We might need to parade current bank regulators down our avenues wearing cones of shame.

Sir, Patrick Jenkins writes: “Bill Coen, secretary-general of the Basel Committee on Banking Supervision… said auditors should be given responsibility for checking banks’ calculations [so as to have] another line of defence to ensure assets are [given] the proper risk weighting”, “Metro Bank sparks call for external checks on loan risks” February 4.

I totally disagree, auditors look at ex post realities, on what banks have already incorporated into their balance sheets, What most matters are the ex ante perceptions of risk. 

Jenkins opines here “The error at Metro was to put some loans into standard risk-weighting buckets, determined by the UK regulator”. Sir, I ask, is that not evidence enough that we should get rid of current bank regulators?

If somebody is to blame, that is precisely the Basel Committee who with its risk weighted capital requirements for banks decided that what bankers perceived ex ante perceived as safe, was so much safer to our bank system than what they perceived as risky.

Basel Committee’s Bill Coen should be asked to explain the rationale of a standardized 20% risk weight for what, rated AAA, is dangerous to our bank systems, and 150% for what, rated below BB-, becomes so innocous. 

Jenkins opines: “The error at Metro was to put some loans into standard risk-weighting buckets, determined by the UK regulator”. Sir, I ask, is that not evidence enough that it behooves us to hold our bank regulators very accountable, perhaps even by parading them down our avenues wearing cones of shame? Perhaps hand in hand with those unable or unwilling to question them.

@PerKurowski

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

Bank regulators would do well reading up on Shakespeare (and on conditional probabilities)

Sir, Robin Wigglesworth writing about risk and leverage quotes Shakespeare in Romeo and Juliet, “These violent delights have violent ends”, and argues “It is a phrase investors in the riskier slices of the loans market should bear in mind.” “Investors should beware leveraged loan delights that risk violent ends” August 25.

Sir, we would all have benefitted if our bank regulators had known their Shakespeare better. Then they might have been more careful with falling so head over heels in love with what looks delightfully safe.

The Basel Committee, Basel II, 2004, for their standardized approach risk weights for bank capital requirements, assigned a risk weight of 20% to what was AAA to AA rated, and one of 150% to what is below BB- rated. 

That meant, with a basic requirement of 8%, that banks needed to hold 1.6% in capital against what was AAA to AA rated and 12% against what is rated below BB-.

That meant that banks were allowed to leverage 62.5 times if only a human fallible rating agencies awarded an asset an AAA to AA rating, and only 8.3 times if it had a below BB- rating.

That meant that banks fell for the violent delights of the AAA to AA rated, which of course caused the violent ends we saw in 2007/08.

Sadly, from what it looks like, our current regulators might not have it in them to understand what Shakespeare meant, just as they have no idea about the meaning of conditional probabilities… if they could they might be able to understand that what is ex ante perceived as risky is really not that dangerous.

@PerKurowski

When being rightly suspicious about making algorithms powerful let us not ignore that powerful humans could be very dangerous too.

Sir, Tim Harford, agreeing with Hayek holds “Market forces remain a more powerful computer than anything made of silicon.” “Algorithms of the world, do not unite!” December 2.

But when regulators decided to replace the risk assessments of thousands of individual and diverse bankers, with those produced by some few human fallible credit rating agencies; and then allowed banks to increase their bets on these ratings being correct, for instance with Basel II allowing banks to leverage a mindboggling 62.5 times if only an AAA or an AA rating was present, we would have benefitted immensely from having some algorithms indicate them this was pure folly.

Because, in the development of such algorithms, it would not been acceptable to look solely at the risks of bank assets as such, but would have required to consider the risk those assets posed for the banks.

And as a result the algorithms would not have allowed banks to leverage more with safe assets than with risky, that because only assets perceived as very safe can lead to the build up of such excessive exposures that they could endanger the whole bank system, were the credit ratings to turn out wrong.

“An Explanatory Note on the Basel II IRB (internal ratings-based) Risk Weight Functions” expresses: “The model [is] portfolio invariant and so the capital required for any given loan does only depend on the risk of that loan and must not depend on the portfolio it is added to.”

And the explicit reason given for that inexplicable simplification was: “Taking into account the actual portfolio composition when determining capital for each loan - as is done in more advanced credit portfolio models - would have been a too complex task for most banks and supervisors alike.”

Sir, algorithms are precisely designed to combat such complexities.

Yes, “Facebook and Google have too much power” but so did the regulators; and with their risk weighting of the sovereign with 0% and citizens with 100%, Stalin would have been very proud of them.

@PerKurowski

FT, do you really think bank regulators know what they are doing? Wake up!

Sir, Izabella Kaminska reminds us of “the fact that information is not the same thing as knowledge” “Imperfect information dims the vision of a digital utopia” September 27.

And she refers: “In a new paper, Nobel-winning economist Joseph Stiglitz, building on decades of work on the economics of information, argues that the information paradigm being promoted by technologists could — if left unregulated by government — lead to the sort of market distortions that constrain welfare creation and innovation for the long term.” 

Hold it there! Government regulations can also “lead to the sort of market distortions that constrain welfare creation and innovation for the long term”

Just look at how the regulators imposed risk-weighted capital requirements for banks that completely distorted the allocation of credit to the real economy.

Sir, do you really think bank regulators know what they are doing? Wake up! They have no idea.

Here two questions:

1. What are the risks banks could build up such excessive exposure to the below BB- rated so that, if the ex ante perception of super riskiness turned out ex post even more risky, that could cause a major bank crisis?

2. What are the risks banks could build up such excessive exposures to the AAA rated so that, if the ex ante perception of super safety turned out ex post wrong, that could cause a major bank crisis?

Hint! Mark Twain described a banker as he who wants to lend out the umbrella when the sun shines and wants it back as soon as it looks like it is going to rain.

Ponder now on that our bank regulators, in their own 2004 standardized Basel II risk-weights, assigned to the first possibility a risk weight of 150%, and to the second, one of only 20%.

Meaning that banks, given a basic capital requirements of 8%, when lending to the below BB- rated needed to hold a reasonable12% of capital, while when lending to the AAA rated, they were only required to hold a sliver of 1.6% in capital.

Meaning that banks, when lending to the below BB- rated, could only leverage some reasonable 8.3 times while, when lending to the AAA rated, they were allowed to leverage their capital (equity) a mindboggling 62.5 times.

Sir, do we really deserve such feeble minded regulators? If not, why do you keep supporting these?

@PerKurowski

In terms of creating systemic risks for our banking system, current regulators are the undisputable champions

Sir, former banker and banking lawyer Martin Lowy writes: “Dodd-Frank and Basel III capital rules have made banks and their holding companies stronger.” “How the next financial crisis won’t happen”, June 10

Well I sure know that the next financial crisis will absolutely not be the result of excessive bank exposures to something perceived as risky, as to what is rated below BB-, that to which regulators assigned a risk weight of 150%. Much more likely it will be from excessive exposures to something rated as safe as AAA, that to which regulators only assigned a meager 20% risk weight.

Really big bank crises, except from really extraordinary unexpected events, are the result of the introduction of something that can grow into a systemic risk.

What systemic risk do I see?

I see credit ratings, like when in 2003 in a letter published by FT I wrote: “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds. Friends, please consider that the world is tough enough as it is”

I see risk weighted capital requirements, like those that allow banks to leverage more with what is “safe” than with what is “risky”., and therefore distorts, for no good reason, the allocation of bank credit to the real economy.

I see standardized risk weights that impose a single set of weights on too many.

I see regulators wanting to assure that banks all apply similar approved risk models, thereby again ignoring the benefits of diversification.

I see stress tests by which regulators make banks test against the some few same stresses, as if real stresses could be so easily identified.

I see living wills, as perfectly capable to create systemic risks that at this moment are hard to see.

In all, in terms of creating dangerous systemic risks, hubris filled bank regulators aee the undisputable champions.

The main cause for that is that our bank regulators find it more glamorous to concern themselves with trying to be better bankers, than with being better regulators.

Regulators, let the banks be banks, perceive the risks and manage the risks. The faster a bank fails if its bankers cannot be good bankers, the better for all.

Your responsibility is solely related to what to do when banks fail to be good banks.

And always remember these two rules of thumb:

1. The safer something is perceived to be, the more dangerous to the system it gets; and the riskier it is perceived, the less dangerous for the system it becomes.

2. All good risk management must begin by clearly identifying what risk can we not afford not to take. In banking the risk banks take when allocating credit to the real economy is precisely that kind of risks we cannot afford them not to take.

As in 1997 I wrote in my very first Op-Ed. “If we insist in maintaining a firm defeatist attitude which definitely does not represent a vision of growth for the future, we will most likely end up with the most reserved and solid banking sector in the world, adequately dressed in very conservative business suits, but presiding over the funeral of the economy. I would much prefer their putting on some blue jeans and trying to get the economy moving.”

@PerKurowski

Using Basel Committee’s standardized risk weights could also be worse than using banks' internal risk models.

Sir I refer to Caroline Binham’s, Laura Noonan’s and Jim Brunsden’s “Basel fails to agree key risk measures” December 1.

Currently: The lower the risk - the lower the capital requirement - the higher the leverage - and so the higher the risk adjusted return on equity. Therefore it is clear that, as long as bank shareholders and bank creditors do not own 100% of the skin in the game, you cannot leave it in the hands of banks to use their own internal risk models. The conflict of interest with these is too much to handle for even the most disciplined banker. You would not like your kids to decide the nutritional values of their diets…would you?

But Sir, Basel II’s standardized risk weights makes it clear you can much less place the responsibility in hands of regulators who have no idea about what they are doing. Just an example: for an asset rated AAA to AA they assigned a 20% risk weight, while for what’s rated below BB-, something which would therefore never constitute a major danger for banks, that received a 150% risk weight.

And regulators assigning 0% risk weight to sovereigns, and 100% to We the People, more than regulators, seem to be simple statism activists.

@PerKurowski

Europe, America, G20, don’t walk away from Basel Committee risk weighted bank capital regulations…you’d better run!

Sir, John Dizard writes about a “meeting of the Basel Committee on Banking Supervision on November 28 and 29… is scheduled to agree a “standardised approach for credit risk” and impose limits on the use of internal models. The idea is that banks in the G20 countries, a group of the world’s most powerful economies, will not engage in regulatory arbitrage, or international game playing that results in a lowering of credit standards.” “Basel’s background noise for the next crisis”, FTfm, November 7.

Of course, the Basel Committee should prohibit banks from using their own models to define their own capital requirements; allowing it, is like letting children use their own nutrition models to pick between chocolate cake, ice cream, broccoli or spinach.

But, to impose a regulators’ defined “standardised approach for credit risk”, is just as loony; it suffices to have a look at what the standardized risk weights included in previous Basel Committee regulations.

One example: Basel II, 2004, set the risk weight for an asset rated AAA to AA at 20% while that of an asset rated below BB- was set at 150%. Anyone believing that what is rated as highly speculative, almost bankrupt, below BB-, is more dangerous to the bank system than what is rated AAA to AA, must be smoking some weird stuff.

Sir, unfortunately Dizard, as most of you in FT, shows little understanding for the whole issue when he questions: “under the current version of the Basel “standardised approach”, unsecured lending to a non-public, below investment-grade corporate borrower requires the same bank capital commitment as project financing secured by assets, liens on equity and cash lockbox arrangements. Based on the past low loss rates for project lending, that is between two and three times as much capital as the risk should require.”

If that is so, should not the difference in risk reflect itself sufficiently in the interest rate and the size of exposures? Why should that same perceived risk also have to be reflected in the capital? Does Dizard (or you Sir) not know that any risk, even if perfectly perceived, leads to the wrong decision if excessively considered?

Sir, ask Dizard: “Why should a bank when lending to a below investment-grade corporate borrower have to hold more capital than when lending to “safe” projects? Will not the “risky” corporate anyhow get less credit and pay higher risk premiums than the “safe” project? 

Sir, again, for the umpteenth time, bank capital should not be required to cover for expected risks; it should be there to cover for the unexpected.

Sir, again, for the umpteenth time, the risk weighted capital requirements for banks have introduced absolutely insane distortions in the allocation of credit to the real economy. If Europe, America, G20, or the whole world do not run away from the regulators’ senseless doubling down on ex ante perceived risk, their economies are doomed to stall and fall.

@PerKurowski

Please help save us from regulators applying their standardized risk models to all banks… that would be the end

Sir, Martin Sandbu, in “Free Lunch: The bank, the fox and the henhouse”, June 13, discusses the issue that “Rules for banks’ capital cannot rely on their own models of risk”

Sandbu writes: “non-initiated may be surprised to know that [some] banks were [and are] permitted to decide how risky their assets were — which determines their capital requirements under rules that set safe capital thresholds as ratios of “risk-weighted assets”. To the extent banks perceive capital requirements as a burden, that creates an incentive for them to engineer risk assessments that minimize that burden.”

And so clearly when “The Basel Committee on Banking Supervision, which recommends global standards for national banking authorities, proposes to replace banks’ internal models of riskiness with external standardized models” this sounds very logic to many.

But the non initiated are not aware either of that, with Basel II, the regulators already gave a set of standardized risk weights to be used by all banks deemed not sophisticated (or big enough) to run their own risk models.

And Sir, it behooves us to fully understand what regulators did, before we dare to hand over to them one iota of more power.

Unbelievable, Basel II derived the risk weights, those that determine the capital requirements, from the ex ante perceived risk of the assets per se, and not from the risk these assets can pose to the banks or the bank system.

And therefore we have that assets rated below BB-, speculative and worse, those assets to which banks would never ever create excessive exposures to, got a risk weight of 150%, while assets rated AAA to AA, those to which banks could easily get to be dangerously exposed, these got a risk weight of only 20%.

So Sir, is there any good reason for us to welcome the same regulators to start working on a Basel IV?

As a minimum minimorum, before Basel IV work begins, we must require regulators to clearly specify what is the purpose of the banks, something they never did before they regulated. I say this because with the distortions produced with Basel I, Basel II and Basel III, they clearly evidenced, they do not give a damn about whether banks allocate credit efficiently to the real economy.

The only useful risk model is that which understands that bank capital is to be there against unexpected events, not against expected credit risks. For example, capital could be 8 percent against all assets.

But perhaps banks do need more capital, like 10 percent, because now we also have to guard them against the “unexpected” reality of regulators being capable of such an immense hubris, they can just push on without a clue about what they’re doing.

PS. To top it up... their risk-weights were portfolio invariant

@PerKurowski ©

We must deregulate the risk-taking of banks in order to keep the world’s labor markets busy

Sir, you write “labour markets in advanced economies need liberalization… But policy makers should not expect that supply side reforms will create their own demand. Appropriately easy fiscal and monetary policies must be pursued. The engine of jobs creation needs fuel to work.”, “Keeping the world’s labour markets busy” March 28.

But again, steadfastly, you say nothing about how the fuel of bank credit can create jobs, if allowed to flow freely. Since Basel I, about 25 years ago, bank credit has been instructed to flow to where the risk-weights are low and so the allowed leverages of bank equity are high. That means that the access to bank credit for "the risky", like SMEs and entrepreneurs, has unfairly become more and more difficult. Anyone who believes this does not affect job creation needs to go and have a look at reality.

Let me put it this way. Suppose their had been no Basel Committee credit-risk-weighted equity requirements; and suppose someone, to solve Greece’s problems, now suggested:

“We must increase the equity requirements for banks when lending to SMEs and entrepreneurs because they are too risky and so it is better that banks give loans to the public sector, so that plenty of good paying public sector jobs are created.”

Would you, the Troika or anyone else approve of such a plan? I doubt it. But as this is how it is, why are you silent about that? Is it because it takes less courage to qualify a proposal as idiotic than to qualify something dumb done and on which one kept silence as idiotic?

Things are not getting better… our current regulators clearly do not know what they are doing.

In the Basel Committees’ consultative document “Revisions to the Standardised Approach for credit risk” I was shocked seeing that the risk-weights are now proposed to be smaller the larger the private corporation is… as if the larger you are the safer or the better able to use the credit you are. How on earth do we achieve more jobs and less inequality when being opposed by such regulators?

@PerKurowski

Sources for disappointments are plentiful indeed: Basel III Revisions to the Standardized Approach for Credit Risks

Sir, Wolfgang Münchau certainly sounds disappointed in “Clever wrapping disguises Europe’s worn-out policies” December 29. And so do I feel.

You know I have always objected to that corporates with good credit ratings, who already have better access to bank credit, shall have even more preferential access to it, because of bank regulations. And that because credit ratings can be wrong; and because the risks are especially big when it is good credit ratings that are wrong (AIG); and mostly because doing so distorts the allocation of bank credit in the real economy.

But now we see a new proposal from the Basel Committee, Revisions to the Standardized Approach for Credit Risks, which indicates that, instead of using credit ratings, they want to apply “risk weights, range from 60% to 300%, on the basis of two risk drivers: revenue and leverage”.

And that, calculated for the basic 8% capital requirement of Basel III, translates into 4.8% to 24% capital requirements; which then translates into a range of allowed leverage of bank capital of 19.8 - 3.1 to 1.

And that means than now it would be those corporate who come up as winners on a “look-up-table”, having more revenues and less leverage, which will generate less capital requirements for banks; and therefore allow banks to leverage their capital more when lending to them; and so therefore allow banks to earn higher risk-adjusted returns when lending to them; and therefore have preferential access to bank credit.

And so now I need to rephrase and ask: why on earth shall corporates have more or less access to bank credit based on their revenues and leverage, than what access to bank credit corporates already have based on their revenues and leverage?

FT, explain to me, why do you believe the Basel Committee insists in distorting the allocation of bank credit to the real economy? Is not the health of the real economy what in the long run is the most important factor in achieving bank stability?

And to top it up their document also states: “These alternative risk drivers have been selected on the basis that they should be simple, intuitive, readily available and capable of explaining risk consistently across jurisdictions”… as if that is which is really important when regulating banks.

PS. We have seen some merger activity based on tax considerations. Are we now to see mergers based on the Basel Committee’s “look-up-table” positioning?