Don’t keep adding bank regulations for what is ex ante perceived risky. It is what is ex ante perceived as very safe that should concern us the most.

Sir, I refer to Sheila Bair discussion of how much banks are to set aside in order to cover for loan losses. “Congress should stay out of new bank rules for loan losses” August 5.

Bair mentions, “that FASB wants to switch to a new rule, known by the name of “current expected credit losses” or “CECL.” That rule “says that banks should set aside enough to cover expected losses throughout the life of a loan, taking into account a wide variety of factors, including historic loss rates, market conditions, and the maturity of the economic cycle.”

Bair argues the new rule has two key benefits. “First, banks will start putting aside money on day one of each loan so when trouble hits — as it did in 2008 — they will not be trying to play catch-up with their reserves.” 

Really, what money would they have had to put aside for the AAA rated securities gone bad? What money would they have had to put aside for loans with a default guarantee issued by an AAA rated entity like AIG?

Then “Second, it should make bankers a little more cautious in their lending decisions, as they will have to account for likely losses when the loan is made, not kick the can down the road until the borrower is actually in arrears.”

That all has me concerned with that we might be adding a new layer of discrimination against the access to credit of the risky.

Those perceived ex ante as risky already get less credit and pay higher risk premiums. Those perceived ex ante as risky already cause banks to have to hold more equity against loans to them. 

If those perceived ex ante as risky must now also require banks to set aside reserves earlier than what is required for those perceived as safe, banks might stop altogether lending to the risky, like to entrepreneurs, and that will absolutely hurt the economy.

And Sir, it would all be for nothing, because major bank crises are never caused by excessive exposures to what was ex ante perceived as risky when placed on banks’ balance sheets. 

http://subprimeregulations.blogspot.com/2019/03/my-letter-to-financial-stability-board.html

@PerKurowski

Regulators gave banks great incentives to smoke around drum barrels marked “empty”, and to stay away from drums marked “full”.

Gillian Tett writes “before 2008 the big banks spent a great deal of time fretting about issues that seemed obviously risky — hedge funds or highly leveraged companies — but tended to ignore anything that seemed safe or boring, such as AAArated mortgage-backed securities” “What the Hopi culture teaches us about risk” June 23.

Sir, if you go to my TeaWithFT blog and click on Gillian Tett, you will find that over the years I must have written her at least 100 letters explaining that what is perceived as risky, drums marked “full”, is never as dangerous than what’s perceived as safe, drums named “empty”. 

But, if a 70 year old paper by US fire-safety inspector Benjamin Lee Whorf, based a lot on Hopi Native American culture, is more convincing to Ms. Tett than my arguments, so be it.

My real complaint though is that Ms. Tett only refers to what bankers did, and does not mention the fact that bank regulators, on top of it all, with their risk weighted capital requirements, allowed banks to smoke (leverage) much more around drums named “empty”, than around drums named “full”. 

So when Ms. Tett writes: “In theory, this danger has now receded: banks have been trained to take a more holistic view of risk and to question whether even AAA ratings are always safe”, let us not forget that with Basel II, regulators allowed bank to leverage a mindboggling 62.5 times if only an AAA to AA rating was present. Since that besserwisser regulatory mentality still prevails, and risk weighting derived incentives still exists, unfortunately I do not share the hope that dangers have receded. New dangerous “absolutely safe” always lurk around the corners.

And Sir, come on, we have European central bankers who told banks “You can smoke as much as you like around that 0% risk weighted drum named Greece”; and they have still not been made accountable for that… and, between you and I, you FT is not entirely without blame for that.

PS. The sad complement to this analysis is that what regulators decreed as drums marked “full”, and made banks stay away from, includes entrepreneurs and SMEs, something which must erode the dynamism of the economy. 

@PerKurowski

The pricing distortions by QEs are leveraged manifold by the regulatory distortion of bank credit.

Sir, Scott Minerd holds: “But in the long run, classical economics would tell us that the pricing distortions created by QE will lead to a suboptimal allocation of capital and investment, which will result in lower output and standards of living over time” “QE likely to impair living standards for generations” March 26.

And Minerd writes: “The long-term consequence of the new monetary orthodoxy is likely to permanently impair living standards for generations to come while creating a false illusion of reviving prosperity.”

It is so much worse than that:

The long-term consequence of the new bank regulatory orthodoxy, that of weighing equity requirements for perceived credit risk, is going to permanently impair living standards for generations to come, while creating a false illusion of making our banks safer.

It is regulating in favor of what is perceived as safe and against what is perceived as risky, as if what’s “safe” is not already benefitted and as if what’s “risky” does not already suffers. That has introduced the mother of all distortions in bank credit allocation… which blocks much of the liquidity provided by QEs to reach what it should reach…and... this is not even an issue!

And all that does it not help to make our banks safer? Of course not! What is perceived as risky is never threat to the banking system, only what is perceived as “safe” is.

@PerKurowski

Why is it so difficult for Martin Wolf to understand the need for rebalancing the access to bank credit?

Sir, Martin Wolf, October 9, writes about “The pain of rebalancing global growth” but, stubbornly, keeps on refusing to even mention the most important rebalancing act that must occur. And I refer to of course the capital requirements for banks which, as these are risk-weighted, produce a completely imbalanced access to bank credit in favor of the “infallible sovereigns”, housing sector and the AAAristocracy; and thereby discriminates against “The Risky”, the medium and small businesses, the entrepreneurs and start-ups

Why can it be so hard for a seemingly so lucid man like Martin Wolf, to understand that “The Risky” are those who most need access to bank credit in competitive terms, for the real economy to thrive?

Wolf also repeats his mantra of criticizing governments for not taking the opportunity of “ultra-low interest rates for a large expansion of investment”. He still does not understand that since those low interest rates do not include the opportunity costs of all the lending to “The Risky” that has not occurred as a result of the regulators favoring the sovereigns, these nominal rates could, in real terms, be the highest ever.

This week Wolf will be doing the rounds in the World Bank and IMF meetings. He could be interested in that, more than 10 years ago, April, 2003, as an Executive Director of the World Bank I formally stated:

"The Basel Committee dictates norms for the banking industry that might be of extreme importance for the world’s economic development. In its drive to impose more supervision and reduce vulnerabilities, there is a clear need for an external observer of stature to assure that there is an adequate equilibrium between risk-avoidance and the risk-taking needed to sustain growth. The World Bank seems to be the only suitable existing organization to assume such a role." 

Unfortunately neither the World Bank, nor any other similar institution, wanted to listen… not then, not yet.