Could the Basel Committee learn enough from puzzles and poker so as to correct their misinformation?

Sir, I refer to Tim Harford’s “What puzzles and poker can teach us about misinformation” FT Weekend December 5.

When deciding on what’s more dangerous to banks the regulators in the Basel Committee, with “expert intuition” and great emotion shouted out the “below BB-” and, for their risk weighted bank capital requirements, assigned these a 150% risk weight, and a very smallish 20% to what’s rated AAA.

But, with what type of assets can those excessive exposures that could really be dangerous to our bank systems built-up, with assets rated below BB- or with assets rated AAA?

Never ever with assets perceived as risky, always with assets perceived as safe.

Sadly, the regulators had missed their lectures on conditional probabilities.

And their “expert intuitions” are so strong that they were not able to understand the clear message sent by the 2008 AAA rated MBS. 

What does Tim Harford think regulators could learn from puzzles and poker to correct their misinformation?

PS. Trying to understand the how come of the so loony bank regulations, by reading Daniel Kahneman’s “Thinking, Fast and Slow” 2011.

@PerKurowski

Sir FT, do you, or our dear The Undercover Economist Tim Harford, have an explanation for what is a monstrous regulatory mistake?

Sir, I refer to Tim Harford’s “The Changing Face of Economics” December 19.

As an economist, if I were to regulate or supervise banks, I would mostly be concerned with bankers not perceiving the credit risk correctly. Wouldn’t you?

That’s why I cannot understand why so many economist colleagues, when acting as bank regulators, can be so dumb so as to bet our banking systems on that bankers will be able to perceive what is safe correctly. 

Let me explain it having bankers answering the four possible outcomes.

If the ex ante risky, ex post turns out safe = “Great News we helped an entrepreneur to have success”

If the ex ante risky, ex post turns out safe = “You see, that is why we lend them little and charge them high risk adjusted interest rates.”

If the ex ante safe, ex post turns out safe = “Just as we expected”

If the ex ante safe, ex post turns out risky = “Holy moly what do we now do? We lend it way too much at way too low interest rates”

But the regulators in the Basel Committee, in their Basel II of 2004, assigned risk weights of only 20% for what is so dangerous to our bank systems as what human fallible credit rating agencies have rated AAA, and a whopping 150% for what has been made so innocous, by being rated below BB-?

Sir, so do you, or our dear The Undercover Economist Tim Harford, have an explanation for what is clearly a monstrous regulatory mistake? 

Or is it that you, and our dear The Undercover Economist Tim Harford, out of sheer collegiality solidarity, both agree with such dumb regulations?

If so, let me assure you that when I studied economics, it was to learn and understand economics, not to join an economists’ union/mutual admiration club.

http://perkurowski.blogspot.com/2016/04/here-are-17-reasons-for-why-i-believe.html

PS Tweet: I can understand a child believing that what’s rated below BB- is more dangerous to our bank systems than what’s rated AAA, and therefore assigning a bank capital requirement of 12% to the BB- rated assets, and only 1.6% to those rated AAA. But mature professionals?

@PerKurowski

As long the mistake that caused a crisis gets to be treated as one that shall not be named, it is doomed to become a Groundhog Day event.

Sir, Martin Wolf writes “financial regulation is procyclical: it is loosened when it should be tightened and tightened when it should be loosened. We do, in fact, learn from history — and then we forget”“Why further financial crises are inevitable” March 19.

Yes and no!

Yes, it is procyclical especially when allowing banks to leverage more with those who, thanks to good times are perceived as safer, and much less in bad times with all those that then are perceived as risky, which of course includes many former very safe.

No, we have not learned from history, because there is too many interested in putting a veil on the mistake with the risk weighted capital requirements. And there is too many who do not want to admit they fell for the populist that told them to relax, because they have weighted the risks.

Even though a leverage ratio has been introduced, the following Basel II risk weights that which evidences an absolute lack of understanding of the concept of conditional probabilities have not been changed, and this even after a crisis that exploded in AAA rated territory.

AAA to AA rated = 20%; allowed leverage 62.5 times to 1.

Below BB- rated = 150%; allowed leverage 8.3 times to 1

Also, the distortion the risk weighting creates in the allocation of credit to the real economy is mindboggling. Just consider the following tail risks:

The best, that which perceived as very risky turning out to be very safe.

The worst, that which perceived as very safe turning out to be very risky.

And so the risk weighted capital requirements kills the best and puts the worst on steroids… dooming us to suffer from a weakened economy as well as an especially severe bank crisis, resulting from especially large exposures, to what was especially perceived as safe, against especially little capital.

Wolf writes: “The bigger the disaster, the longer stiff regulation is likely to last. [But] Over time, regulation degrades, as the forces against it strengthen and those in its favour corrode.” I agree, but I would have to add something to it, namely, the bigger the disaster the more the running away from responsibilities… and accountability. 

@PerKurowski

Bank regulators insist on feeding the systemic risk of credit ratings, even after it became tragically evident.

Sir, Kate Allen writes “Funds that allocate capital based on instruments’ investment grades and index weighting may look as if they are playing it safe but they are, in fact, taking a gamble, creating towers of risk, any floor of which could prove unstable… do not look to the canaries in the financial markets’ coal mines to sound an early warning. By the time the downgrades come, it will be too late” “Tail Risk” February 28.

Indeed by the “time issuers’ credit ratings were downgraded, [banks] were already staring the worst-case scenario in the face.

Basel II’s standardized risk weights for the risk weighted bank capital requirements:

AAA to AA rated = 20%; allowed leverage 62.5 times to 1.

Below BB- rated = 150%; allowed leverage 8.3 times to 1

Absolute lunacy! With the same risk weight banks would anyway build up much more exposure to what they ex ante perceived as very safe, than against what they perceived as very risky.

As is, that regulation dooms our bank systems to especially large crisis, resulting from especially large exposures, to what is perceived as especially safe, against especially little capital. 

Allen observes: “An investment structure that is revealed to have done a bad job only when disaster arrives, as in the financial crisis”. Unfortunately no. Bank regulators blamed the credit rating agencies, and not themselves for betting too much on these, and so that so faulty regulations that should have been eliminated with a big “Sorry!” is still very well active. 

PS. In FT January 2003: “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds. Friends, please consider that the world is tough enough as it is.”

PS. At World Bank: April 2003: "Market or authorities have decided to delegate the evaluation of risk into the hands of much fewer players such as the credit rating agencies. This will, almost by definition, introduce systemic risks in the market"

@PerKurowski

Why is it not obvious that what bankers perceive as safe must, by definition, be more dangerous to our bank systems than what they perceive as risky?

Sir, Jonathan Ford writes, correctly, “One concern with using risk-weighted assets is that bank bosses can influence the calculation by tweaking the asset number”, “Money to burn at the banks? It all depends on how you count it” December 3.

But you really do not have to go there to be very concerned, it suffices to ask yourself: What is more dangerous to our bank systems, that which bankers perceive as risky, or that which bankers perceive as safe?

And then you do not have to use bankers models, it suffices to know that in the standardized risk weights of Basel II, the regulators themselves assigned a meager 20% risk weight to the rated AAA to AA, that which really could be dangerous (like in 2008) and a whopping 150% weight to the innocous below BB- rated, that which bankers won’t like to touch even with a ten feet pole.

I agree with those wanting a straight equity requirement for banks, a leverage ratio, like Mervin Kings’ 10% or Professor Anat Admati’s 15%, but much more than for the safety of our banks, I want that so as not distort the allocation of bank credit to the real economy. 

Sir, I am convinced that, a 0% bank capital requirement, with no supervision of banks, with no deposit guarantees to its depositors, would be much better for our real economies, and much safer for our banks systems, than the current dangerous regulatory nonsense… which only guarantees especially big crisis, resulting from especially big exposures, to something perceived as especially safe, against especially little bank capital.

Unfortunately, you seem to believe our bank regulators really know what they’re doing… or is your motto “Without fear and without favour” just a marketing ploy?

http://subprimeregulations.blogspot.com/2018/08/risk-weighted-capital-requirements-for.html

@PerKurowski

Hercules Poirot, as a bank regulator, would be much more watchful of the “safe” than of the obvious risky.

Sir, Gillian Tett reminds us that “Any fan of Agatha Christie mystery books knows that distraction is a powerful plot device: if there was a commotion in the kitchen, detective Hercule Poirot would look for a body in the library, or other clues being hidden in plain sight, amid the noise.” “Federal Reserve attack is just a distraction”, November 30.

Indeed, but she could rest assure that Poirot, if cast as a bank regulator, would laugh at his current colleagues who show so much concern with what seems obviously risky, like when they in Basel II assign a risk weight of 150% to what’s rated below BB-, and so little about what seems very safe, like giving only a 20% risk weight to what’s rated AAA and is, therefore, if wrong, truly dangerous for the bank system.

Ms. Tett argues here that President Donald Trump “uses weapons of distraction more effectively than almost any leader before him”

She could be right but also, when GDP and inflation data are fraught with may uncertainties or outright errors, to hear the Fed discussing the “neutral rate”, could also be an intent to distract from the fact that they find themselves in that “dark room” deputy Fed chair Rich Clarida is quoted to have mentioned, and so that they therefore have not the faintest idea about what’s going on, and much less about what to do. 

Sir, when not knowing the answer to a question, proceeding to with a firm voice give an answer nobody is guaranteed to fully understand, also qualifies as a high quality distraction.

PS. That 20% risk weight of the AAA to AA rated, translated to a capital requirement of only 1.6% (8%*20%) which meant the banks were allowed to leverage mindblowing 62.5 times with such assets (100/1.6) which translated in to the cause numero uno for the 2008 crisis. 

@PerKurowski

Our banking systems have been made especially fragile, because of especially bad bank regulations.

Sir, Martin Wolf writes “The world’s economy and financial systems are fragile … the most important source of fragility is political… In country after country, populists and nationalists are in, or close to, power. Salient characteristics of such politicians are myopia and entrenched ignorance. Inevitably, they spread uncertainty.” “Politics puts the skids under bull market” October 17.

In April 2003, as an Executive Director of the World Bank I delivered a statement that contained the following: "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 may calcify its structure and break with any small wind."

One of those “Best Practices” has been the risk weighted capital requirement for banks. These give banks incentives to create especially large exposures to what is perceived or decreed as especially safe, against especially little capital; making our banks, and the sector lending thereby favored, like sovereigns and houses, extremely fragile.

Populism? Sir, few things as brazenly populists as “We will make our bank systems with our risk weighted capital requirements because we sure know about risks. 

PS. Wolf, during the last annual meetings of IMF and the World Bank in Bali when interviewing Christine Lagarde, mentioned: “As a journalist I am paid to be skeptical”

But Wolf refuses to ask bank regulators about what they were thinking when they assigned a meager 20% risk weight to assets that because rated AAA represents great dangers to bank systems, compared to a whopping 150% for the so innocous below BB- rated. Sir, could it be you are not paying Wolf enough?

PS. In a similar vein during the interview Mme Lagarde said, “In IMF’s view capital flow management measures should: not be first order of priority, only be used in exceptional circumstances, not be a substitute for macroeconomic and macroprudential policies.”

So why does IMF keep mum about the risk weighted bank capital requirements? In a letter FT published in November 2004 I wrote: “our bank supervisors in Basel are unwittingly controlling the capital flows in the world.” Could it be that IMF still does not understand that that regulation distorts, controlling credit flows in favor of the “safe” present and against the “risky” future

PS. Ref the same interview: Trade protectionism? What neo-Bretton Woods Conference will be needed to help us get rid of bank regulations made to protect banks but that only endangers bank systems?

PS. Ref the same interview: Balance sheet vulnerabilities. Are not the consequences of central banks huge liquidity injections, with QEs, especially for emerging countries, precisely the same as those of the 1974 to 1981 recycling of oil revenues surpluses?

PS. Ref the same interview: Is the eurozone crisis over? “No!” says Mme Lagarde. After 20 years way too little has been done about solving the challenges of the euro and that, if not solved could bring EU down… and still Wolf categorizes his homeland Britain as “my idiotic country” because of Brexit.

PS. Ref the same interview: With respect to Greece, not a word was said about the EU authorities 0% risk weighting of Greece, which doomed it to its excessive public indebtedness.

@PerKurowski

Bank regulators would do well reading up on Shakespeare (and on conditional probabilities)

Sir, Robin Wigglesworth writing about risk and leverage quotes Shakespeare in Romeo and Juliet, “These violent delights have violent ends”, and argues “It is a phrase investors in the riskier slices of the loans market should bear in mind.” “Investors should beware leveraged loan delights that risk violent ends” August 25.

Sir, we would all have benefitted if our bank regulators had known their Shakespeare better. Then they might have been more careful with falling so head over heels in love with what looks delightfully safe.

The Basel Committee, Basel II, 2004, for their standardized approach risk weights for bank capital requirements, assigned a risk weight of 20% to what was AAA to AA rated, and one of 150% to what is below BB- rated. 

That meant, with a basic requirement of 8%, that banks needed to hold 1.6% in capital against what was AAA to AA rated and 12% against what is rated below BB-.

That meant that banks were allowed to leverage 62.5 times if only a human fallible rating agencies awarded an asset an AAA to AA rating, and only 8.3 times if it had a below BB- rating.

That meant that banks fell for the violent delights of the AAA to AA rated, which of course caused the violent ends we saw in 2007/08.

Sadly, from what it looks like, our current regulators might not have it in them to understand what Shakespeare meant, just as they have no idea about the meaning of conditional probabilities… if they could they might be able to understand that what is ex ante perceived as risky is really not that dangerous.

@PerKurowski

What if there had been a plumber and a nurse in the Basel Committee for Banking Supervision? Would the 2007-08 crisis have happened?

Sir, I refer to Andy Haldane’s “Diversity versus merit is a false trade-off for recruiters” July 23.

After just a couple of months as an Executive Director of the World Bank, I told my colleagues that since most of us seemed to have quite similar backgrounds (although I came from the private sector), if by lottery we dismissed two of us, and instead appointed a plumber and a nurse, we would have a better and much wiser Board. That of course as long as the plumber and the nurse had sufficient character to opine and ask, and not be silenced by any technocratic mumbo jumbo. 

For example what if when the Basel Committee for Basel II in 2004 set their standardized risk weights for the AAA rated at 20% and for the below BB- at 150%, a plumber or a nurse had been present to ask the following three questions:

1. Has that credit risk not already been very much considered by the banker when deciding on the size of their exposures and the risk premiums they need to charge?

2. My daddy always told me of that banker that lends you the umbrella when the sun shines and wants it back when it looks like it might rain, so is it not so that what is perceived as safe is what could create those really large exposures that could turn out really dangerous if at the end that safe ends up being risky?

3. And is credit risk all there is about banking? What if that below BB- rated has a plan on what to do with a credit that could mean a lot for the world, if it by chance turns out right? Are you with these risk weights also not sort of implying that the AAA rated is more worthy of credit?"

Those very simple questions could have changed the course of history as the banks would not have ended up with some especially large exposures to what was perceived (houses) decreed (sovereigns) or concocted (AAA rated securities) as safe, against especially little capital (equity), dooming the world to an especially serious crisis.

Sir, how do we get some nurses and plumbers, meaning real diversification, not just gender or race diversification, into the Bank of England and the Basel Committee? These mutual admiration club types of institutions, with their groupthink séances, urgently need it 

https://teawithft.blogspot.com/2004/11/basel-is-just-mutual-admiration-club.html

https://subprimeregulations.blogspot.com/2018/05/if-only-these-four-simple-questions-had.html

@PerKurowski

Predictability, in bank regulations, is more a dangerous threat than help

Sir, I refer to Robin Wigglesworth’s excellent discussion on the difficulties and hard choices central banks face when communicating their feelings and policies “Central banks might benefit from a healthy dose of ‘constructive ambiguity’”. May 14.

But let me focus (for the umpteenth time) on the concluding note “Predictability may be a hindrance rather than a help”

The Fed’s Governor Laid Brainard, in a recent speech “An Update on the Federal Reserve's Financial Stability Agenda” said: “The primary focus of financial stability policy is tail risk (outcomes that are unlikely but severely damaging) as opposed to the modal outlook (the most likely path of the economy).”

That is how it should be, but it is not! That the riskiness of bank assets, for instance with the help of credit rating agencies, could be somewhat predicted, tempted regulators into creating risk weighted capital requirements for banks; but that same “predictability” also blinded them completely to the fact that the safer something is perceived, the more dangerous does its fat-tail-risk become. For instance they assigned a risk weight of only 20% to the AAA rated and one of 150% to that which was rated below BB-. Is not the fat-tail-risk of what has been rated below BB- almost inexistent?

Governor Leal Brainard also writes: “Treasury yields reflect historically low term premiums--. This poses the risk that term premiums could rise sharply--for instance, if investor perceptions of inflation risks increased.” 

Indeed, but to that we must also add the possibility of the investor perceptions of Treasury infallibility changes for the worse.

When in 1988 the regulators, with Basel I, decided to assign a 0% risk-weight to some sovereigns they painted these into a corner. If that risk weight is not increased, then sovereigns will become, sooner or later over-indebted, and risk will grow until it hits 100%. If that risk weight is increased, ever so slightly, markets will be very scared. How to get out of that corner is the most difficult challenge central banks and bank regulators face. Let us not forget that in 1988 US debt that was $2.6 trillion. Now it is US$21 trillion, growing, and still 0% risk weighted.

PS. The only way to solve the 0% sovereign risk weight conundrum that I see, is to increase the leverage ratio applicable to all assets, until that level where the risk weighted capital requirement totally loses its significance.

PS. Brainard also stated “Regulatory capital ratios for the largest banking firms at the core of the system have about doubled since 2007 and are currently at their highest levels in the post-crisis era.” Regulatory capital ratios, when risk weighted, might mean zilch.

@PerKurowski

Does not “safe(ish) activities such as holding government bonds” contain the fattest most dangerous tail risks?

Sir, Gillian Tett writes “the Fed and the Office of the Comptroller of the Currency introduced proposals to “tailor leverage ratio requirements to the business activities and risk profiles of the largest domestic firms”. In plain English, this means banks can operate with a little less capital to absorb losses, provided they focus on safe(ish) activities such as holding government bonds.” “Trump’s mixed record on rolling back bank reform” April 13.

The Fed’s Governor Laid Brainard, in a recent speech “An Update on the Federal Reserve's Financial Stability Agenda”said: “The primary focus of financial stability policy is tail risk (outcomes that are unlikely but severely damaging) as opposed to the modal outlook (the most likely path of the economy).”

So let me ask: What is the tail risk of “safe(ish) activities” compared to that of riskier activities?

How fat or dangerous is the tail risk of what is rated below BB-? Very skinny indeed.

How fat or dangerous is the tail risk of what is rated AAA? Very, very fat indeed.

Government bonds? When in 1988 the regulators, with Basel I, decided to assign a 0% risk-weight to some sovereigns they painted themselves into a corner. If that risk weight is not increased, then sovereigns will become, sooner or later over-indebted, and their risk will grow until it hits 100%. If that risk weight is increased, ever so slightly, markets will be very scared. How to get out of that corner is the most difficult challenge central banks and bank regulators face. Let us not forget that in 1988 US debt that was $2.6 trillion. Now it is US$21 trillion, growing, and still 0% risk weighted.

PS. The only way to solve the 0% sovereign risk weight conundrum that I see, is to increase the leverage ratio applicable to all assets, until that level where the risk weighted capital requirement totally loses its significance.

@PerKurowski

Ex post dangers are inversely correlated to ex ante perceptions of risk.

Sir, Stephen King writes: “One of the main “costs” of global economic success… is excessive risk taking. Put simply, the good times don’t tend to last because we start to do stupid things that bring them to an end. Until the equity market wobbles in early February, most investors appeared to be as complacent about potential risk as they had been ahead of the crisis.” “Global good times make the world act stupidly” March 9.

Is that really excessive risk taking, or is not more a belief that there is little risk?

It is surprising how much ex post dangers get to be confounded with ex ante perceptions of risk.

The most dramatic example of that are the bank regulators who, in Basel II, assigned a risk weight of 150% to the below BB- rated, that which everyone knows is risky, and only of 20% to the AAA rated, that which everyone can so dangerously believe is very safe?

That our banks have landed in the hands of such mentally feeble minds as those of the Basel Committee, is indeed a tragedy.

http://perkurowski.blogspot.com/2016/04/here-are-17-reasons-for-why-i-believe.html

Per Kurowski

If you pick the wrong data stream, as bank regulators did, real tragedies can happen

Sir, Rana Foroohar writes: “The ability of a range of companies — in insurance, healthcare, retail and consumer goods — to personalise almost every kind of product and service based on data streams is not just a business model shift. It is a fundamental challenge to liberal democracy.” “Digital democracy is dangerous” January

Yesterday I received the following message from Amazon: “Based on your recent activity, we thought you might be interested in: The Complete Guide to Building with Rocks & Stone: Stonework Projects and Techniques”. Since, at least after the age of eight, I am absolutely sure I have never harbored any intention, much less a burning desire, to build with Rocks & Stone, I suppose that, in terms of using the correct data streams, they business are not really there yet. Neither are bank regulators, though that has much more serious consequences than me not clicking on that book.

Foroohar writes: “Illah Nourbakhsh, a professor at the Robotics Institute of Carnegie Mellon, [has] launched a project to educate elementary school children about the power of data, its risks and rewards, and how to use it to advocate for themselves.”

Great! I hope professor Nourbakhsh makes a case of explaining to the young that the regulators, when setting their current risk weighted capital requirements for banks, used the data about the riskiness of assets, and not the data about what risks those assets posed to the bank system. Had they picked the correct data stream, they would never ever have assigned a minimal risk-weight of 20% to what, perceived so safe as to be rated AAA, could be truly dangerous, and 150% to what, being perceived so risky so as to validate a below BB- rating, is totally innocous.

And then the professor could also, if he dares, explain to these youngsters that these perceived risk adverse regulations now have banks solely refinancing and extracting all value from the “safer” present economy; and not financing the “risky” future that they as young need to be financed, if they are going to have a reasonable future.

http://perkurowski.blogspot.com/2016/04/here-are-17-reasons-for-why-i-believe.html

@PerKurowski

If AI was allowed to have a crack at the weights used by current risk weighted capital requirements for banks, the regulators would surely have a lot of explaining to do.

Sir, John Thornhill writes that he saw an artificial intelligence program crack in 12 minutes and 50 seconds the mindbendingly complex Enigma code used by the Germans during the second world war” “Competent computers still cannot comprehend” January 9.

I wish AI would also be asked to suggest some weights for the risk weighted capital requirements for banks.

For instance in Basel II the standardized risk weight assigned to something rated AAA, and therefore perceived as very safe, something to which banks could build up dangerous exposures, is 20%; while the risk weight for something rated below BB-, and therefore perceived to be very risky, and therefore banker won’t touch it with a ten feet pole, is 150%.

I would love to see for instance Mario Draghi’s, Mark Carney’s, and Stefan Ingves’ faces, if artificial intelligence, smilingly, came up with weights indicating a quite inverse relation between perceived risks and real dangers to a banking system.

http://perkurowski.blogspot.com/2016/04/here-are-17-reasons-for-why-i-believe.html

@PerKurowski

Perceptions change realities. In banking, what’s perceived risky is safe and what’s perceived safe is dangerous

Sir, John Authers writes: “It is not the risks we worry about that harm us. It is what Donald Rumsfeld once called the “unknown unknowns” that we were not thinking about and did not even know about. In markets, assets deemed high risk tend to be priced so that they do little harm when things go wrong”, “Crises happen when what is thought to be safe surprises us”, November 11.

Precisely. So how would now Authers explain the logic behind the risk weighted capital requirements for banks, the pillar of current bank regulations? That which in Basel II risk weighted what is AAA rated with 20% and the below BB- with 150%. That which by allowing banks different leverages for different assets senselessly distorts the allocation of bank credit. That and about which I have written more than 2.600 letters to FT and that it has decided to ignore.

Sir, when will you dare to wake up to that harrowing fact that our banks are in the hands of regulators that have no idea of what they are up to? Or do you really think that all this is a minor problem?

@PerKurowski

Mr. Powell. Tear down that wall of risk weighted capital requirements that destroy bank systems and economies

Sir, Sam Fleming writes that Jeremy Stein, a Harvard academic describes Jay Powell, the newly appointed chairman of the Fed, as curious, incredibly collegial, and willing to learn. “A safe pair of hands takes over the Fed” November 4.

Sir, for the umpteenth time: All major bank crisis have resulted from unforeseen events, like major devaluations or wars, criminal behavior or excessive exposures to something that was perceived as safe when incorporated in the balance sheets of banks. Never ever from excessive banks exposures to something ex ante perceived as risky.

Therefore I pray Jay Powell is curious enough to ask the following question:

Colleagues, the standardized Basel II risk weights sets 20% for what is AAA rated and could be very dangerous; and 150% to what is below BB-, that which seems so innocous because bankers would not touch it even with a ten feet pole. Could you please explain the thinking process that supports such risk weights?

If he does, I hope Mr Powell will not be hindered by too much collegiality, so that he is able to realize that the absence of a convincing answer to that question should make him seriously suspicious of some of his colleagues. 

And if he then wants to learn something I would offer him as an appetizer offer him the following:

Mr. Powell, the future problems of the Fed (and other central banks) will be insurmountable if we persist in using risk weighted capital requirements for banks.

Credit is not flowing to where free markets offer the highest risk adjusted net margins but, since 1988, Basel I, and most specially since 2004, Basel II, it is flowing to what offers the highest risk adjusted returns on capital, something which totally distorts when banks are allowed to leverage assets differently, depending on how their risk have been perceived, decreed or concocted as safe.

And the distortions are alive and kicking in Basel III too.

That impedes the economy to realize its full potential and also does not in any way guarantee financial stability, much the contrary.

Our savvy bank loan officers have now been replaced by saddening bank equity minimizing, bonuses maximizing officers.

And for a more complete explanation I would refer Mr. Powell here

@PerKurowski

A designated group of Wise People, often self-designated from a mutual admiration club, does not guarantee any wisdom

Sir, Howard Davies the chairman of the Royal Bank of Scotland, when discussing financial regulations after Brexit writes. “The choice is presented as being between continued market access, as a rule taker from Europe, or taking back control of our own regulation and losing market access. The dilemma is nothing like so stark —EU bank capital regulations derive from the Basel Accords, and the UK remains a full member of the Basel Committee.” "Post-Brexit financial regulation cannot be left to negotiators" November 1

And to Work “out a new arrangement which responds to these realities” he suggests designating a group of Wise People.

Indeed, but Britain, Europe, we all need is bank regulators acting like wise men, and not like self-interested not accountable to anyone bankers.

Let me for the umpteenth time ask some questions.

What creates those excessive exposures that can endanger a bank system?

That which is perceived as very safe, or that which is perceived as very risky?

The regulators obviously believe the second, the very risky, as they in Basel II assigned a risk weight of 20% to what is AAA rated and one of 150% to what is below BB-rated.

What do you think is a more important purpose for our banks?

Lending to sovereigns and the AAA rated those with already ample access to credit, or lending to SMEs and entrepreneurs those that could help the economy to keep moving forward?

The regulators obviously believe the first, as they in Basel II allowed banks to leverage 62.5 times to 1 or more when lending to sovereigns and AAA rated, but only 12.5 times to 1 when lending to the unrated.

But have not Basel III changed it all? No, the risk weighted capital requirements remain in place and, on the margin, are just as distorting as ever.

How has this happened? The regulators acted like bankers and looked at the risks of bank assets, instead of wisely concerning themselves with if bankers perceived or managed the risks correctly.

Any risk, even if perfectly perceived, causes the wrong action if excessively considered.

And so for Britain and for the long-term prospects of the English banks that we have learned to admire, assure yourself of getting rid of all that pernicious Basel influence and so that your bankers can again be savvy loan officers, and not just the small equity minimizers they have so willingly become… in order to maximize their bonuses.

@PerKurowski

Beware, data, even when in data trusts, can be exploited in very dangerous dumb ways.

Sir, John Thornhill writes: “A country’s ability to exploit data in safe and creative ways will increasingly determine its success. It is high time for institutional innovation to encourage the process...” “Data trusts can stimulate the digital economy” October 30

Indeed but if data is exploited erroneously that can also cause great tragedies.

For example, even though there must exist loads of data on what caused bank failures, the regulators used data about the failures of the borrowers; something which of course c'est pas la même chose.

That explains how they could risk-weigh that rated so safe as AAA, and which could therefore create excessive exposures that could endanger bank systems, with only 20%, while that rated so risky as below BB-, and which bankers do not like to touch with a ten feet pole got 150%.

As a result we got a crisis because banks held too many securities rated AAA and too high exposures to what was also assigned very low risk-weights like sovereigns, like Greece.

As a result millions of not rated SMEs and entrepreneurs, and who were risks weighted 100%, have had their credit applications denied, as banks cannot leverage their equity as much as with other alternatives.

Sir, I suspect that “The EU’s sweeping General Data Protection Regulation, which comes into force in May and will be adopted by Britain also [though it] imposes strict restrictions on data use, will probably not contain any language with respect to dumb data use.

@PerKurowski

The Financial Times’ FT’s lack of curiosity is astonishing

Sir, to this date I have written you 50 letters questioning the wisdom of those bank regulators who assigned a risk weight of only 20% to what is AAA rated, and of 150% to what is below BB- rated.

It is precisely what’s perceived as very safe, AAA rated, that could cause the buildup of dangerous exposures that could result in major bank crisis if those perceptions turn out to be wrong; and it is precisely what’s perceived as very risky, below BB-, that is the most innocuous to our bank systems, since banks would never ever create any larger exposures to borrowers or investors so rated.

One could have thought that Financial Times would be interested in exploring and analyzing the arguments regulators could have been using to come up with such strange risk-weights.

But Sir you are clearly not curious at all about this. Why? Is not your motto "Without fear and without favor"?

PS. I have tried to make sense out of it all but failed

@PerKurowski

Monsieur Macron, more than a finance minister/ministry, Europe needs bank regulators who know what they’re doing.

Sir, Reza Moghadam lays out a proposal for a European finance minister/ministry that, though it “stops short of Mr Macron’s vision of fiscal union, with Europe-wide taxes and spending… focuses on the essential: a collective action mechanism for managing and stabilising economies in crisis.” “Macron is right — the Eurozone needs a finance minister” September 29.

Moghadam suggests the job description for that post should answer some key questions, and among these: “How can the risk of crises, and so fiscal payouts, be minimised? What would be the role of the minister in a crisis?”

The prime answer to the first question should be:

Getting rid of current risk weighted capital requirements for banks. These only guarantee that banks will hold the least capital, when a crisis, as usual, arises because of something that was ex-ante perceived as very safe turns out ex-post to be very risky.

The prime answer to the second question should be:

Make sure any stimulus, like QEs or low interest rates, flows freely so that the market has a chance to use it as efficiently as possible. This also requires getting rid of current risk weighted capital requirements for banks. These, by allowing banks to earn higher risk adjusted returns on equity on what is perceived safe than on what is perceived risky, seriously distorts the allocation of bank credit to the real economy.

Sir, in other words, much of what Europe could need from a finance minister, could be achieved by just firing the current inept bunch of bank regulators.

Basel II’s standardized risk weights of 150% for the below BB- rated and of 20% for the AAA rated, should be more than enough evidence on how little current regulators understand of banks and of finance.

Monsieur Macron, do you know bank regulators have decreed inégalité?

PS. Perhaps Monsieur Macron could ask his wife what has a better chance of causing those big bank exposures that can result in a major bank crisis, the ultra-safe AAAs, or the ultra-risky below BB-? I am sure Mme Macron would give him a more correct answer than what Mario Draghi would do; and this even though Draghi was the previous chairman of the Financial Stability Board and is now the chairman of the Group of Governors and Heads of Supervision the oversight body of the Basel Committee of Banking Supervision.

Perhaps Monsieur Macron should also ask Mme Macron what she thinks of 0% risk weights of sovereigns. Does she really think government bureaucrats know better than the private sector how to use bank credit efficiently? Reza Moghadam, who was previously at the IMF, has not expressed any sort of concern with that… but then again he is now the vice-chairman for sovereigns and official institutions at Morgan Stanley.

@PerKurowski