Any new IMF managing director should at least know, as a minimum minimorum, that two current important financial policies are more than dumb.

Sir, I refer to John Taylor’s “Choice of new IMF head must not be dictated by the old EU order” August 12.

I have no problems whatsoever with all what Taylor argues and neither with IMF changing its bylaws to allow someone over 65 years to take up the post of managing director.

But I do have two very firm ideas about what the next managing director should know.

First, that the risk weighted capital requirements for banks, based on that what’s perceived as risky, like loans to entrepreneurs and SMEs, is more dangerous to the bank system than what’s perceived as safe, like residential mortgages, is more than dumb. These only guarantee a weakening of the real economy and especially large bank crises, caused by especially large exposures to something perceived, decreed or concocted as especially safe, which turns into being especially risky, while held against especially little capital.

Second, that to assign a 0% risk weight, as that which has been assigned by EU authorities to all eurozone sovereigns, and this even though these take on debt that de facto is not denominated in their own domestic printable currency, something which could bring down the Euro and the EU with it, is also more than dumb. 

Sir, I wonder if anyone of the G20 Eminent Persons Group, international worthies and the names Taylor mention understand and know this. And if they do, why are they silent on it?

@PerKurowski

To explain the 2008 financial crisis a two pieces puzzle could suffice.

Sir, Tim Harford writes, “Raghuram Rajan, when he was chief economist of the IMF, came closest to predicting the 2008 financial crisis. He later observed that economists had written insightfully on all the key issues but had lacked someone capable of putting all the pieces together”, “How economics can raise its game” June 29.

According to 2004’s Basel II, a corporate rated AAA to AA, could offer banks to leverage their equity 62.5 times (100%/(8%*20%)) with its risk adjusted interest rate, while one rated BB+ to BB-, or not rated at all, could only offer banks to have their risk adjusted interest rate leveraged 12.5 times (100%/(8%*100%))

Sir, I am not arguing whether it is better to be a hard or a soft economist but, any economist looking at that proposition and not seeing it would cause serious misallocation of bank credit, should either go back to school, perhaps to take some classes on conditional probabilities, or go out on Main-street, and learn a bit of what real life is about.

62.5 times leverage? What banker could dare resists that temptation and stay out of competition thinking, what if that AAA to AA rating is true?

PS. That leverage applied for European banks and US investment banks supervised by SEC.

@PerKurowski

The financial crisis can was just kicked forward. At any moment it will roll back on us, with vengeance.

Sir, Raghuram Rajan, though indicating problems, writes: “The world economy has finally managed to recover from the financial crisis” “Bond markets send signals of a looming recession” June 29.

Sir, on the surface the signs of a recovery are there but, under the surface there are huge build-ups of asset values, shares and house prices, and of personal, public and corporate debt, that herald difficult times.

In August 2006, when trouble was already in the air, you published my letter titled “The long term benefits of a hard landing”. Clearly nothing of what I there argued was considered.

With QEs, Tarps, Asset Purchase programs, fiscal deficits, low interest rates and the keeping of much of the insane low capital requirements for banks, the crisis can was just pushed forward. 

Add to that Eurozone, China, Brexit, robots grabbing jobs, trade wars, migrant issues and so many unresolved problems, and one can perhaps begin to understand a not to be named reason for how so many want to legalize the use of marihuana.

Sir, again, much of the current mess is directly produced by the frantic efforts of regulators and central bankers to hide their responsibility in causing the 2007-08 crisis and ensuing hardships.

For God’s sake! In Greece they are hauling in front of courts a statistician for telling the truth, while those that with their absurd and irresponsible 0% risk weighing of that nation doomed it to excessive public debt, are free to roam and lecture us about good economics. 

@PerKurowski

We urgently need one judge hauling a bank regulator to his court, in order to ask him one very simple question

Sir, Chris Giles writes that Raghuram Rajan, the head of the Indian central bank said he was a supporter of stimulus policies to “balance things out” in short periods when households or companies are proving excessively cautious with their spending, but eight years after the financial crisis he said we now “have to ask ourselves is that the real problem”. “Underlying performance suffers from loose policies, says India governor” May 16. About time!

Sir, as you know, for a long time I have held that any stimulus policy is really wasted as long as the risk-weighted capital requirements for banks impede bank credit to flow efficiently to the real economy. Those regulations are just another stimulus for bank lending to “The Safe”, and that is not the kind of stimulus the next generations need.

Those regulations odiously discriminate against the access to bank credit of those perceived as “The Risky” like SMEs and entrepreneurs.

And I would love to haul any of the big name bank regulators, like Draghi, Greenspan, Bernanke, Ingves, Carney or many other, in front of a judge to have him, under oath answering the following question:

Mr. Regulator, current risk weighted capital requirements for banks indicate a risk weight of 150% for what is rated below BB- and of only 20% for what is rated AAA to AA. Do you sincerely believe that what is rated below BB- and that one would therefore presume is not an attractive asset for a bank, to be so much riskier for the banking system than those rated AAA to AA?

If the regulator answers “Yes”, the judge should ask for a detailed explanation.

If the regulator, being under oath, truthfully responds “No”, then the judge should ask: Does that not indicate that there is something fundamentally wrong with the credit risk weighting?

And then persons like me, who for over a decade have not been able to extract an answer from the regulators, would at least have something to work with.

In the case of India, such trial evidence could help us to remind Raghuram Rajan that risk-taking is the oxygen of any development. And of that if some developed countries seem to have had enough of development, and do not want to risk climbing further up their ladder, this does not mean that a developing country should copycat such dumb credit risk aversion.

@PerKurowski ©

If Britain had applied current bank regulations when it was developing, it might even have found itself below India

Sir, you write: “Even if one puts to one side doubts about India’s economic statistics, private investment remains weak. The government has rightly emphasized improved administration, faster decision-making and greater ease of doing business” and you quote Eswar Prasad of Cornell University ideas with “Markets for land and capital remain distorted. Several public sector banks are in dire shape. They need recapitalization and radical reform”, “Modi fails to exploit India’s great opportunity” April 4.

But again you fail to mention the fact that the Basel Committee’s credit risk weighted capital requirements for banks, which by favoring “the safe” disfavor “the risky”, is as anti-development and pro-inequality as can be.

Do you really think that allowing banks to earn higher expected risk adjusted returns on equity with “the safe” than with “the risky” is the way to go for a country that has not reached sufficient altitude climbing the mountain of development?

And it is not that these bank regulations keep you high up, they also impose a fast descent. With it Britain has expelled its spirited and adventurous risk taking and embraced the risk aversion of the scared.

Hello India, we, Britain, will soon catch up with you, while climbing down.

When the Bible says “But the meek will inherit the land and enjoy peace and prosperity” I am sure it was not to excessive risk-adverseness it was referring.

God make us daring!

@PerKurowski ©

Raghuram Rajan, your own bank regulations are more important to mobilize development funds in India than the World Bank.

Sir, I refer to Victor Mallet’s and James Crabtree’s “Rajan issues call for World Bank and IMF reforms” October 8.

It states that Raghuram Rajan, Indian central bank governor and former chief economist of the International Monetary Fund, gave the example of financial regulations with global reach that would typically be discussed among representatives of advanced economies behind closed doors and presented only at a late stage to those of emerging markets. “Eventually what emerges is a compromise among the advanced countries, even though we’ve been at the table when the final vote is there,” Rajan said.

Not so! Technocratic members of a small mutual admiration club might discuss those financial regulations, but there is nothing to stop Raghuram Rajan to question those regulations openly; and there is nothing forcing India to accept those regulations, except of course that of their own local regulators also wanting to be seen as loyal members of such an exclusive and sophisticated club.

For instance, at the High-level Dialogue on Financing for Developing at the United Nations, New York, October 2007, I questioned bank regulations coming out of Basel, based on the fact that developing countries cannot afford to have regulations that block them from the risk-taking needed in order to develop. And nowhere did I see India or any other developing country lending support to my arguments.

Of course I agree with Rajan supporting the request to increase the capital of the International Bank for Reconstruction and Development, but, for India, and for the financial resources India could mobilize for its development, he has much more important thinks to do.

He could request from the World Bank, as the world’s premier development bank, a clear opinion of how regulatory risk aversion, as currently expressed in risk weighted capital requirements for banks, harmonizes with the needs of developing countries… and even with the needs of developed countries, who also need economies moving forward in order not to stall and fall.

The World Bank has previously expressed some concerns. In its Global Development Finance 2003, in relation to the minimum capital requirements of the Basel II proposals, it stated that these “include the likelihood of increased costs of capital to emerging market economies; and an “unleveling” of the playing fields for domestic banking in favor of international banks active in developing countries”. But why has WB kept silence on it thereafter?

Raghuram Rajan, those risk weighted capital requirements odiously discriminate against the possibilities of “The Risky” to access bank credit in a fair way and, expressed in terms of trade, are just vulgar tariffs distorting the allocation of capital around the world… especially in the emerging and development countries. Do something about that! For a start don’t follow the Basel Committee; it has in fact no idea about what it is doing.

It has deemed the risky SMEs and entrepreneurs, those risky tough ones we must need to get going when the going gets tough, to be the untouchables of the banking sector.

PS. The document I presented at the UN was also published in “The Icfai University Journal of Banking Law” of India in October 2008.

@PerKurowski ©  J

Here are two recommendations to Raghuram Rajan on how to get India’s banks to become functional banks

Sir, I refer to David Keohane’s and James Crabtree’s “India’s central bank struggles to ensure lenders pass on interest rate cuts” April 22.

There are references to a “broken down process of monetary transmission through which the wishes of the central bank are transmitted to the real economy”, and to “a banking system frozen by high rates of bad loans”.

The following is what I would advice Raghuram Rajan to do, if he really wanted banks to become functional financing efficiently the real economy.

First, get rid of stupid Basel bank regulations that, with their different equity requirements based on credit risks, so distort the allocation of bank credit. These introduce a regulatory risk-aversion that has no place anywhere, but much less in a developing country, since risk-taking is the oxygen of any development. In its place put for instance an 8 percent equity requirement on all bank assets, and throw out forever, the portfolio invariant credit-risk equity requirements. Of course that could create a big need for fresh bank equity, and so…

Second, in order to take away the dead weight caused by the bad loans, and to help to fill any new bank equity needs, the central banks should proceed like Chile did during its financial crisis. Namely capitalizing all the banks by purchasing their non-performing loans, against the commitment by the banks to repurchase these assets from the central bank with their retained earnings, before any substantial dividend payments to their shareholders could be made.

You would then have well capitalized banks, ready to give credit on non distorted terms to for instance “risky” SMEs and entrepreneurs, and simultaneously been made so much safer that, presumably, they would have to pay less interest rates to depositors, and in the medium or long terms less dividends to shareholders. Not bad for a couple of hours work eh?

@PerKurowski

Friend-of-the-bank’s-owner ratings would be more useful than credit ratings when setting capital requirements for some banks.

Sir I refer to James Crabtree´s lunch with Raghuram Rajan, “Everyone expects you to be a prophet” August 16.

In his famous speech at Jackson Hole 2005 Raghuram Rajan said: “Something as intimate as credit risk is now being traded with strangers. In fact the same way as parent are asked ‘Do you know where your children are?’, bankers nowadays are asked ‘Do you know where your risks are held’”?

That was a somewhat incomplete observation because just as many parents would have answered “with their nannies”, bankers would then need to answer “in the hands of very few human fallible credit rating agencies”, because that was what Basel II approved in June 2004, instructed banks to do.

And of course, as was doomed to happen (see my letter in FT January 2003), soon thereafter some AAA ratings awarded to some securities guaranteed with mortgages to the subprime sector, became the nail in the coffer of those financial markets which even Rajan at that time called to be “in extremely healthy shape”.

And Rajan also concluded his speech admonishing regulators to allow “markets to signal the winners and losers” without reflecting that when it comes to the allocation of bank credit the risk-weighted capital requirements for banks are precisely distorting those market signals.

And I say all this because when now Rajan is quoted saying “Central bankers have had enormous responsibilities thrust on them to compensate, essentially for the failings of the political system”, he and we should not forget that central bankers, in their close nexus to bank regulations, also hold enormous responsibilities for the current failings of the banking system.

But I also say this because when I read Rajan complaining about “Many businesses groups treat public sector banks as their equity kitty”, and which of course is the same as the problem of private owners of banks also treating these as their equity kitty, it occurred to me that friends-of-the-bank’s-owner ratings could prove to be more useful than credit ratings when setting the banks´ capital requirements.

PS. Afterthought. Should not owner-controlled-banks and management-controlled-banks merit different regulations?

The west also depends on restoring the equal access to bank credit opportunities.

Sir, Raghuram Rajan holds that “The west’s legitimacy rests on restoring opportunity” October 18. He is correct, but he ignores what in my concept is one of the greatest opportunity killers ever. 

Bank regulators decided, I guess basically on their own, to give the banks incentives to lend more and cheaper to those ex-ante perceived as The Infallible, and make it harder and more expensive for “The risky”, the small businesses and entrepreneurs, to access bank credit. 

And, doing so, they were not only immorally negating the latter equal opportunities, but, worse, they were simultaneously condemning our own economy to turn flabby and fall. 

If regulators are so scared they cannot visualize banks taking the quite manageable risks on “The Risky” our economy needs… why do they not commit hara-kiri on their own, and leave us alone? 

What the regulators have done, and are still doing, is only making our banks build up unmanageable and very unproductive risks on “The Infallible”… including of course on the “infallible” sovereigns.

We do not need bold stability, we need bold risk-taking!

Sir, Barry Eichengreen and Raghuram Rajan in “Central banks need a bigger and bolder new mandate” October 25, write “Financial stability must become an explicit objective of central banks, along with price stability” and I just must ask… what is so bold about that? 

The authors also opine the world has been rethinking bank regulations to make economies more stable and that has clearly not been the case. Basel III like Basel II is built upon the pillar of capital requirements for banks that discriminate based on ex-ante perceived risk and it was precisely that which caused this crisis by means of giving the banks those fabulous incentives that led to the buildup of so dangerous excessive exposures to what was ex-ante perceived as not risky. 

No what we need is bold rethinking which starts by asking Central banks and bank regulators to dare to tell us what they believe the purpose of our banks is… since nowhere is that to be found. 

The Western World became what it is based a lot on the willingness of banks to take risks… and especially when the going gets to be risky as now and we need our risk-takers, like small businesses or entrepreneurs to get going, we cannot allow some nannies to turn our banks into veritable wimps in the name of some misunderstood quest for stability.

The IMF and the World Bank did not listen then… and, unfortunately, they still do not listen enough

Sir Alan Beattie in “Watchdog says IMF missed crisis risks” February 10 makes reference to ignored warnings such as those delivered in 2005 by Raghuram Rajan, the then chief economist of the fund, and which mentioned the threat of widespread financial instability.

Mr Rajan was far from being alone in that. I myself, as an Executive Director of the World Bank, in a formal statement at the Board in 2004 said: “We believe that much of the world’s financial markets are currently being dangerously overstretched through an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions.”

No one wanted to listen then… the real problem though is that most still don’t. (And this would include also FT)

The baby-boomers called out “Stop the World, until we get off”… too early.

Sir Martin Wolf painting the horrifying dimensions of the crisis that still lay ahead of us references a paper from 2005 by Raghuram Rajan titled “Has financial development made the world riskier?” “Three years on, fault line threaten the world economy.” July 14.

Though that paper is indeed excellent, especially when treating the subject of how bankers could or would respond erroneously to remuneration incentives, it does not really touch on the even more important issue of the very wrong turn taken at a regulatory crossroad which got us here.

When bank regulators in the early 90’s decided to impose a system of handicap weights based on the perceived risk of default, they basically ordered the world to a halt... “Let us not risk what we got!” Everything big and already established and which therefore already had better access to credit was given an additional boost from causing lower capital requirements for the banks, while anything small and new and which therefore already had more difficulties in getting bank credit, got even more restrained by causing higher capital requirements in relative terms.

Basel II, in 2004, was the ultimate refinement of this “Stop the World, until we get off.” In it, a credit to an unrated client requires the bank to hold 8 percent in capital while any bank operation with an AAA rated client only requires the backing of 1.6 percent.

Unfortunately for the too early out baby-boomers, the finance world immediately went after the extraordinary source of profit that the margin between the official credit rating agency ratings issued and the underlying true reality allowed for. The greater the differences in those margins, like when between AAAs and subprime, the greater the profits. Indeed, one of the much ignored aspects in the current discussions is that an absolute perfect credit rating, leads to no financial intermediation profits at all.

If we are to find ourselves a way of this mess, with or without the baby-boomers, we must understand much better were we come from.

Politicians and regulators are the same… they only look out for their own interests.

Sir Erik Berglof and Raghuram Rajan in “Progress in emerging markets is being put at risk” July 18, and as a result of the current crisis that gives oxygen to populism, say that “Many of the actions against the financial sector are proposed in the name of the poor, even though the true beneficiaries are the politicians themselves. Absolutely true, but just in the same vein it can be said that most of the current bank regulations are exclusively the result of regulators only wanting to avoid a crisis on their watch, selfishly not caring a jota about the true development needs of the poor and the not so poor.

The pastor risk is the risk that investors just share into blissful ignorance.

Sir, Wolfgang Münchau is correct when saying “A risk shared may be more risky, not less”, April 23. As arguments he presents, first the deceased US economist Hyman Minsky’s general pessimism (or may we dare say realism) that instability is an inherent part of the system, and then Raghuram Rajan’s, former director of research at IMF, who argues along the line that the investor’s increased willingness to invest in “tail risk” and their “herd” mentality could lead to a catastrophic meltdown.

I myself have been writing and warning on these specific issues for a long time, though mostly on the risk present in assigning too much market decision power to very few credit rating agencies and which introduces not a herd but a “systemic pastor” risk.

For instance in the ongoing subprime mortgages debacle, the distance between the borrower and the final lender increased too much, just because everyone counted on others to be able to provide sufficient oversight. When we now start seeing how credit rating agencies rated without even sending a team to walk the streets in order to sample how those subprime mortgages originated, we should be able to conclude that the investors besides sharing risks, were also sharing blissful ignorance.