Regulators, shareholders and clients, do not have a vested interest in banks holding little capital; only bankers do, because of their bonuses.

Sir, Sheila Bair discussing ongoing pressures in the US to reduce bank capital levels, especially for the big banks, correctly opines: “Tough capital rules are a competitive advantage, not weakness. Studies show that well-capitalised banks do a better job of lending than more leveraged rivals. Thick capital buffers keep the banking system functioning through economic cycles. Every dollar reduction in bank capital weakens the public’s protection against big failures.” “The US must hold firm on bank capital rules”, October 2.

That is the argument that should prevail and the more it is understood that those who mostly stand to win by low bank capital requirements, are just the bankers themselves, as the less equity there is a need to compensate, the higher can the bonuses be.

To that I would perhaps add what I wrote in an Op-Ed in 2001, “Today, when the world seems to be asking much for bank mergers or consolidations, I wonder if we on the contrary should be imposing on banks special reserves depending on their size. The bigger the bank is, the worse the fall, and the greater our need to avoid being hurt.”

In 2003, in a workshop for regulators at the World Bank I repeated, “Knowing that “the larger they are, the harder they fall,” if I were regulator, I would be thinking about a progressive tax on size. “

But what is sadly almost completely left out in the debate is that, no matter how high or how low the capital requirements are, different requirements, especially when like the current risk weighted ones do are based on risks perceived and mostly already cleared for, dangerous distortions in the allocation of credit to the real economy could result.

Again, for the umpteenth time risks, even if perfectly perceived, cause the wrong actions if excessively, or insufficiently considered.

In that respect my first recommendation on any bank regulation reform would be to get rid of the risk weighted capital requirements for banks. They stand out as one of the worse piece of regulations ever.

What was the 2007-08 crisis (and Greece’s tragedy) made off? Exclusively, 100%, by assets ex ante perceived (or decreed) as safe, and against which banks needed to hold especially little capital.

@PerKurowski

Are bankers stopping their regulators from boarding a ‘listening bus’, scared these might wake up and then wake them up?

Sir, Gillian Tett asks: “can lofty chief executives ever find a way to get out of the C-suite and view life from a completely different perspective?” “Jamie Dimon’s ‘listening’ bus? Get on board”

Sir, of course it is good that Jamie Dimon, or anyone else for that matter, tries to listen to different opinions, though a bus is not really needed for that. 

But much more important than Jamie Dimon doing so it would be for the lofty besserwisser bank regulators to walk down Main street in order to learn more about banking, and life.

Then they might begin to understand that it is not what bankers perceive as risky which is dangerous to the bank system, it is what they perceive as safe.

But, being able to hold assets perceived as safe against so little of bank equity, meaning obtaining the highest returns on equity with what’s “safe” and not having therefore to venture into riskier terrains, sounds like a banker’s wet dream come true. Therefore perhaps it is bankers, like Dimon, whom all block regulators from leaving their desks, except for some controlled visits to Davos and Jackson Hole.

PS. As the less equity that needs to be compensated the more room there is for big banker bonuses, I am really not referring to an insignificant wet dream

@PerKurowski

FT, though fearlessly blaming accountants, seems to sheepishly favor bank regulators.

Sir you write: “Unscrupulous managers, increasingly rewarded with equity incentives linked to accounting measures, have exploited the system. By writing up asset values in line with market values — whether real or estimated — they could book profits, distribute dividends, boost share prices and make incentive payments. Consider investment bankers’ bonuses, distributed ahead of the 2008 financial crisis but based on asset values that tumbled only months later.” “Reform accounting rules to restore trust in audit” August 3.

I agree, quite often accounting is a tool used for not quite ethical behavior. But, when you refer to the investment bankers’ bonuses, you are sure pointing in the wrong direction.

I dare you dare to go back and look at how these investment (and European) banks, before the 2008 crisis, were leveraged with assets perceived (mortgages), decreed (sovereigns) or concocted (AAA rated securities) as safe. Do you think that if they had been required to hold as much capital against these assets, as they needed to hold against assets perceived as “risky”, like loans to entrepreneurs, there would have been room available for all those bonuses? No way Jose!

And you do seem to suggest somehow that the accountants, before that crisis, should have considered the possibility of asset values tumbling only months later. Sir, the explosion, and its real causes, is much more important than the how it is accounted. If accounting is to become even more predictive then we are surely feeding even more worms into that open can of undue behavior.

When we have regulators who believe that what is perceived as risky is more dangerous to our bank systems than what is perceived as safe, I assure you that much more important than reforming any accounting rules, is reforming bank regulation rules. 

Sir, whenever, for whatever great sounding reason, it is argued that banks should not be required to hold more capital, you can be sure there are some neo-bankers thinking about their bonuses behind it.

PS. Neo-bankers? Yes because that is not the bankers I remember. Then they were savvy loan officers, now they are just equity minimizing financial engineers. I am sorry for feeling quite nostalgic.

PS. Most of the bonuses that are currently paid out to bankers, are still firmly rooted in the low capital requirements against what is perceived, decreed or concocted as safe.

@PerKurowski

High bankers bonuses results from having to remunerate very little shareholders’ capital

Lex writes: “More than 700 high earners last year in Deutsche Bank were paid a weighted average of €1.9m a year”. July 11.

What would they be paid if the bank needed to hold 10% in capital against all assets? The equity minimization is the prime driver of high bonuses. 

@PerKurowski

Bank regulators, get rid of risk weighted capital requirements, so that savvy loan officers mean more for banks’ ROE’s, than creative equity minimizers.

Sir, Gillian Tett referring to IMF’s recent warnings about the risks of overheating in risky loan and bonds markets; like “The proportion of US loans with a rating of single B or below (ie risky) rose from 25 per cent in 2007 to 65 per cent last year. And a stunning 75 per cent of all 2017 institutional loans were “covenant lite” writes: “it is possible — and highly probable — that non-banks are taking bigger risks, since they have less historical expertise than banks, and thinner capital buffers.” “The US has picked the wrong time to ease up on banks” April 27.

Yes, with risk weighted capital requirements banks ROE’s began to depend more on maximizing leverage, and so banks sent home many savvy loan officers and hired creative equity minimizers instead. As a result someone else had to serve “the risky”. 

But then Tett warns “Trump-era regulators” with a “it is foolish to be encouraging risky lending right now”. Wrong! It is always foolish to encourage risky lending. 

What Tett does not understand is that “risky lending” has nothing to do with a borrower being risky, and all to do with whether the lending to those perceived risky or those perceived safe, is done in such a way, with adequate exposures and risk premiums, so that the resulting bank portfolio is well balanced. 

The current extremely risky bank lending is the result of way too large exposures, at way too low risk premiums, to what is perceived, decreed or can be concocted as safe; and way too little exposures, at way too high risk premiums, to anything perceived as risky.

What regulators really should do, is to get rid of the risk-weighted capital requirements for banks. Then bank loan officers, those that could also show the non-banks the way would return, for the benefit of both the banks and the real economy.

Why do many bankers hate such possibility? Because high leverage, meaning little equity to serve, is the main driver of their outlandish bonuses. 

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

@PerKurowski

To allow banks to regain public trust and better serve the UK economy, begin by explaining how their regulators distorted banking.

Sir, you write about “the highly concentrated nature of the UK system, which is dominated by a handful of large institutions, with balance sheets skewed towards mortgage lending and other forms of consumer finance” and of a popular resentment of banker’s pay, “Corbyn’s calculated ‘threat’ to the banks”, December 2.

Banks’ balance sheets are skewed towards less-capital or very high risk-premiums, like lending to the sovereign, mortgage lending and other forms of consumer finance

Banks’ balance sheets are skewed away from what requires holding more capital and cannot afford to pay too high rates, like SMEs and entrepreneurs.

If you required banks to hold as much capital for all their assets as they must hold when lending to SMEs and entrepreneurs, then the story would be much different.

If you allowed banks to hold slightly less capital against loans to SMEs and entrepreneurs than against all other assets, that would more than compensate for the lack “of community banks or Sparkassen”; and introduce such economic dynamism that it could more than help you to confront any Brexit difficulties.

If banks needed to hold more capital in general, and therefore needed to compensate shareholders more, then there would be less available space for current abnormal banker bonuses. Ask Sergio Ermotti how much he has to thank regulators for his bonuses.

So, how to ensure that the banking sector can regain public trust and better serve the needs of the UK economy? Sir, why not begin by explaining what the bank regulators have done. We can of course not ask the bankers to explain that.

Oops, but that would mean you would have to explain why you have silenced my soon 2.700 letter to you on this, and that could be too embarrassing for one with your motto.

A brief aide memoire

@PerKurowski

Our dear George Banks, having anteceded the Basel Committee, would never have dreamt about current bank bonuses

Sir, Jonathan Ford writes: “As Andy Haldane of the Bank of England points out, there are few ways for banks to bolster their returns to shareholders. One is to loosen underwriting standards and so increase the riskiness of assets they invest in. The other is to squeeze the amount of regulatory capital they set against the investments they make.” “Banking bonuses ought to be dead and buried by now” August 14.

Haldane is wrong about the increase of riskiness of assets, to improve the return on equity that is of little and doubtful sustainable value (bankers have even been fired for that); but he is absolutely correct about the regulatory capital.

When current bank regulators were taken for a ride by bankers and convinced, like for instance with Basel II of 2004, to set the capital requirements against something rated AAA to AA at only 1.6%, meaning an authorized leverage of equity of 62.5, they allowed bankers to earn returns on equity beyond their shareholders’ wildest dreams, and this even after keeping for themselves huge eye-watering bonuses.

Place a 10% capital requirement on all bank assets and those bonuses would immediately begin to vanish in the air as a result of shareholders becoming again important to banks.

As a huge bonus for the rest of the economy, that would also eliminate the current odious distortion of bank credit in favor of “the safe”, sovereigns, AAArisktocracy and houses, and against the risky, SMEs and entrepreneurs.

PS. Here is a letter from George Banks III, after having been called a bankster.

George Banks (the first)

@PerKurowski

Should bank shareholders really want lower capital requirements for what’s perceived as “safe” than for what’s “risky”?

Sir, Simon Samuels writes, “it may soon be time for shareholders to place their bets on how they like their banks — skinny on capital but with a ton of rules designed to cramp their riskier activities, or fat on capital with the freedom to take more risks… should [bank] shareholders celebrate or fear more lenient regulators?”, “Shareholders’ dilemma on financial regulation” April 17.

That is a faulty or at least incomplete description of the problem.

Current capital requirements are lenient for what is perceived, decreed or concocted as safe, and more severe for what is ex-ante perceived as risky. And that means, in one word, DISTORTION.

As a consequence banks will not be allocating credit efficiently, so the real economy will stall and fall, something that has severe consequences, at least for the bank shareholders’ grandchildren.

Also, though low equity against assets perceived as safe might in the interim produce high risk adjusted returns o equity, sooner or later the bank will, GUARANTEED, end up holding dangerously large exposures to something ex ante perceived as safe but that ex post suddenly turns out to be very risky.

I can understand some bank managers going for maximizing their bonuses in the short run, at whatever cost, they don’t have to give back their bonuses when shit hits the fan; but I cannot understand a bank shareholder who, aware of the regulatory distortions, find this acceptable.

Samuels ends with “shareholders should focus less on the rules the regulators set and more on how managers navigate their business. To quote Warren Buffett: “Banking is a very good business, if you don’t do anything dumb.”

On the contrary, as is, the regulators must focus on the rules the regulators set because these rules, this interference, is the greatest source of dangers for their banks and for everyone’s economy.

Sir, what good does a great run on bank profits do you if at the end of the day you find yourself standing on top of some worthless rubbles?

PS. Sir, do not forget that, amazingly, these risk weighted capital requirements are portfolio invariant.

PS. THE QUESTIONS

@PerKurowski

Low capital requirements for banks lead, automatically, naturally, to high bonuses for bankers

Sir, Diane Coyle writes: “If the chief executive of a company seriously tells me, as a shareholder, that he will not put in as much effort as he otherwise would unless I link his pay to a handful of metrics, I have every reason to be doubtful about hiring him to do the job” “Burger flippers deserve bonuses, bankers do not” May 26.

That is absolutely right; as long as the shareholder was putting in enough efforts himself… otherwise he might better shut up in silent complicity.

If you make the argument that the bankers are helping to convince the regulators that the shareholders of a bank need to put in very little equity, and therefore the shareholders are made more irrelevant, then it is much easier to understand why bankers have been able to get away with what they are doing.

Bank equity, allowed to be highly leveraged, especially on what is perceived as safe, has produced great returns, which have kept bank shareholders happy and in a complacent mood.

Ask the banks to triple their capital, or at least put up 10 percent of equity against absolutely all assets, and then you might begin see some bonus restricting relations developing between bank managers and the shareholders of banks.

@PerKurowski ©

The huge bonuses paid to bankers were enabled by lousy regulators, and were not the result of free market capitalism

Sir, John Plender writes: “Like the robber barons, today’s bonus-hungry bankers have shown once again how capitalists excel at giving capitalism a bad name”, “Capitalists excel at giving themselves a bad name” January 25.

No! Free market capitalism would never ever have enabled the payment of extraordinary high bonuses to bankers… because in free market capitalism banks would have had to hold much more equity than what banks currently hold, and so therefore not only would the risk adjusted returns on equity be lower than what has been seen, but there would also have been less left over for bankers’ bonuses.

With Basel II regulators allowed banks to hold extremely little capital (equity) against assets perceived as safe… for instance only 1.6 percent when lending to the AAArisktocracy. That allowed banks to leverage extraordinarily the explicit and implicit support given by society, for instance by deposit insurance schemes… while having to provide a decent return on very little equity… which left of course a lot of margin to pay the huge bonuses.

The real question is how come these extremely lousy regulators are getting away with what they did and are doing… having even been promoted for it.

@PerKurowski ©

If FT cares more about bankers pay than about the distortions that caused the tragedy of Greece… what’s for the rest?

Sir, I do not know how many articles I have read in FT, since the crisis of 2007-08, about how much too much bankers are paid; the latest Laura Noonan’s "Top US bank chiefs race ahead of rivals on pay” July3.

But I sure know there have been very few articles, if any, in FT about the distortion that credit-risk weighted capital requirements for banks cause in the allocation of bank credit to the real economy.

Because of Basel II, between June 2004 and November 2009, and because of Greece’s credit ratings, banks had to hold only 1.6 percent in capital when lending to the government of Greece… an authorized bank leverage of more than 60 to 1 when lending to Greece? Have you ever heard such a crazy notion? Of course that distorted and made banks lend much too much to the government of Greece… Has anyone for instance asked Merkel about the responsibility of German banks in satisfying the spending addiction of the Greek governments? When it comes to the use of drugs don’t we usually punish the pusher more than the consumer?

But no, clearly how much bankers earn is of much more interest to FT.

FT why don’t you try to figure out how much bonuses were paid out to bankers from book profits derived from pushing loans to Greece? That would perhaps be a more interesting angle.

PS. Greeks, beware of Basel Committee's bank regulators bringing gifts to your government!

@PerKurowski

Stop blaming low productivity on the “bonus culture” there are even worse cultures, like the Basel Committee’s

Sir, I refer to Andrew Smithers’ “Executive pay holds the key to the productivity puzzle”. May 29.

Smithers writes: “Productivity improves with the amount of capital per employee, and the efficiency with which it is used…. We do not know how to improve the efficiency with which capital is used”.

Yes we do! And the first thing to do is to eliminate those odiously manipulating credit-risk-weighted capital requirements for banks, which distorts all the allocation of bank credit to the real economy.

Of course bonuses distorts but, in the great scheme of things, there is little to be achieved correcting for that, in the bigger companies where the problem is present, if we do not allow all “the risky” SMEs and entrepreneurs to have fair access to bank credit, because of outrageously dumb regulations.

Really, unless blessed with eternal ignorance, how can bank regulators live with themselves knowing what they are doing?

@PerKurowski

Though capable Giants could be great at smoothing over a crisis, the not so capable could help more getting over it.

“How lucky could you be that you have a guy who spent his life studying the Great Depression [Bernanke], combined with a guy who’d spent almost his whole life working on every global financial crisis for the previous 20 years and was a genuine markets guy [Geithner], combined with somebody who had been chief executive and chairman of one of the top investment banks in the world [Paulson, in the leadership positions they were in during the biggest financial crisis of the century”

Sir, that is what James Gorman, “the Morgan Stanley boss”, tells Tom Braithwaite during his “Lunch with the FT”, “Banking is sexy, creative and dynamic” May 23. I first wince a little bit about the “genuine markets guy” since we really did not see a lot of genuine market solutions but, what really comes to my mind, is the following.

What if instead of these Giants, there would instead have been some perfectly inept in their government positions? It would clearly have been a much harder and harsher landing… but could it no be that in such case we would have gotten over the crisis faster and more completely? As is the experts might be experts smoothing things out during a crisis but perhaps not in solving it. As is we still live with much overhang in terms of huge government borrowings, QEs to reverse, the permanence of some actors the world could have been better off getting rid of, and the same source of distortion that caused the crisis, the credit risk weighted capital requirements for banks.

In August 2006 FT published a letter I sent it titled “Long-term benefits of a hard landing”, and year after year I find more reasons to argue for that. Sir, had there been a harder landing don’t you think that the system would for instance have cleansed itself more of “$22.5m” CEOs annual pay packages?

The smoothing of a crisis, though nice for some, creates its own victims… Our young, with lousy employment perspectives, could well be the victims of the capable Giant's guiding and smoothing hands. 

http://teawithft.blogspot.com/2006/08/long-term-benefits-of-hard-landing.html

@PerKurowski

Limit tax deductibility on what is paid to a CEO, to 10 times the average salary. That sends a discreet social message.

Sir, I refer to Michael Skapinker’s “It is time for a brave CEO to ask for lower simpler pay” May 21.

Skapinker is of course right in his wishes… also because I believe it is very useful for a company to attract CEOs that do not give the factor of financial remuneration an importance weighting of, let us say, more than 50 percent.

But why not also help “the brave CEOs” to make up their mind. For instance what about limiting the tax-deductibility for the company of all salaries and bonuses paid to the CEO to 10 times the amount of the average (or median) salary paid in the company? That should be a good place to start sending out a discreet social message to corporations and their shareholders alike.

As compensation above that limit would be made with after tax profits that would stimulate everyone to make really sure the CEO has really earned it.

@PerKurowski

PS. http://teawithft.blogspot.com/2013/03/why-must-uk-say-no-to-eu-on-bonuses-cap.html

Bank regulators facilitated, even empowered, financiers to turn their back on the forces of equality.

Sir, John Kay writes about how the share of finance professionals in the growing top 1 percent share of all income has grown dramatically, “How financiers turned back the forces of equality" Wednesday 7.

Kay holds that results from “the growth of the finance sector; and the explosion of the remuneration of senior executives”.

To that, at least in the case of banks, and which set the tone for the whole sector, we would have to add: The lower the capital requirements the smaller is the relative importance of shareholders, and so the larger the availability for the remuneration of professionals. And that becomes especially important when the markets perceive, that governments will to a very large degree step in and defend the banks if they run into problems.

And so let’s retitle it. Bank regulators facilitated, even empowered, financiers to turn their back on the forces of equality.

Bankers, by limiting the voice of their parents to the 4 to 8 percent capital range, find it easier to write their own bonuses.

Sir, I sympathize deeply with much of the arguments presented by Lucy Kellaway in a “Lesson from kindergarten on executive bonuses” June 2.

That said I am not sure the analogy to her challenges as a mother is so accurate in this case, since I have the feeling that she does indeed still influence quite a lot the bonuses of her kids. And, that is not the case of banks.

The bankers, the kids, have been able to convince the regulator that the voice of their parents, the shareholders, should be very limited… to the 4 to 8 percent range. And the result of it all is that bankers are in essence very much capable of setting their own bonuses, which is something I am sure Lucy Kellaway would rightly fear if her kids could do.

Let us give banker’s parents more voice!

Instead of labor and capital struggling against each other, perhaps they should discuss what to do with their intermediaries

“The real disaster lies in youth unemployment” writes John Plender in “Recession has revived labour´s struggle against capital” January 11.

And there is no doubt he is right about it and there is no doubt we have no chance of solving it while we have bank regulators who insist on that “unexpected losses”, those for which they require banks to have capital, are higher for the “risky” than for the “safe”.

Because, by means of Basel´s risk-weights, this translates into the banks being able to earn much higher risk-adjusted returns on equity when they lend to the “safe”, than when they lend to the “risky”.

And that translates of course into that banks will not any longer lend to finance the “riskier” future as much as previous generations of banks did.

And Plender writes: “The real driver of income inequality over the past decade has been top pay – specifically, of chief executives and bankers” and I ask. Could the bonuses of bankers have been as high as they were if bank capital has been required to be as much as it used to be pre-risk weighting days? No way!

And so instead of labour and capital struggling against each other, perhaps they should discuss what to do with the intermediaries… whether these are executives, regulators or politicians.

I mean, do not those who receive low salaries have a lot in common with those who receive low interest rates on their savings?

“Little people”, do not listen to Chris Giles, if they finance you at a too high rate, try to keep your consumption low

Sir, Chris Giles writes “It is also deeply patronizing for those with reasonable comfortable incomes to fret that the little people are consuming too much for their good and for that of the wider economy”, “In economics consumption is for life not just for Christmas” December 19.

That might be easy for him to say, he who probably either pays off in cash his credit cards or has the benefit of a reasonable financing rate. If Mr. Giles simply looked at what the “little people” paid in finance costs for their financed consumption, he might think differently.

One of the problems is that much of what the “little people” could spend in consumption, for their good and for that of the wider economy”, goes to pay bonuses to bankers… would Chris Giles by any chance be a banker or a shareholder of a credit company?

What´s banker´s bonuses got to do with it?

Sir, Sharon Bowles, the Chair of the Economic and Monetary Affairs Committee of the European Parliament writes: “We know from bitter experience that the size of bonuses induced overly risky behavior and the peddling of poorly understood products contributed significantly to the financial crisis”, “Bureaucrats are not behind bonus cap proposal”, March 7.

Wrong! Being able to extract some investor value, like an AAA rating, from something not at all that valuable, is a normal financial operation, which often provides benefits to all parties involved.

The problem this time was that the appetite for what detonated the crisis, the securities collateralized with mortgages to the subprime sector in the US, just went crazy, when suddenly banks were allowed, by their regulators, to hold these securities against only 1.6 percent in capital, only because they had an AAA credit rating, issued by some human fallible credit raters. An authorized mindboggling leverage of 62.5 to 1!

No one, except those receiving them of course, likes runaway or not merited bonuses. And perhaps governments should cap the tax-deductibility of bankers’ annual pay. But, to read, five years after the crisis detonated, bureaucrats believing that fixing banker´s bonuses problem should have a high priority that is truly saddening.

The EP should concentrate instead on eliminating how regulations favor so much bank lending to “The Infallible” and thereby discriminates against “The Risky”, and thereby creating huge distortions in the real economy, because that is what is really taking Europe down… and fast.

The EP should also ask itself whether is wise to keep on consulting with bank regulators which by any accounts should have been fired long ago. Hollywood would never be so dumb to allow someone who produced a Basel II flop, to go out and try Basel III, with the same scriptwriters

PS. To help EP better connect the dots let me remind it that when banks lent to Greece, they were also allowed to leverage 62.5 times to 1; and also that nothing perceived as “risky” has ever created a major banking problem, only Potemkin Infallible do that. Capisce?

Stop your fixation with bankers’ bonuses tree, and look at the forest of misallocated resources instead

Sir, I agree with much of what Andrea Leadsom writes in “Britain must do whatever it takes to nix the bonus cap”, March 5. 

That said I wish he and you would all stop focusing on the trees and look at the forest instead. Much worse than unmerited bonuses are all those missed opportunities and misallocated resources which result from the current bank regulators having concocted dumb capital requirements for banks which favor “The Infallible”, those already favored, and thereby additionally discriminate against “The Risky”.