The risk weighted capital requirements give banks great incentives to hide risk from their regulators.

Sir, Eric Platt and Alistair Gray write “US regulators have joined investors in voicing concern over risky bank lending… particularly when projections make a company appear more creditworthy… ‘The agencies continue to see cases of aggressive projections used to justify pass ratings on transactions that examiners consider non-pass’… although they said the number of cases was “at much lower levels than in prior periods” “Wall Street watchdogs sound alarm over risky bank lending” July 4.

In good old banking days, around 600 years, before Basel Committee’s risk weighted capital requirements, bankers argued their clients riskiness in order to collect higher risk premiums. Now banks argue more their clients safety, in order to convince regulators that they can hold less capital. That distortion makes the efficient allocation of bank credit to the real economy.

“The Fed and its fellow regulators… give deals a pass or non-pass rating which is then used to build a picture of banks’ lending activities.”

Considering that bank crisis only result from unexpected events or excessive exposures to something perceived, concocted or decreed as safe, and never ever from something perceived as risky, does this pass or non-pass rating activity make any sense? Absolutely not! It is as silly as can be… except for those who earn their livings from working on bank regulations. 

If banks keep on thinking on how to for instance pass some ratings, so as to be able to leverage more their capital in order to obtain higher rates of return on equity, than on the real risks of their clients… they will again, like in 2007/08, go very wrong, more sooner than later.

If banks keep on thinking on how to for instance pass some ratings, so as to be able to leverage more their capital in order to obtain higher rates of return on equity, than on the real risks of their clients… they will again, like in 2007/08, go very wrong, more sooner than later.

“the agencies said that risks had declined slightly but remained “elevated”. Lending considered to be non-pass had fallen from 10.3 per cent to 9.7 per cent of the overall shared national credit portfolio” As I see it, we could just as well argue that where the real dangers lie, increased from 89.7% to 90.3%.

Sir, again for the umpteenth time, without the elimination of the insane risk weighted capital requirements, there is no way our banks will recover their sanity. I am amazed on how you have decided to keep silence on this.

@PerKurowski

What would the consequences be for failed bank regulators if failed air-traffic controllers or cruise ship captains?

Sir, Kara Scannell, in the analysis on US housing, “After the gold rush”, October 30, with respect to the mortgage frauds writes: “Critics say that prosecutors have gone after easy targets – low level fraudsters - while going easy on Wall Street executives whose banks packaged billions of dollars worth of toxic mortgage securities.”

Indeed, and though it might be difficult to condemn any one of those executives for something illegal, by now we should at least have had on the web a list of the 20 most important toxic mortgage packagers, so as to be able to shame them.

But, that said, and since for me the subprime mortgage mess was a direct consequence of the regulators having created irresistible temptations for banks to holding any AAA rated securities, namely allowing them to hold these securities against only 1.6 percent in capital, the first thing that should have happened, is for these regulators to be sent home, in utter disgrace. But that has not happened.

Not only is the name of most regulators unknown to us, but some of them have even been put in charge of drawing up new regulations, Basel III, and others promoted, like for instance Mario Draghi, from being Chairman of the Financial Stability Forum, later the Financial Stability Board, to being the President of the European Central Bank. Amazing!

But let me be even clearer about what I mean:

In November 2004, in a letter published by the Financial Times 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)?”

But yet, even if a little me, not a regulator nor a banker, could have been sufficiently preoccupied about the excessive lending to sovereigns to write that, the regulators allowed the banks in some cases to lend to sovereigns against zero capital, and for a sovereign rated like Greece was, required the bank to hold only 1.6 percent in capital. That signified allowing a bank to leverage its equity some mindboggling 62.5 times to 1 when lending to Greece.

And so let me just ask: what would have happened to airport controllers or cruise ship captains who had made mistakes of this exorbitant nature, and caused damages as huge as this financial crisis?

I have absolutely nothing personal against any of the regulators, and I do not know any one of them. But what I I do know is that if we are going to have bank regulations with a global reach, like those produced by the Basel Committee for Banking Supervision, we absolutely need those regulators to be held much more accountable for what they are up to.

Yes the credit rating agencies let the regulators down... but it was they who gave the credit rating agencies such an excessive importance and they should have known; again as little me wrote in another published letter January 2003 in FT: “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

Yes they can argue they trusted the financial models too much… but that is not an excuse. If little me, presumably not more a financial modeler than they were, in a written formal statement delivered as an Executive Director of the World Bank, in October 2004, could warn: “[I]believe that much of the world’s financial markets are currently being dangerously overstretched through an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions” they should also have been suspicious about the models.

Before going after the titans of Wall Street, we need to go after the petit bureaucrats of bank regulations

Sir, John Kay ends an article that includes many truths about bank regulations with “the only sustainable answer to the issue of systemically important financial institutions is to limit the domain of systemic importance. Until politicians are prepared to face down Wall Street titans on that issue, regulatory reform will not be serious.” “Take on Wall Street titans if you want reforms” September 19. 

Yes, but, the systemically important financial institutions grew to be systemically important institutions, much with the help of bank regulators who, I do not really know with what authority, decided that banks could hold many assets against little or no capital, as long as these assets were perceived as “not-risky”. 

Had for instance Basel II decided that banks would need 8 percent of capital for any asset it held, we might still have systemically important financial institutions, but their systemic importance would be just a fraction of their current. 

And since there has been about five years since the crisis began, and current bank regulators have still not admitted the simple truth that their capital requirements based on perceived risk distort the markets, before we hit the titans of Wall Street down, we have to hit the petit bureaucrats of bank regulations who believe themselves titans in risk management down. 

John Kay also wrote that any capital target “will be gamed by those who observed the letter rather than its spirit”. Yes that is true, that is a fact of life, but, let us at least not have petit regulators also trying to simultaneously game the markets with their silly risk-adverse risk-weights. 

Frankly, who authorized bank regulators to do to our banks what they did?

This is no classic crisis

Sir I could not agree more with Mr William Jacobson that we need to concentrate more on the real economy as opposed to the financial economy, since the first has much better possibilities of delivering fundamental positive economic change, “Restore balance to financial and real economies.” November 24. This of course does not imply that Wall Street is irrelevant to Main Street.

But when Mr Jacobson says “that the current credit crunch is the aftermath of a classic leverage-fuelled financial boom” I must disagree. There I nothing classic in a crisis caused by investors having followed officially empowered risk surveyors, the credit rating agencies, to such a swampland as the one represented by the extremely bad awarded mortgages to the subprime sector in the US. That is by all means a first, and let us pray it also becomes a last.

Viva Wall Street!

In the Washington Post of March 25 Lyla Ward, in “Who needs a fence? Viva Mexico, USA!” suggests that the USA should simply go ahead and acquire Mexico and she is obviously unaware of how the financial markets work. The fact is that as Wall Street could just as easy execute a leveraged buy out of the USA by the Mexicans financed by the Chinese, they would be more favorably inclined to do so as they could make much more money than if it was the USA buying Mexico. Having said that I wonder if it really is so necessary to formalize an affair or a takeover between the two countries, in a church or in a notary, since for all practical purposes both countries have been for quite some time living de facto together, more steamily than those who are bound together in the more formalized relationship of the European Union.