “For markets there is such a thing as too much information” February 2.

Indeed it is a very difficult topic. Even if you want markets to have information, you also need for markets to be guessing in order the keep them on their toes and in form. A market with perfect and timely information could soon lose some of its strength. Its analytical capacity would be much less appreciated and everything would tend to be boringly perfectly priced.

Closely related to this in 2007 I wrote “The dark side of knowledge”. In it I held that too much timely information could chip away at what good is often derived from blissful ignorance.

Also if you report on problems too soon, there will be less time available to correct these, and the curtain might be brought down much too early.

If knowledge suffices then wisdom is worthless

Britain could be against bankers, bank lobbyist and bank regulators… but should never be versus its banks.

Sir I refer to Philip Augar’s “Britain versus the banks” July 19… what an unfortunate title.

Augar writing about Alex Brummer’s “Bad banks: Greed, incompetence and the Next Global Crisis” says the author poses the ultimate question for the authorities who have to decide “what sort of banking they actually want and the extent to which the market driven requirements of high returns through risk can be balanced with society´s desire for safe banking”.

What? “society’s desire for safe banking”? And what about all other society’s desires for banks… like helping to finance the creation of jobs?

Does Brummer for instance agree with that “market driven requirements of high returns [for banks]” and for which bank lobbyists convinced regulators to lower the capital requirements for banks when lending to what is perceived as safe, should trump the right of the “risky” small businesses and entrepreneurs of not being discriminated more than normal when accessing bank credit?

Sir, Just like Philip Augar starts by quoting JK Galbraith, so did I in my first article published in 1997 in the Daily Journal of Caracas, “Puritanism in banking”. In it I wrote:

“In his book “Money: Whence it came, where it went” (1975) [and of which the author signed a copy for me in 1978] John Kenneth Galbraith addresses the function of banks in the creation of wealth…

Galbraith speculates on the fact that one of the basic fundamentals of the accelerated growth experienced in the western and south-western parts of the United States during the past century was the existence of an aggressive banking sector working in a relatively unregulated environment. Banks opened and closed doors and bankruptcies were frequent, but as a consequence of agile and flexible credit policies, even the banks that failed left a wake of development in their passing.”

And clearly, the almost fanatic obsessions of current regulators with stopping banks from failing, impedes these from helping out in financing the development we need but that of course entails a lot of risk-taking. It also, with its minimalist capital requirements for anything that can dress up as "absolutely safe" guarantees the growth of the Too Big To Fail Banks.

And I also wrote “Galbraith refers to the banks’ function of democratization of capital as they allow entities with initiative, ideas, and will to work although they initially lack the resources to participate in the region’s economic activity. In this second case, Galbraith states that as the regulations affecting the activities of the banking sector are increased, the possibilities of this democratization of capital would decrease. There is obviously a risk in lending to the poor.”

And indeed few regulations can be argued to be as anti-democratic as the risk-weighted capital requirements for banks based on perceived risks… something which is amazingly ignored in these days when inequality is much discussed. 

Sir, let me finalize again by quoting Galbraith from the same “Money”. “It should be the simple truth in all economic and monetary matters that anyone who has explained failure has failed. We should be kind to those whose performance has been poor. But we must never be so gracious as to keep them in office”.

Indeed we should, perhaps, not tar and feather those who had anything to do with Basel II… but we should send them home, not promote them, and the least of it all… allow them to have anything to do with Basel IV… as they have already contaminated Basel III.

If reckless banking was to be a criminal offence, should not criminally stupid bank regulations also be it?

Sir, what would you opine if UK´s Department of education decided the exams of students should be more favorably graded the more they had stayed inside and avoided the risks of going out? And this even though long term that would mean students because of the lack of exercise they will suffer much more from obesity. If they did that would you not find it to be criminally stupid? Well, that is exactly how the regulators are regulating the banks by the use of capital requirements based on perceived risks.

I mention this in reference to Philip Augar´s “Reckless banking should be a criminal offence” June 19. If a banker can get to be hauled in front of a court, not because a purposeful endangerment of a bank but because of plain stupid recklessness, should we not have the same right when it comes to regulators? In fact, given its more overreaching implications, should they not stand there accused of high treason?

For instance, Mario Draghi, during many years the Chairman of the Financial Stability Board, agreed with regulations which allowed banks to lend to Greece against only 1.6 percent in capital, a mindboggling authorized leverage of 62.5 to 1, while at the same time required banks to hold 8 percent in capital against much smaller loans given to Greek unrated business. Is that not criminally stupid? And since regulators insist on using the same insane principle developing Basel III, do we not need to set an urgent example?

More than protecting banks from future crisis, we need to protect our real economy from dysfunctional banks

Sir, Philip Augar, writes “Britain´s regulators were feted for their light touch” “Salz offers a prescription to protect banks from future crisis” April 9.

What? If Augar believes regulations which intrude on the markets through capital requirements for banks which allow banks to leverage 60 times or more on their equity any interest rates paid by “The Infallible” while restricting to a 12 to 1 leverage interest rates paid by “The Risky”, are “light touch” he has just not informed himself of what has been happening.

Augar writes that the most important recommendation by the recent Salz Review, commissioned by Barclays to study its culture and business practices, is the “necessity of creating the right environment for feedback… and to question accepted wisdom constantly”.

Indeed, I have for years been trying to ask regulators about their reasons for capital requirements for banks which are based on perceived risks, when those perceived risks are already cleared for by the banks in the interest rate they charge, the size of the exposure and other terms. And I have never ever received an explanation more than the normal “more risk more capital, less risk less capital that sounds logical” mumbo jumbo.

Those differential capital requirements are distorting all common sense out of the real economy. Let us remember that much more important than to protect our banks from future crisis is to protect our real economy from being assaulted by banks made dysfunctional by regulators.

And so much more urgent than opening up the boardrooms of banks, is opening up The Basel Committee, the mother of all the non-accountable to anyone mutual admiration clubs.

Since Basel has become too one minded to regulate we must break up the regulator too

Sir not only do I agree with Philip Augar and John McFall in that “To fix the system we must break up the banks” September 11, but perhaps we need to break up the regulators too…because Basel has become too one minded to regulate. (It is probably not comme il faut to quote from another newspaper, but it is such a small paper so here I go.)
In February 2000 in the Daily Journal of Caracas, Venezuela, in an article titled “Kafka and global banking” I wrote:
A diminished diversification of risk. No matter what bank regulators can invent to guarantee the diversification of risks in each individual bank, there is no doubt in my mind that less institutions means less baskets in which to put one’s eggs. One often reads that during the first four years of the 1930’s decade in the U.S.A., a total of 9,000 banks went under. One can easily ask what would have happened to the U.S.A. if there had been only one big bank at that time.
The risk of regulation. In the past there were many countries and many forms of regulation. Today, in Basel, norms and regulation are haughtily put into place that transcend borders and are applicable worldwide without considering that the after effects of any mistake could be explosive.
Excessive similitude. By trying to insure that all banks adopt the same rules and norms as established in Basel, we are also pushing them into coming ever closer and closer to each other in their way of conducting business. Unfortunately, however, nor are all countries the same, nor are all economies alike. This means that some countries and economies necessarily will end up with banking systems that do not adapt to their individual needs.
Sir and I hold that I am still right.