A governance code that forces regulators to clearly define the purpose of banks is much needed.

Sir you write, “From January 1, a revised corporate governance code will apply to UK-listed companies, for instance. It now states that the board’s duty is to ‘establish the company’s purpose, values and strategy, and satisfy itself that these and its culture are aligned’”. “Taking the measure of good corporate culture” December 27.

Sir, if only such code had existed and been applied by bank regulators.

As is the risk weighted capital requirements for banks which so dangerously distorts the allocation of credit to the real economy, were developed without any consideration to what is the purpose of banks, that is unless you think that being a safe mattress into which to stash away cash, is all that banking is about.

If “What are banks for?” had been asked, the Basel Committee would not have allowed banks to leverage much more with “safe” residential mortgages than with “risky” loans to entrepreneurs, those who could perhaps help to create more of the jobs needed in order to be able to service the mortgage and pay utilities.

You also write: “The Banking Standards Board, set up in 2015 to help the UK sector regain trust, runs an annual assessment of members, monitoring areas from honesty to accountability with a staff survey, focus groups and interviews.”

Sir, with respect to accountability, has that Board ever asked regulators why they think that what bankers perceive risky is more dangerous to our bank systems than what they perceive as save?

@PerKurowski

It was the regulatory culture and not the banking culture that went wrong. The regulators need a real bashing.

Michael Skapinker writes about “the recent decision by the UK Financial Conduct Authority to drop its probe into the culture of banking is wrong, and why members of the Treasury parliamentary committee are right to call for hearings into why it did so.” “Bankers need a (metaphorical) bashing — as do the rest of us” January 7. He also opines that: “Lax regulation led to the 2008 banking crisis.”

Sir, what if FCA’s probe into the culture of banking would have come up with the following:

“The culture of bankers has not changed; as usual they do their best to provide their shareholders with the highest risk adjusted returns on equity possible.

This time though, the regulators, the Basel Committee, allowed banks to leverage their equity differently with assets, depending on the ex ante perceived risk of these. For instance with Basel II, they authorized a leverage of over 60 to 1 for any AAA to AA private asset but only 12 to 1 in the case of a loan to an unrated corporation.

That meant of course that the risk adjusted returns on equity for safe assets shot up in the sky. An expected 0.5 percent risk adjusted margin to something safe could produce a 30 percent on equity, while a loan to a risky SME or entrepreneur, with the same expected risk adjusted margin, would only yield about a 7 percent ROE.

And so banks, naturally, as should have been expected, went overboard in exposures to for instance AAA rated securities and loans to Greece. And assets perceived ex ante as safe but that ex post turn out to be risky, is precisely the stuff bank crisis are made off. In this particular case the crisis ended up so much worse by the fact that banks were holding very little capital when the ex post realities set in.

Another unfortunate consequence has of course been that banks have either completely abandoned the lending to the risky, or are charging them extra premiums in order to compensate for the regulatory distortions.

We have to make a note that the distortion that caused the crisis remains in effect with Basel III.

In order for regulators to introduce the necessary correction, we want to remind them of the following:

Bank capital is to cover for unexpected losses and so, to have these based on expected credit risk, a risk already cleared for by banks by means of interest rates and size of exposure makes absolutely no sense.

The safer and asset is perceived the greater its potential to deliver unexpected losses.

The regulators should not worry about the credit risk of bank assets but about how banks manage those risks, and a good place to start is by not introducing distortions that makes it more difficult for them.

In conclusion “lax regulations” had nothing to do with causing this crisis. It was all about seriously bad regulations. Of course we feel sad about it, but our bank regulation colleagues must be held accountable for what they did, otherwise the moral hazard becomes just too big to handle.

Yours truly”

Sir, could it not be that FCA has abandoned its probe into the culture of banks because its conclusions would reflect very badly on the culture of regulators?

Skapinker with respect to the malpractice that is allowed to go undetected, like because of the silence of the media before the 2008 crisis writes: “One part of society needs to step in when another does not. It is through their actions that the system is kept honest, more or less, or at least honest enough for it to keep functioning”

Absolutely, but why has FT not helped me to do so? How can you be so sure I am wrong… or is it something else?

@PerKurowski ©

John Reed, competing on equal terms with equal capital requirements, traditional and investment bankers can be friends

Sir, John Reed writes that combining traditional banking and investment banking into a universal banking is inherently unstable and an unworkable model “Our universal banking mistake”, November 12. 

Reed argues: “Mixing incompatible cultures… make the entire finance industry more fragile…Traditional bankers tend to be extroverts, sociable people who are focused on longer term relationships. They are, in many important respects, risk averse. Investment bankers and their traders are more short termist. They are comfortable with, and many even seek out, risk and are more focused on immediate reward. In addition, investment banking organisations tend to organise and focus on products rather than customers. This creates fundamental differences in values.”

Reed might have a point, but, in my opinion, the main reason for the system being fragile is because regulators treat the different activities differently. With the credit-risk weighted capital requirements for banks, some are allowed to leverage their activities much more on equity than others. That introduces distortions that are impossible to clear for.

Apply one single capital requirement for all assets, for instance 8 percent, and the leveling of the internal playing field would strengthen the system and help to drive out many of those cultural differences. 

PS. Could farmers and the cowboys be friends, if treated so differently?

@PerKurowski ©