The pulmonary capacity of banks went from unlimited, through 62.5, 35.7 to 12.5 times of allowed leverage. Where do you think bubbles were blown?

Sir, I refer to John Authers review of “Ray Dalio’s” “A Template for Understanding Big Debt Crises” September 22, 2018.

I have not read the book, and something in it could apply to other bubbles but, if Dalio left out mentioning the distortions produced by the risk weighted capital requirements for banks, those that caused the 2008 crises, he would surely have failed any class of mine on the subject.

Sir, let me be as clear as I can be. 100%, not 99%, 100% of the bank assets that caused the 2008 crisis were assets that, because they were perceived as especially safe, dumb regulators therefore allowed banks to hold these against especially little capital. 

The allowed leverages, after Basel II, that applied to European banks and American investment banks like Lehman Brothers were:

AAA rated sovereigns, including those the EU authorities authorized, like Greece, had a 0% risk weight, which translated into unlimited leverage.

AAA rated corporate assets, were assigned a risk weight of 20%, signifying a permissible 62.5 times leverage.

Residential mortgages were assigned a risk weight of 35%, translating into a 35.7 allowed leverage.

Of course, after the crisis broke out, any few “risky” assets banks held, like loans to entrepreneurs, those that banks could only leverage 12.5 times with went through, (and still do), a serious crisis of their own, when banks began to dump anything that could help them improve that absolutely meaningless Tier 1 capital ratio.

http://subprimeregulations.blogspot.com/2016/12/here-is-succinct-but-complete.html

@PerKurowski

Tier one capital ratios is a game invented by regulators for banks to play.

Sir, Jonathan Ford mentions “An average tier one capital ratio of 8 per cent —. An accounting measure of their soundness, it meant banks could lose that proportion of the value of their risk-weighted assets before their loss-absorbing capital was spent.” “Financial fragility lurks behind a confident façade” September 17.

No, not really-really so. Let us, just for the example suppose that a bank carries only very “safe” corporate assets rated AAA to AA assigned by the regulators a risk weight of 20%. Based on the Basel II basic capital requirement of 8%, that meant it needed to hold only 1.6% in capital against those assets. That would give the bank a tier one ratio of 8%... but how much could it afford to lose on its assets that had been risk weighted before its capital was completely gone? Not 8%, but 1.6%.

The risk-weighted assets only give a correct indication if the perceived risk reflected are correct and if bankers will manage those perceived risks correctly. What are the chances of that? Quite slim, especially when banks have all the incentives to minimize equity they are holding, something that makes it easier for them to maximize the return on equity to their shareholder (and of course the bankers’ own bonuses)

In other words, the Basel Committee tier-one bank capital ratio, based on risk-weighted assets, as if risks were known, is just devious and dangerous false information that feeds a false sense of security. Nothing of what accountancy can misreport beats that. Worse, by distorting the allocation of credit, much more than concealing realities, it changes realities… on a global scale.

PS. Here is an aide memoire on the mistakes in the risk weighted capital requirements for banks.

@PerKurowski

The most stressful banks to me are those who least help the future of our real economy.

Sir, Laura Noonan, Rachel Sanderson and James Shotter present EU’s bank stress test results. “Bank stress tests single out the usual suspects” August 1.

And it ranks the banks based on their 2018 fully loaded common equity tier one ratio, which is CRD IV Common Equity Tier 1 capital divided by CRD IV Risk Weighted Assets. And so let us be very clear, if the risk weights used are wrong, the results are absolutely meaningless.

Sir, how long will you all play along with the current regulators as if they were geniuses setting risk weights, as if they had any idea of what they are doing? Are you totally deprived of intellectual honesty?

If you go to EBA’s stress result you will read “The EU banking sector has significant shored up its capital base in recent years leading to a starting point capital position for the stress test sample of 13.2 % CET1 ratio at the end 2015… 2% higher than the sample of 2014 and 4% higher than the sample in 2011”. 

That’s great!... sort of… because it also states that “the aggregate leverage ratio decreases from 5.2% to 4.2% in the adverse scenario”. In terms of real leverage what does from 5.2% to 4.2% leverage ratio mean? It means that in their “adverse scenario” the bank leverage of equity has increased from 19.2 to 23.8 to 1… and that’s just the average!

How is it possible, an increase of the CET1 ratio, at the same time the leverage increases? Easy, banks take on more of those assets perceived, decreed or concocted as safe that carry low risk weights, and less of those assets perceived by bankers and regulators alike like more risky that carry higher risk weights, such as loans to SMEs and entrepreneurs. The real economy will suffer the impacts of this stupid and short-sighted regulatory risk aversion.

We should of course be concerned with the safety of our deposits in our banks… but, should we not concerned with that these banks take the risks needed to offer our children and grandchildren a future at least as good as that one our parents offered us? I sincerely think so.

PS. And it not only about the young. The welfare of future pensioners depend very much too on the health of the economy.

@PerKurowski ©

Banks, tell me who your “absolutely infallible” are, and I will tell you who your “really risky” are.

Sir, Thomas Hale, Christopher Thompson and Josh Noble report on that “most major Chinese banks have existing Tier-1 capital adequacy ratios of at least 9.5 percent according to CLSA, meeting Basel III requirements”, “China financials lead EM debt sales” July 16.

What does that really mean? Which are the low-risk weight bank assets in China? For instance in the case of European banks these were AAA rated securities, mortgages in Spain and loans to infallible sovereigns like Greece.

For instance if we divide the risk weighted capital Tier-1 ratio of a bank by its un-weighted leverage ratio, then we have a better idea of how much could be hiding in the officially sanctioned safety… the fictitious safety ratio... the Basel Risk Ratio