Why is it so hard to understand that risks should not only be correctly perceived but also correctly considered?

Sir, Patrick Jenkins, discussing the Basel Committee’s push “to finalise another leg of post-crisis global financial reform” writes that “financial and economic stability is more important than a blinkered crackdown.”, “Basel Committee boss needs to reconsider hard line on reform” October 18.

What? “financial AND economic stability”? That’s a new one. Until now it has only been financial stability, which is why regulators (and journalists) have not cared to analyze how much current bank regulations distort the allocation of credit to the real economy. For instance Stefan Ingves, the chair of the Swedish Riksbank and of the Basel Committee, seems not to understand at all that the so much lower risk weight assigned to financing houses (35% in Basel II), when compared to the risk weight when financing SMEs (100%), has something to do with prices of houses going up and up, and the credits to SMEs going down and down.

Jenkins, on the possibility of part of the capital requirements to be based on the conduct of the banks, like misdeeds, argues: “The logic is flawed”, since “basing future capital demands on past fines duplicates the impact of a penalty”.

Indeed, but why Sir is it so hard for Jenkins, for the Basel Committee, for you and for all other in FT to understand that, basing capital requirements on ex ante perceived credit risks already cleared for by banks with interest rates and size of exposures, also “duplicates the impact” of perceived credit risks?

Is it really so hard to understand that any risk, even if perfectly perceived, causes faulty actions, if that risk is excessively considered?

@PerKurowski ©

Sweden, ask Stefan Ingves a simple question before granting him more powers.

Sir, I refer to Richard Milne’s “Sweden central bank chief [Stefan Ingves] gains forex intervention powers” December 5.

And “Andreas Wallstrom, an economist at lender Nordea, called Mr Ingves’s new powers “truly sad” because currency interventions often failed to bring about the intended result.”

Mr. Ingves, as the current Chair of the Basel Committee, is one of the experts on interventions that fail to bring about the intended results.

Take just the case of regulations that force banks to hold more equity against what is perceived as risky than against what is perceived as safe, and which dangerously distorts the allocation of bank credit.

The result, dangerous bank exposures to AAA rated securities and Greece and equally dangerous lack of exposures to “risky” SMEs and entrepreneurs.

So just ask Mr Ingves the following:

Sir, would you be so kind so as to provide us with one example of a major bank crisis that resulted from excessive bank exposures to assets that were perceived as risky when placed on the balance sheet of banks.

If he cannot answer, should that not be a sufficient indication he might have no idea about what he is doing?

Regulators assigned a 20 percent risk weight to AAA rated private sector bank assets and a 150 pecent risk weight for similar assets rated below BB-. I can think of many instances were bankers were lulled into a false sense of security by good credit ratings, but I cannot for my life imagine bankers building up excessive exposures to something rated below BB-. Sir, can you?

#1 Macro-prudential rule is never take for granted those in charge, like bank regulators, know what they are doing

Sir, Richard Milne quotes Stefan Ingves with “sailing a small boat on the ocean: it’s good if you know how to sail.”, “Riksbank head warns on tools to tackle crises”, September 14.

But let us not forget that Stefan Ingves is the current chairman of the Basel Committee, and as such, we could presume he agrees entirely with the current risk-weighted capital requirements for banks. In essence that regulation implies the following:

The better things are going for some assets, and so the safer these look (like house mortgages), the less capital are banks required to hold against these, and so the more incentives do banks have to lend, and thereby make these assets look even better yet… that is until the overcrowding of those safe havens become so dangerous that the whole banking system fails.

The worse things are going for some assets, and so the riskier they look (like loans to SMEs), the more capital must banks hold against these, and so the more incentives will banks have to reduce lending, and thereby make these assets look even worse yet… that is until riskier but perhaps more productive bays are left so unexplored that the whole economy fails.

Sir, the first and most important macro-prudential rule is that of never taking for granted that those in charge of sailing the boats know how to sail. And as I have argued for years, current bank regulators, which include Mr. Ingves, have no idea about what happens out there on the real oceans… their experience might be restricted to having played with toy boats in bathtubs.

The second most important macro-prudential rule with respect to banks, and boats, is that instead of by all means trying to stop these from going under, assist these to fail expeditiously, whenever they seems to be insufficiently seaworthy.

If it were up to me, and knowing these are to cover against unexpected losses I would set the capital requirements for banks based of cyber attack or being struck by asteroids, so as not have to spell out these as based on risks of bankers not knowing how to manage perceived risks, and worse, on risks of regulators trying to manage risks.

PS. “Gud gör oss djärva” “God make us daring” is a Swedish psalm. It would do us much good if bank regulators tried to understand its message....perhaps Riskbank would be a more appropriate name than Riksbank for a nation that has prospered thanks to risk-taking and much reasoned audacity.

PS. Axel Oxenstierna, 1648: “An nescis, mi fili, quantilla prudentia mundus regatur?”, “Do you not know, my son, with how little wisdom the world is governed?”, “¿No sabes, hijo mio, con que poca sabiduría el mundo esta gobernado?”, “Vet du inte, min son, med hur litet förstånd världen styrs?” 

@PerKurowski

The response to monetary stimulus must be different in totally different banking systems

Sir, we have had two complete different worlds of banking.

One when banks decided to whom they would lend to and at what interest rates and what terms, based on what they perceived the credit risks to be.

The other word, the quite recent one, is one in which regulators intrude and distort the allocation of bank credit by declaring that also the bank capital, meaning equity, banks were required to hold should also be based on perceived credit risks.

And that of course increased the risk-adjusted returns on equity for banks when lending to the “absolutely safe” making lending to the risky, like small businesses and entrepreneurs, something much less attractive.

To think that the economy would respond in the same fashion to various economic stimuli with such different bank systems is quite idiotic.

And Sir, that is why, when reading Richard Milne’s “Stockholm syndrome”, November 20, about the Swedish Riksbank’s crisis-fighting measures, and where there is even a reference to 1937, I find that discussion to be so completely out of context.

It states: “‘Sadomonetarist’ rate rises led to a toxic bout of deflation and criticism from economists.”

If anything, in that respect, what we really have is sadistic risk adverse regulations.

On risk-weights for banks when financing houses vs. jobs, regulators do not answer, though stiff upper lips starts to wobble.

Sir, Stefan Ingves and Per Jansson, of Sveriges Riksbank, respond quite strongly against some criticism made by Wolfgang Münchau of the monetary policy in Sweden, “Monetary policy has had positive results in Sweden” July 24. 

In their letter they mention that Sweden has been doing relatively fine in terms of reducing unemployment but that household debt and house prices have increased and “create risks of financial instability with serious macroeconomic consequences”.

Although my mother is from Sweden and lives there, I know little about its monetary policy but, since Stefan Ingves is the current chairman of the Basel Committee, and Münchau now has him on the line, would it not be great to ask him the following?

Mr. Ingves the risk-weights for defining the capital requirements for banks for house mortgages is 15% (I have heard some rumors about an increase to 25%) and the risk-weight for lending to an SME is 100%. Does it really make sense allowing banks to leverage 667% more times when financing houses than when financing the creation of the next generations of jobs… meaning banks can obtain a 667% higher risk adjusted return on their equity when financing houses than when financing the creation of the next generations of jobs? Do you not think this distorts the allocation of bank credit in the economy? 

Since jobs seem more important than houses, and SME’s have never caused a bank crisis, which house financing has certainly done, why not the other way round?

Sir, when I have asked bank regulators from many countries a similar question their usually stiff upper lips have begun to wobble… but I have not been able to extract an answer from them. Perhaps Wolfgang Münchau could have more luck.

PS. Remind them of a Swedish psalm... "God make us daring!"