It behooves us to stress-test our main bank regulators; the Basel Committee and the Financial Stability Board

Sir, Caroline Binham, Stephen Foley and Madison Marriage report “Systemwide and individual stress-testing of asset managers, as well as examining whether greater disclosure should be made by mutual funds, were among 14 recommendations made by the Basel-based Financial Stability Board to authorities across the G20 nations yesterday” “Stress test asset managers, says FSB” June 23.

Much more important for us is to stress-test bank regulators, to be sure they really know what they’re doing.

Since about two decades I have been asking regulators many questions that have not been answered. And so for a start I would like to ask Mark Carney, the current chair of the FSB; Mario Draghi, the former chair of FSB and the current chair of the Group of Governors and Heads of Supervision of the Basel Committee for Banking Supervision; and Stefan Ingves the current chair of the Basel Committee, the following:

For the purpose of setting the capital requirements for banks, in Basel II you assigned a risk weight of 150 percent to what is rated highly speculative and worse, below BB- but only 20 percent to what is rated AAA to AA.

Gentlemen why did you do that? Major bank crises have never ever resulted from excessive exposures to what is perceived as really risky, but always from what ex ante was perceived as safe but that ex post turned out not to be.

If these regulators are not capable of giving us a credible answer, then I submit they are not capable enough to stress test any bank, asset manager or mutual fund.

And, if they dare answer the first question, then make them explain all this!

@PerKurowski ©

Bank regulators minimizing the social impact of banks more than neutralize the social impact maximizing investors.

Sir, Stephen Foley and Adam Samson quote write about the efforts of Pope Francis to champion ‘impact’ investments, “FT Big Read. Investment: Blessed returns” June 17.

And Pope Francis is quoted with: “It is increasingly intolerable that financial markets are shaping the destiny of peoples rather than serving their needs”. I believe that having a tête-à-tête with the Basel Committee for Banking Supervision, could serve the Pope better than speaking with social impact investors.

The pillar of current regulations, the risk weighted capital requirements for banks, allow banks to earn higher risk adjusted returns on equity, for no other purpose than that to avoid ex ante perceived credit risks. That’s a very a poor objective for those who have a prime responsibility of allocating bank credit efficiently to the economy.

As a result those perceived safe, those who because of that already have plenty and cheaper access to bank credit, now find even more generous terms, while those perceived as risky, like SMEs and entrepreneurs, those who already had less and more expensive access to bank credit, have to fight much harsher conditions.

Clearly that regulation only guarantees to diminish the social impact of bank lending. It is the direct consequence of regulators regulating banks, without defining the purpose of these. That is an unpardonable irresponsibility of them!

Social impact based capital requirements for banks, which would allow banks to earn higher risk adjusted returns on equity when producing a high social impact, could sound as an attractive possibility, but is not free from dangers. To base capital requirements for banks on for instance the GIIN list of 559 metrics, those ranging from ‘greenhouse gas emissions avoided due to products sold’ to the number of suppliers who were minority/female/low income” could be gamed and also distort credit allocation in many other ways.

But, just to require the Basel Committee to answer a question of whether bank credit should not have a social impact, could open up a much-needed discussion on the need of eliminating the current regulatory discrimination based on perceived credit risk.

@PerKurowski ©

Just thinking of all growth opportunities that have irreversibly been lost the last 12 years, makes you want to cry.

Sir, the regulatory credit-risk aversion that is present in the current risk weighted capital requirements for bank started back in 1988 with Basel I, but it really took on huge force with Basel II of June 2004, when even the private sector was split up into different risk baskets.

The risk weighing allowed banks to leverage more with assets perceived, decreed or concocted as safe than with “risky” assets. And so bankers were able to realize their wet dreams of making their largest risk-adjusted returns on equity on the safe, which therefore allowed them to be able to abandon the “risky”

Now, 12 years later, we should cry for all those opportunities of SMEs and entrepreneurs gaining access to credit, and helping move our economies forward, that have irreversibly been lost. Damn the Basel Committee and its regulations! Now our banks do not finance the risky future but only refinance the safer past. Now we are sitting here waiting for the next safe-haven to become dangerously overpopulated.

But what makes me want to cry the most is that the regulatory blocking of initiatives that would be opening up new activities and job opportunities for our youth is not even been discussed.

And to top it up, had all the credit opportunities that would normally have been awarded been awarded, banks would not be any riskier, because lending to the “risky” is not the stuff major bank crises are made off. If you know how connect dots, try doing so between what banks were allowed to hold against little capital, because it was “safe”, and what caused the 2007-08 crisis.

Yes, short-term bank returns on equity, as a consequence of not allowing banks to leverage so much with “safe” assets would have suffered but, long-term, even banks stand to benefit from a strong economy.

Stephen Foley, writing about a conference at the Milken Institute tells of “concerns [about] the US public pension funds… in an era of weaker demand, anaemic business investment and low growth, yet the average fund is still forecasting a 7.6 per cent annual return on investment portfolios, basically the same returns as the past 25 years.” And, as if lack of expertise was the problem: “Vicki Fuller, chief investment officer of the New York State Common Retirement Fund, said public funds tended not to have the expertise to pick good private equity investments.” “Financial elite hum a sunny tune as signs of disruption gather” May 10.

A financial elite that does not understand the destructive distortion in the allocation of bank credit to the real economy the credit risk weighing produces, is sincerely not a financial elite to write home about.

Here a link to an aide memoire about the idiocies of current bank regulation

@PerKurowski ©

Having carbon taxes fund Universal Basic Income schemes would align the fights against inequality and climate change

At least in the 1980s (I do not know of the before and after) high European taxes on gas (petrol) were defended by the need to protect the environment, while at the same time, at least in Germany and Spain, the much dirtier coal was being subsidized. And the resulting tax revenues are of course huge.

Stephen Foley writes about how investors should adapt their exposures to fossil fuels given all declarations of war against climate change. ”Even oil barons are giving up on fossil fuels”, April 4.

But the taxman needs also to adapt. If we consume less gas/petrol tax revenues will go down, so it is not farfetched to think that those hungry for tax revenues to manage, will again exploit the environmental argument to increase taxes… though they must know that puts their tax revenues on a sort of unsustainable path.

I believe though that climate change is best fought on its own merit, which means keeping the climate change profiteers, whether private or governments, at far distance.

In my own country Venezuela, as a tool to get rid of monstrously large gas subsidies, I have been proposing that all the net income the government derives from the domestic sale of gas, should be paid out in equal parts to all citizens, so as to keep the redistribution profiteers at bay.

And if the whole world did the same, using carbon taxes as a fundamental source of income to pay for a Universal Basic Income, that would not only help to increase fiscal transparency, but also beautifully align the fight against inequality with the fight against climate change.

Any regulator that would call what is currently happening an unexpected consequence is clearly not fit to regulate.

Sir, I refer to Stephen Foley’s “BlackRock chief warns ripple effect of strong dollar threatens US growth” April 7.

It states that Larry Fink, CEO of BlackRock “highlights the risk that monetary easing has inflated asset bubbles as investors such as pension funds searching for yield in a low interest environment are pushed into riskier classes”. And it quotes Mr Fink with: “This mix of growing assets and shrinking yields is creating a dangerous imbalance”. I am left wondering whether Mr. Fink really knows what is going on.

Does he know that one reason for why pension funds “are pushed into riskier classes”, is that they are pushed out from the perceived safe havens by bankers pushed into safer classes by their regulators with their silly and dangerous credit risk weighted equity requirements for banks? And that is just going to get worse the tighter bank equity gets to be, and when insurance companies also regulated with Solvency II in a similar way?

Indeed, “monetary policy seem insufficiently attuned to the conundrums their actions are creating for investors” But regulators are equally attuned to the conundrums their actions are creating for the fair access to bank credit of “the risky”, like for all the SMEs and entrepreneurs we need to get going when the going is tough.

And regulators please do not call all this an unexpected consequence. If you do it just evidences even more that you are definitely not fit to regulate.

@PerKurowski

Banks should pay all fines by issuing voting shares.

Sir, I refer to Kara Scannells’and Stephen Foley’s “Credit Suisse to pay $2.6bn in tax case” May 20 and to all other reports about bank fines.

All these fines go against bank’s capital accounts, and will therefore, because of bank capital requirements, cut down on the credits a bank can give.

And that hurts mostly the innocent… those who will now not get a credit because the bank does not have the shareholders’ equity to back it up with.

The only way out of it is to force all bank fines to be paid by the issuance of bank voting shares, at their current market value, for an amount equivalent to the fine.

To do elsewise is, as I see it, only statist sadism.

Our finance markets should not be regulated with a pro-statist ideology bias... that’s too dangerous.

Sir, Stephen Foley writes that “New [US money market fund industry] rules look set to reduce short-term borrowing costs for the US Treasury, at the expense of higher interest charges for corporate borrowers”, “Fund industry reform is a win for Uncle Sam”, May 6.

Foley should reflect on that in fact all regulations during the last decades have been a win for governments and a loss for citizens. In November 2004 in a letter that FT published (before I was send to Siberia) I wrote “Our bank supervisors in Basel are unwittingly controlling the capital flows in the world. How many Basel propositions will it take before they start realizing the damage they are doing by favoring so much bank lending to the public sector (sovereigns)? In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits.”

Just this week, during a conference at the Brooking Institute, I asked again, for the umpteenth time, whether higher capital requirements for banks when lending to businesses than when lending to sovereigns did not distort the allocation of bank credit. Mr. Jörg Decressin, the deputy director in the IMF’s European Department, the former deputy director in charge of IMF’s Research Department, gave me a surprisingly honest answer. Here follows its short version.

“Do you believe that governments have a stabilizing function in the economy? Do you believe that government is fundamentally something good to have around? If that is what you believe then it does not make sense necessarily to ask for capital requirements on purchases of government debt…

If on the other hand your view is that the government is the problem then you would want a capital requirement, so it depends on where you stand [ideologically]”

What a mess! Who authorize the regulators to regulate the finance sector applying their ideology? It is not a question whether the public or the private, it is a question of an adequate equilibrium between those two, and that has obviously been broken, to everyone’s peril.

And citizens could sue agencies for too good credit ratings of sovereigns, which caused governments to borrow too much.

Sir, I refer to Stephen Foley’s and Guy Dinmore’s “Italy eyes €234bn suit after ratings groups failed to value la dolce vita” February 5. It reminded me of an Op-Ed of September 2002 titled “The riskiness of country risk”.

In it I wrote: “What a nightmare it must be to be risk evaluator! Imagine trying to get some shuteye while lying awake in bed thinking that any moment one of those judges, those with the global reach that have a say in anything and everything, determinates that a country has become essentially bankrupt due to your mistake, and then drags you kicking and screaming before an International Court, accused of violating human rights.

What a difficult job to be a rater of sovereign creditworthiness! If they overdo it and underestimate the risk of a given country, the latter will most assuredly be inundated with fresh loans and will be leveraged to the hilt. The result will be a serious wave of adjustments sometime down the line. If on the contrary, they exaggerate the country’s risk level, it can only result in a reduction in the market value of the national debt, increasing interest expense and making access to international financial markets difficult. Any which way, either extreme will cause hunger and human misery.”

And so what’s more to say. If the Italian Government sues the credit rating agencies for having given Italy too bad ratings, an Italian citizen might equally sue these for having given Italy too good ratings

And after that, what about suing the regulator who with their risk-weighted capital requirements for banks multiplied immensely any signal emitted by the credit ratings?

FT, you must stop pardoning the hubris of Basel bank regulators, and feeding false illusions about credit ratings

Sir, Stephen Foley in “Outlook unchanged” January 15 writes: “Rating agencies’ outsized role in the credit crisis is well known. By validating the transformation of subprime mortgages into triple A-rated securities, based on mistaken assumptions about the US housing market, they contributed to the infection of the global financial system.” 

Indeed, but the only reason why the credit rating agencies detonated the crisis, was the “outsized role” loony bank regulators assigned them, when with their Basel II they allowed banks to hold only 1.6 percent in capital, meaning a mindboggling authorized bank leverage of 62.5 times to 1, only because a human fallible rating agencies deemed a security to be of AAA quality. 

That, as I have so many time explained to you increased the demand for these securities so dramatically that the market, as usually happens, when it ran out of well awarded mortgages, produced bad ones which ended up in some AAA Potemkin rated securities. 

I dare you to answer: When has a bank or a bank regulator most problems, when a bad rating turns out to be correct, or when a good ex-ante rating ex post ends up being incorrect? It is clearly the second. And so explain to me why you think we should allow our regulators to bet our whole bank system on the credit ratings to be correct? 

In January 2003 in FT you published a letter I wrote and where I said “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds”. 

Sincerely, FT, should be ashamed of yourself feeding the illusion that if we can only get the credit ratings agencies to be better at what they do, then our banks can bet their (and ours) last shirt on the credit ratings. 

Foley also writes “attempts to strip credit ratings of their central role in financial regulation are proving complicated”. But that is only so because regulators foolishly hang on to the idea that, by means of capital requirements for banks based on perceived risk, they can play risk managers to the world. I swear to you, the world cannot afford such hubris. 

Also, again, for the umpteenth time, FT, if banks clear for the information provided in credit ratings by means of interest rate, size of exposure and other terms… why the hell should they clear for that same information in the capital requirements too?