Compared to more than three decades ago, what is the current leverage ratio of our banks?

Sir, Martin Wolf, in FT on July 12, 2012, in “Seven ways to clean up our banking ‘cesspit’” opined: “Banks need far more equity: In setting these equity requirements, it is essential to recognize that so-called “risk-weighted” assets can and will be gamed by both banks and regulators. As Per Kurowski, a former executive director of the World Bank, reminds me regularly, crises occur when what was thought to be low risk turns out to be very high risk. For this reason, unweighted leverage matters. It needs to be far lower.”Soon a decade since, are bank capital requirements much higher and really sufficient?

No! Though bank capital requirements are mostly needed as a buffer against the certainty of misperceived credit risks & unexpected events, in this uncertain world, these are by far, still mostly based on the certainty of the perceived credit risks.

Consequently, when times are rosy, regulators allow banks: to lend dangerously much to what’s perceived as very safe; to hold much less capital; to do more stock buybacks and to pay more dividends & bonuses. Therefore, banks will stand there naked, when most needed. 

The leverage ratio is also important because it includes as assets, loans to governments at face value, and thereby makes it harder for excessive public bank borrowers to hide behind Basel I’s risk weights of 0% government, 100% citizens. No matter how safe the government might be, those weights de facto imply bureaucrats know better what to do with credit they’re not personally responsible for than e.g., small businesses and entrepreneurs.

November 19, 2004, in a letter you published 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?” That this factor, in the face of huge government indebtedness, is not even discussed, as I see it can only be explained by too much inbred statism.

Before the Basel Committee Accord became operative in 1988, Basel I, banks were generally required to hold about 10 percent of capital against all assets, meaning a leverage ratio of 10.

Where do banks find themselves now? I know well it’s hard, and extremely time consuming, to make tails and heads out of current bank statements, but I’m absolutely sure most financial media, if they only dared and wanted, have the capacity to extract that information.

Should not such basic/vital data be readily available and perhaps even appear on front pages? It’s not! Why? Has media been silenced by capital minimizing/leverage maximizing dangerously creative financial engineers?

Sir, I’m not picking especially on financial journalists, the silence of the Academia, especially the tenured one, is so much worse.

@PerKurowski

Martin Wolf, again, any good economic plan needs, sine qua non, to get rid of bank credit distorting regulations.

Sir, I refer to Martin Wolf’s “Without an economic plan, patriotism is Johnson’s last refuge” FT, October 18, 2021

In Martin Wolf’s Economist Forum of October 2009, FT published an opinion I titled “Please free us from imprudent risk-aversion and give us some prudent risk-taking” (The link is gone, I wonder why)

In that article, commenting partly on the 2008 crisis, I held that getting rid of the risk weighted bank capital requirements, that which distorts the allocation of credit to the real economy, was an absolute must. 

Now, 11 years later, I must still insist in that, without doing so, there’s no economic plan that can deliver sustainable results.

The history I’ll tell my grandchildren has little to do with Philip Stephens’ history.

Sir, Philip Stephens writes: “Twenty-five years ago… the world belonged to liberalism. Soviet communism had collapsed. Historians will record the 2008 global financial crash as… the moment western democracies suffered a potentially lethal blow. The failure of laissez-faire economics was visible before the collapse of Lehman Brothers.” “The west is the author of its own weakness” Financial Times, October 1, 2021.

The history I will be telling my grandchildren is quite different.

Thirty-three years ago, the world belonged to liberalism and Soviet communism was collapsing. Historians will record how in 1988, one year before the Berlin Wall fell, the western world’s bank regulators introduced risk weighted bank capital requirements that distorted the allocation of credit. That put an end to any laissez-faire economics. With risk weights of 0% the government and 100% citizens, as if bureaucrats know better what to do with credit than e.g., entrepreneurs, communism took over. 

The 2008 global financial crash resulted from banks being allowed to leverage their capital/equity/skin-in-the game a mind-boggling 62.5 times, with assets that human fallible credit rating agencies had assigned a AAA to AA rating.

Yes, the west is the author of its own weakness… it much renounced to the willingness to take risks that had made it great. 

Sadly though, there are way too many interested in not disclosing what really happened… and therefore our banks are still in hand of insane risk aversion. “Insane”? Yes, because those excessive exposures that could become dangerous to our bank systems, are always built-up with assets perceived as safe, never ever with assets perceived as risky.

PS. My 2019 letter to the Financial Stability Board

Will this tweet be ignored by FT?

How much hubris is needed for regulators to impose risk weighted bank capital requirements, as if they know what the risks are?

How much wishful hoping is needed when even Nobel Prize winners in Economic Sciences believe that the regulators do know?

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

12 years since, and yet the true cause of the 2008 crisis shall seemingly not be told

Sir, John Flint a former Before chief executive of HSBC writes: “Before 2008, regulators’ approach to conduct risk in banking was what they called “principles based” — deliberately light touch. It relied too much on banks’ abilities to govern themselves and it failed.” “Warning lights are flashing for Big Tech as they did for banks” November 30.

“principles based”? Yes, but tragically with risk weighted bank capital requirements based on a very wrong principle, namely that what’s perceived as risky is more dangerous to our bank system than what’s perceived as safe.

“It relied too much on banks’ abilities to govern themselves and it failed.”? No, it relied way too much on some very few human fallible credit rating agencies, a systemic risk.

“deliberately light touch”? If as Basel II allowed​, ​ banks could leverage a mindboggling 62.5 times their capital with assets rated AAA to AA, I would not call that a “light touch”, I would call it putting Minsky Moments on steroids.

“This time it is the technology sector rather than the financial that is leaving us all exposed.”

Sir, current bank capital requirements, 12 years since the 2008 crisis, are still mostly based on the expected credit risks banks clear for on their own; not on misperceived credit risks, 2008’ AAA rated MBS, or unexpected dangers, like COVID-19. Therefore, banks will again stand there with their pants down. A good job Sir?

@PerKurowski

Here a formal statement in 2003 as an Executive Director of the World Bank 

Here my brief explanation of the 2008 crisis

And here the 2019 letter I sent to the Financial Stability Board

Does Martin Wolf’s “The tragedy of two failing superpowers” conform with FT’s beautiful motto of “without favour”?

Wolf opines about Donald Trump in terms of “a malevolent incompetent” and for this looks for the support of that totally unbiased Jeffrey Sachs who writes about “devastatingly of the ill will and ineffectiveness on display”. “The tragedy of two failing superpowers” April 1.

Sir, if this is what it comes down to, let me be clear that I much prefer the support of a highly incompetent but more principled Donald Trump, against our evidently thousand times more malevolent incompetents, like Hugo Chavez and Nicolas Maduro, than the support given to them by “extremely competent” Barack Obama and Jeffrey Sachs.

Wolf then writes: “For those of us who believe in liberal democracy” Really? Are we to believe that anyone who, for purposes of bank capital requirements, agrees with assigning a risk weight of 0% to his sovereign’s debt and 100% to fellow citizen’s debts, something which de facto implies that bureaucrats knows better what to do with credits for which’s repayment they're not personally responsible for than for example entrepreneurs, could be defined as a believer in a liberal democracy? I don’t think so, to me he would just be a disguised communist.

@PerKurowski

Do we have a banking system with banks as they are supposed to be?

Sir, I refer to your “Non-bank lenders will bear brunt of credit crisis”, March 25

John Augustus Shedd (1859–1928) opined: “A ship in harbor is safe, but that is not what ships are for”

But bank regulators paid banks with lower capital requirements to stay safe, thereby overcrowding “safe” harbors. As a result, those who had real reasons to stay in safe harbors, like many non-bank lenders, and were less prepared to do so, like many non-bank lenders, had then to take to the risky oceans.

You opine “we are in a better place today because regulators forced greater protections on the banking system” What greater protection? A measly 3% leverage ratio supposed to cover for misperceptions of risks, like 2008’s AAA rated, and unexpected dangers, like coronavirus? You’ve got to be joking.

You quote Ben Bernanke “If you do not have a banking system, you do not have an economy.” Sir, do we really have a banking system with banks as the bank’s we used to know, or as banks are supposed to be?

I mean, with zero bank capital requirements against loans to the government and eight percent against loans to citizens you do not have a free market economy, you have financial communism.

With lower bank capital requirements for residential mortgages than for loans to the entrepreneurs or SMEs, those who can create the jobs needed in order to service utilities and mortgages, you will not have a functional economy, and houses have morphed from being affordable homes into being the main risky-investment of way too many families.

Sir, for the umpteenth time the Basel Committee’s risk weighted bank capital requirements: guarantees especially large bank crisis, caused by especially large exposures held against especially little capital to assets perceived as especially safe, but one of which suddenly one turns out as especially unsafe.

If John A. Shedd was alive today he might have opined: “A ship is safer on the oceans than staying in  a safe harbor, which might become dangerously overcrowded.”

http://subprimeregulations.blogspot.com/2019/07/risk-weights-are-to-access-to-credit.html

@PerKurowski

Well-invested small savings surpluses are better than big ones thrown away at fluffy sovereign spending projects.

Sir, Martin Wolf correctly points out “Without the shelter of the eurozone, the Deutschmark would have greatly appreciated in a low-inflation world” “How Germany avoided the fate of Japan” October 30.

Indeed it would have appreciated, but that does not necessarily mean that it would have been bad for Germany… or for the rest in the eurozone.

Wolf holds that Germans need to realize “that the euro is already working to their benefit, by stabilising their economy, despite its huge savings surpluses.”

Q. Without the euro would those huge savings surpluses exist? A. No!

Q. Without the euro could not whatever smaller saving surpluses have resulted much better invested? A. Yes!

Wolf points out: “Even at ultra-low interest rates, domestic private investment in Germany fell far short of private savings. [And] since the government too ran fiscal surpluses, in Germany, capital outflows absorbed all the private surplus [much through] German financial institutions, with their huge foreign assets”

And that’s their problem. Because of risk weighted bank capital requirements that favors financing the safer present over the riskier future, plus that insane debt privilege of a 0% risk weight assigned to all Eurozone’s sovereign debts, even though none of these can print euros, most of those German saving surpluses ended up financing mediocre eurozone governments… and building up such unsustainable huge debt exposures, that it will come back to bite all, the euro, perhaps the EU, and of course Germans too.

The day when Germans citizens realize the real meaning of that their banks need to hold around 8% of capital when lending to German entrepreneurs, but need zero capital lending to eurozone sovereigns, and that they will not be able to collect on those loans, those German citizens are going to be very wütend.

.And Sir, again, for the umpteenth time, Wolf returns to his: “The chance to borrow at today’s ultra-low long-term interest rates is a blessing, not a curse.” 

Wolf just refuses to accept that today’s ultra-low long-term interest rates, is an unsustainable artificial concoction that mainly benefits public debts, in other words, pure unabridged statism, based dangerously on that government bureaucrats know better what to do with credit, for which repayment they are not personally responsible for, than for instance the private entrepreneurs. When it comes to bank regulations a Communist Wall was constructed in 1988, one year before the Berlin Wall fell.

PS. The Euro had one characteristic that differentiated it from US$. That made me less optimistic as to its chances of success. The US$ is backed by a solidly unified political entity, USA. The Euro was aimed at creating unity and cohesion, not the result of it.

@PerKurowski

The Basel Committee jammed banks’ gearboxes… not only in India

Amy Kazmin reporting on India quotes Rajeev Malik, founder of Singapore-based Macroshanti, in that “A well-oiled, well-functioning financial system is the gearbox of the economy”, “Financial system is ‘like a truck with a messed-up gearbox’” September 23.

The financial system’s gearbox got truly messed up when regulators decided that banks could leverage differently their capital based on perceived risk… more risk more capital, less risk less capital… as if what is perceived as risky is more dangerous to bank systems than what is perceived as safe.

And Kazmin writes: “The financial companies that had provided much of India’s credit growth in recent years are now struggling with access to funding themselves after the shocking collapse of AAA-rated infrastructure lender, IL&FS, last year.”

Could that have something to do with the fact that since 2004 Basel II regulations banks needed to hold only 1.6% in capital when human fallible credit rating agencies assigned an AAA to AA rating to a corporation?

And Kazmin writes: “With its own voracious appetite for funds to finance its fiscal deficit, New Delhi is now mopping up much of the country’s household savings through a clutch of small schemes such as post office savings that offer higher rates than commercial banks.”

Could that have something to do with the fact that since 1988 Basel I regulations, banks need to no capital at all against loans to the government of India… but 8% when lending to Indian entrepreneurs.

Sir, risk taking is the oxygen of any development so, with such a dysfunctional gearbox, how is India going to make it? None of the richer countries would ever have developed the same with Basel Committee’s bank regulations… and all their bank crises, those that always result from something safe turning risky, would have all been so much worse, as these failed exposures would have been held against especially little capital. 

Here is a document titled “Are the bank regulations coming from Basel good for development?” It was presented in October 2007 at the High-level Dialogue on Financing for Developing at the United Nations. It was also reproduced in 2008 in The Icfai University Journal of Banking Law. 

@PerKurowski

It's what's safe that's risky!

When "setting bank equity requirements, it is essential to recognise that so-called “risk-weighted” assets can and will be gamed by both banks and regulators. As Per Kurowski, a former executive director of the World Bank, reminds me regularly, crises occur when what was thought to be low risk turns out to be very high risk." Martin Wolf

https://www.ft.com/content/7a95df3e-cb50-11e1-b896-00144feabdc0

Wolf ends with:“We cannot hope for miracles. But we can make bankers more useful and less dangerous. Focus on that.”

Indeed, let's all focus on that.

Please free us from imprudent risk aversion and give us some prudent risk-taking

My 2019 letter to the Financial Stability Board: Acknowledged and Ignored.

PS. Read what #AI ChatGPT OpenAI opines on this.

Here a 2010 homemade YouTube in which I tried to explain the Global Financial Crisis with a 2x2 matrix.

PS. 2023 tweets

A tweet: "Incentives matter: The escape valves of risk weighted bank capital (equity) requirements, cause banks’ risk models to be more about equity-minimizing/leverage-maximizing, than about analyzing bank assets’ true risks. That’s life!"

Another tweet: "The world has been duped/lulled into a false sense of security by the use of risk weighted assets (RWA) as a real and valid measure of banks' risk exposure. E.g., the duration risk of #SVB long-term government bonds is not included in the weighted risks."

Another tweet: “SVB regulators were ‘asleep at the wheel’” What’s a supervisor to do? Inform his boss Treasury bonds' 0% risk weight must be increased?  It is difficult to get a man to understand something, when his salary depends on his not understanding it” Upton Sinclair

Another tweet: "The most dangerous risk banks take, #unwittingly, is the buildup of huge exposures with assets perceived as safe, those which caused all major bank crisis. Regulators’ risk weighted bank capital/equity requirements, unwittingly, puts that risk on steroids."

Another tweet: "A mixture of thousand solutions, many of them inadequate, may lead to a flexible world that can bend with the storms. A world obsessed with Best Practices [risk weighted bank capital/equity requirements] may calcify its structure and break with any small wind."

Another tweet: "Bank capital/equity requirements mostly based on perceived credit risks, not misperceived risks or unexpected events, e.g., covid, inflation, war, interest rate rise, doom banks to stand naked, when needed the most, when hardest to raise equity"

Another tweet: “A regulation that regulates less, but is more trigger-happy & treats a bank failure as something normal, as it should be, could be a much more effective regulation. The avoidance of a crisis, by any means, might lead us to… the mother of all bank crises”

Another tweet: "Risk weighted bank capital/equity with decreed weights: 0% government – 100% citizens, as if bureaucrats know better what to do with credit than e.g., small businesses and entrepreneurs, is that communism, fascism or just plain vanilla Banana Republic?"

Another tweet: "#SVB have all besserwissers Monday morning quarterbacks explaining us duration risk; why holding long-term government bonds was dangerous. Not a word about why regulators require so little capital/equity/skin-in-the game against these assets.

Another tweet: "The stress test that shall not be dared. What if that what’s perceived as safe is more dangerous to bank systems than what’s perceive risky, and therefore the risk weighted bank capital/equity requirements do not reflect real bank risks?"

Another tweet: "When concocting the risk weighted bank equity requirements, evidently no regulator asked: What would Mark Twain opine about with what assets banks might create dangerously large exposures, with some perceived as risky or with some perceived as safe?

On bank regulations, I’m not a newcomer nor a Monday morning quarterback.