“Relax” or “tighten” has little to do with better regulation of US’s banks. Revise, correct and simplify, is what it should all be about.

Sir, I refer to Hal Scott’s and Lisa Donner’s discussion “Head to head: Should the US relax regulation on its big banks?” March 2.

Hal Scott writes: “There is empirical evidence that higher bank capital requirements cut lending and economic growth. A recent Fed paper concludes that a 1 percentage point rise in capital ratios could reduce the level of long-run gross domestic product growth by 7.4 basis points.”

And Lisa Donner writes: “Increased capital requirements lower the return on equity and, by extension, the bonuses linked to it. The desire of a small number of very wealthy people to become still richer should not drive public policy.”

They both, obviously each one from to the point of view of their respective agendas are correct in recognizing that capital requirements have clear effects. But then, as is unfortunately the current norm, they both ignore the problem of the distortions in the allocation of credit that different capital requirements produce.

And, if there is any problem in current bank regulations that needs to be tackled, that is getting rid of those distortions. If there is one analysis needed that is whether the bank’s balance sheets correspond with the best interests of our economies. The answer would be “NO!”

Scott asks: “Do we really want banks to hold enough capital to survive events that have no US historical precedent? If such an extreme economic event did occur, would any amount of capital be enough to withstand the panic it could trigger?”

Ok, agree, but then why should we want our banks to keep especially little capital when such events occur? Like when 20% risk weighted AAA rated securities exploded?

Scott, mentioning stress tests that depend on secret government financial models to predict bank losses argues: “avoid ‘model monoculture’ in which every bank adapts its holdings in order to pass the tests and they all end up holding assets the government model favors. A diversity of bank strategies is preferable given that risks are hard to predict.”

Absolutely and that is why, April 2003, as an Executive Director of the World Bank I held "A mixture of thousand solutions, many of them inadequate, may lead to a flexible world that can bend with the storms. A world obsessed with Best Practices may calcify its structure and break with any small wind."

The stress tests, by focusing too much on the risk flavor of the day, as I have written to you before, are in themselves huge sources of systemic risk.

Scott informs “The living wills process requires banks with more than $50bn in assets to hold minimum amounts of “safe” assets; currently this stockpile totals more than $4tn in government debt”

Holy moly, $4tn is close to 20% of all US public debt. Is there really no interest for trying to figure out where real rates on US government debt would be if banks were not given the 0% risk-weight incentives for these debts, or, alternatively, be forced by statist regulators to hold lots of it?

Donner argues: “There is no fundamental trade-off between sound regulation of the financial system and shared prosperity. Quite the opposite. Even as tighter bank capital and liquidity requirements were phased in after the crisis, bank credit to the private sector has surged to new heights as a percentage of global output.”

But really, is that credit surge an efficient one? Are banks financing enough the “riskier” future, or are they mostly writing reverse mortgages on our “safer” present economy? 

Sir, what kind of crazy model could hold that economic growth is the result of banks being able to earn their highest risk adjusted return on equity on what is perceived, decreed or concocted as “safe”, and so avoid lending to “risky” entrepreneurs? 

@PerKurowski

Would adequate SIFIs’ designations have helped to avert the last crisis? Of course not!

Sir, I refer to Patrick Jenkin’s “MetLife ruling poses threat to drive towards global financial stability” April 5.

Jenkin sounds very much upset: “This is absurd. The FSOC — with its expert mandate and responsibility for “identifying risks and responding to emerging threats to financial stability” — is being torpedoed by an inexpert judge.”

Sir, you know I hold that the regulator, the Basel Committee and friends, was the real responsible for the crisis that errupted in 2007-08. Its risk weighted capital requirements for banks distorted the allocation of bank credit to the real economy, and allowed banks to leverage absurdly much on assets deemed, decreed or concocted as safe… and all this when history clearly shows that “safe” assets is precisely the stuff that big bank crises are made of.

Had the oversized exposures to AAA rated securities and sovereigns to Greece anything to do with what the regulators now tries to catch with their SIFI methodology? No is the simple answer.

In fact working on how to manage SIFI’s, keeps regulators from working on mending their own mistakes. And frankly I see no reason for Jenkins to deposit so much naïve faith in the expertise of FSOC or FSB or any other member of the regulatory logia.

He writes “The time may have come for the G20 to give the FSB proper statutory powers to ensure shortsighted political interests do not put the world on the road to financial ruin once more”

He should know that there is nothing as shortsighted as the risk weighted capital requirements. These have stopped the banks from financing the risky future and have them only refinancing the, for the very short term, safer past.

If anything Sir, I would wish for that “inexpert judge” to also look into whether the unauthorized discrimination against the access to bank credit of the “risky”, which is imbedded in that regulation, should really be allowed in the Home of the Brave.

It is high time the world starts to reflect on whether it really wants to allow an Ultra Important Regulator to introduce, as it wishes and thinks fit, dangerous systemic risks into the banking system.

The absolute minimum we must ask for is for the regulator to first give us its working definition of what is the purpose of our banks, so to see if we agree.

“A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926

@PerKurowski ©

Rules that make all banks behave the same can pose greater systemic risks than all SIFIs put together.

Sir, I refer to Brooke Masters article on “systemically important financial institution whose failure could destabilise the economy” “MetLife’s court win means US regulators should redraft rules” Saturday 2.

Before regulating or redrafting anything, regulators should at least come to understand that their own rules might be the source of the most dangerous systemic risks.

In 2001, in an OpEd I wrote the following onbank regulations:

“The regulatory risk: Before there were many countries and many ways of how to regulate banks. Today, with Basel proudly issuing rules that should apply worldwide, the effects of any mistake could be truly explosive. 

Excessive similarity: Encouraging banks to adopt common rules and standards, is to ignore the differences between economies, so some countries end up with inadequate banking systems not tailored to their needs. Certainly, regulations whose main objective appears to be only to preserve bank capital, conflict directly with other banking functions, such as promoting economic growth, and democratize access to capital. 

Low diversity of criteria: A smaller number of participants, less diversity of opinion and, with it, increased risk of misconceptions prevailing. Whoever doubts that, should read the dimensional analysis that ratings agencies publish. 

Backlash: The development of decision-making processes has benefits but also risks. Thus we see that the speed of information itself, which promotes quick and immediate response, can exacerbate problems. Before, those who took the problem home to study it, and those who simply found out late, provided the market a damper, which often might have saved it from hurried and ill-conceived reactions.”

And already in 1999 in another OpEd I had written: “The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause its collapse”

And then Basel II’s 20 percent risk weight for AAA rated securities, caused the financial crisis 2007-08; while Basel I’s zero riskweight assigned to sovereigns, doomed sovereigns like Greece.

Of course there is a need to think about the systemic risk of SIFIs, but even more important, is looking to minimize the systemic risks of bank regulations… or at least to recognize their existence.

A million of individual small banks can easily be turned into a very dangerous Systemic Overall Important Banking System, by just some rules drafted by some members of that mutual admiration club known as the Basel Committee for Banking Supervision.

@PerKurowski ©

Real stress tests on banks are not performed, since these would evidence the failure of regulations.

Sir, Gillian Tett writes “One reason the banks got into such trouble before 2007 was that they had all learnt to game the regulatory system in a similar way”, “Stress tests are predictable act of public theatre” Marc 6.

That’s not so. There was no reason to game regulations that explicitly allowed banks to hold little or no equity against exposures to sovereigns (like Greece), exposures to AAA rated (like the securities collateralized with mortgages to the subprime sector) or to real estate (Spain).

But the current stress tests are indeed useless spectacles.

Societies give their banks a lot of supports. And obviously that is not only so that banks will repay deposits, since for that a storage center for matrasses containing cash would be more efficient. We support banks because, one way or another, we expect banks to support our economies. And so in this respect any real stress test would have to analyze whether banks were performing and under stress would be able to perform with what is expected of them… like continuously giving small businesses and entrepreneurs, reasonable fair access to bank credit.

Those real stress tests are not performed because they simply would put in evidence the total failure of current bank regulations. If banks are not performing now... how on earth will they perform if subjected to stress?

PS. Gillian Tett mentions that “the same consultants, now offering advice about stress tests”, aided banks gaming before 2007. If so, those consultants, who should be named, do represent a systemic risk, the Systemic Important Consulting Groups. Those SICGs and might be even more part of the Systemic Important Financial Institutions, the SIFIs than anyone of the Too-Big-To-Fail banks.

Systemic distortion of bank credit allocation, is worse than risks with “global systemically important banks”

In November 1999 I concluded and Op-Ed with: “Currently market forces favors the larger the entity is, be it banks, law firms, auditing firms, brokers, etc. Perhaps one of the things that the authorities could do, in order to diversify risks, is to create a tax on size.”

And in May 2003, then as an Executive Director of the World Bank, addressing many regulators at a workshop, I argued: “Knowing that ‘the larger they are, the harder they fall’, if I were regulator, I would be thinking about a progressive tax on size.”

And so Sir, of course I agree with John Gapper in that “Regulators are right to cut the biggest banks down to size” January 8.

But that said, why is it that even though Gapper clearly understand the meaning (and cost) of higher capital requirements for banks, he seemingly cannot understand what different capital requirements for different bank borrowers mean.

The “risky”, because their borrowings generate higher capital requirements for banks than the “safe”, are being negated fair access to bank credit.

More important than increasing the capital requirements for those banks like JPMorgan that because of their size pose a “global” systemic risk, it is much more important to get rid of the risk–weighted capital requirements which constitute, not just a risk, but an existent systemic distortion that impedes the efficient allocation of bank credit.

Why do so many care so much more about the risks banks should avoid, than about the risks they should take?

Sir, Martin Arnold in reference to Mark Carney’s, the head of the Financial Stability Board proposal for systemically important banks to hold more equity writes “Carney’s ‘too big to fail’ buffer represents clear progress despite doubt”, December 9.

And therein Arnold describes the proposed total-loss-absorbing capacity (TLAC) to be worth between a fifth and a quarter of risk-weighted assets.

That could mean that a bank would need to hold 25 percent in loss absorbing capacity against assets risk-weighted 100%, like loans to small businesses and entrepreneurs, while at the same time only be required to hold between 0 and 5 percent of that same sort of TLAC back up, against assets risk-weighted 0 to 20 percent, like the infallible sovereigns and the AAAristocracy.

Does Arnold really think that increased distortion in the allocation of bank credit signifies any sort of progress? He’s got to be joking... or he signs up wholeheartedly on the après nous le deluge that spoils the future of our children.

Arnold also concludes in that “it is only when the next financial crisis hits that we will find out whether Carney really has consigned taxpayer bailouts of banks to history books.” Is he aware that the taxpayers who are most going to pay for the current crisis will be our children and not we the parents... and they will have to pay those taxes mostly for nothing?

As a central banker Mark Carney might be great, but, as a bank regulator, like the rest of that bunch, he stinks.

Sir, I do not opine on Mark Carney´s qualifications as a traditional central banker, these are probably fabulous, but, as a bank regulator, like Mario Draghi, Lord Turner, Michel Barnier, the Americans and the rest of the current bunch, he is not qualified.

Anyone who does not understand that lower capital requirements for banks on assets perceived as “The Infallible” than on assets perceived as “The Risky”, artificially elevates bank returns for the first and makes the other uninteresting, cannot be a good bank regulator… and this is simply so because a good bank regulator also thinks about the purpose of a bank, primarily that of allocating efficiently resources in the economy.

To me all current regulators are also non-transparent statists, since only statists could think of requiring a bank to have some capital when lending to “The Risky”, like the small businesses and entrepreneurs, while allowing the banks to get away with zero or very little capital when lending to “The Infallible”, like to “infallible” sovereigns, and to their courtiers, the triple-A rated.

Well, the result of all their badly concocted risk-adverse regulations, Basel I, II, and III, will be that we are all going to see our banks and our savings drown into oceans of absolutely worthless “absolutely safe assets”; and only then will the regulators perhaps remember that the actions of “The Risky” are in fact through history those that most have contributed to our economic well being.

That they´ve learned their lesson? Forget it! Basel III only doubles down on their mistake. Now on top of capital requirements based on perceived risk, we are also going to have liquidity requirements based on perceived risk; and the too big to fail their regulations helped to grow, have now been promoted into "Systemic Important Financial Institutions", leaving the rest of the banks in the unimportant segment.

I assure you that history will not be kind on these regulators (nor on their collaborators)

PS. This mostly references Brooke Masters´ and Claire Jones´ “Outspoken and innovative, Carney enjoyed a good crisis” November 28.

Pray for some shadows sufficiently dark for some banks to escape the regulators... Caveat emptor, regulators regulating!

Sir when reading Brooke Masters report on “Regulators to tackle shadow banking”, November 19, and given the regulators doing that are the same old failed regulators, I can only fret for the future of whatever they identify as “shadow banking”.

If the regulators keep acting according to their so mistaken paradigm of weighting anything for perceived risks, even if those risks have already been weighted for, then they are dooming the shadow banks, like the surface banks, to create dangerously excessive exposures to what becomes officially considered as “The Infallible”… just like those exposures created in AAA rated securities back with lousily awarded mortgages to the subprime sector, loans sovereigns like Greece, or real estate financing in Spain.

And in that case, let us pray there will still be some banks hidden away in sufficiently dark shadows so that “The Risky”, like our small businesses and entrepreneurs, can at least have some access to bank credit… even if on the unnecessary expensive terms that the regulators’ dumb and useless risk-aversion has created. 

Lord Turner magnanimously admits that “Shadow banking is like cholesterol. There is good and there is bad”, but says “now we’ve got the really difficult job of getting national authorities to dive in and determine [which part of shadow banking] really worries us.” And that should worry us… because that sounds just like when the regulators discovered the too-big-to-fail banks they helped create, they just proceeded to make it worse by naming these Systemic Important Financial Institutions, SIFIs, and thereby relegating the rest into being systemic unimportant financial institutions. 

When will the regulators understand how much they distort all, when just distorting some? Why do they not just loudly proclaim that caveat emptor rules the shadows? Or perhaps we must: “Caveat emptor, regulators regulating!”

Before going after the titans of Wall Street, we need to go after the petit bureaucrats of bank regulations

Sir, John Kay ends an article that includes many truths about bank regulations with “the only sustainable answer to the issue of systemically important financial institutions is to limit the domain of systemic importance. Until politicians are prepared to face down Wall Street titans on that issue, regulatory reform will not be serious.” “Take on Wall Street titans if you want reforms” September 19. 

Yes, but, the systemically important financial institutions grew to be systemically important institutions, much with the help of bank regulators who, I do not really know with what authority, decided that banks could hold many assets against little or no capital, as long as these assets were perceived as “not-risky”. 

Had for instance Basel II decided that banks would need 8 percent of capital for any asset it held, we might still have systemically important financial institutions, but their systemic importance would be just a fraction of their current. 

And since there has been about five years since the crisis began, and current bank regulators have still not admitted the simple truth that their capital requirements based on perceived risk distort the markets, before we hit the titans of Wall Street down, we have to hit the petit bureaucrats of bank regulations who believe themselves titans in risk management down. 

John Kay also wrote that any capital target “will be gamed by those who observed the letter rather than its spirit”. Yes that is true, that is a fact of life, but, let us at least not have petit regulators also trying to simultaneously game the markets with their silly risk-adverse risk-weights. 

Frankly, who authorized bank regulators to do to our banks what they did?

Control the regulators, do not let them sell “Too big to fail” franchises for a meager 3 percent of additional bank equity.

John Authers writes that “Self-control is the key to an investors life” June 11. He is right but the self-control that we all need and should be able to expect is that of the regulators.

The regulator, even though one of the markets most dangerous sources of imperfection could be the banks trusting the credit rating too much, were not able to control themselves and intervened as risk managers making the capital requirements of the banks a function of the same credit ratings the banks were already looking at. And what disaster that resulted in.

And now, displaying again a total lack of self-control, they want to sell “too big to fail” franchises to (SIFIs/G-SIFIs) banks for a mere 3 percent in additional capital. Not only will 3 percent of additional bank capital end up being almost meaningless in the case of a systemic explosion or implosion of these huge banks, but it is also probable that precisely those too big to fail banks that we least should want to be too big to fail, will be those most likely to exploit the franchise for all it is worth, in order to compensate the additional equity required, in the ways we would least like to see these franchises exploited. 

Of course regulators will argue these franchises will be the subject of special supervision. Who are they fooling? Is it not hard enough for them to supervise these behemoths without labeling them as the most likely candidates for special support?