Bank regulators’ magnificent pro-cyclical machine is fueled by credit rating downgrades

Sir, Eric Platt writes: “US corporate downgrades soar past $1tn as defaults gain pace” December 5.

He discusses several of its implications but forgets one of the most important, namely its impact in the capital requirements for banks. As is, because of the risk weighted capital requirements for banks, these will be required to hold more capital, meaning they will be able to lend less, or even have to dispose of assets, meaning everything will get worse, all the courtesy of dumb and useless pro-cyclical regulations.

The moment a bank puts an asset on its books, that is the moment when it needs to have sufficient capital, and that sufficiency should obviously include the possibility of a future downgrading.

How is it bank regulators cannot understand that the safer something is perceived the larger the potential for bad news?

@PerKurowski ©

Capital requirements, non-performing loans, down-ratings and fines are causing severe bank credit austerity.

Sir, Henny Sender writes: “A world awash with dollars is rapidly being replaced by a dollar-scarce world” “Pain for those most in debt looks certain to become more severe” August 26.

Yes, and that dollar scarcity will, as is, primarily generate a contraction of bank credit. Consider what is happening:

Regulators are increasing capital requirements, which put banks lending capacity under pressure.

More non-performing loans and credit down-ratings of borrowers put additional strain on the banks.

And to top it up there are the fines. The recently reported fines of $260bn for the largest 25 banks, when calculated for a leverage of 15 to 1 results in about 4 trillions less bank-credit availability.

But when Sender writes: “It is still not sure how the pain will be distributed though”, I would tend do disagree.

If bank regulations keep the risk-weighted capital requirement component, there is no doubt of who are going to suffer the most; that will be those who generate the highest needs of capital, namely “the risky”, like SMEs, entrepreneurs and the downgraded.

Since those risky already are perceived to generate much expected losses, they will generate much less “unexpected losses”, and so we should lower the capital requirements for banks when holding these assets.

Sir, if austerity has to be imposed, I much prefer that to be government spending austerity than bank credit austerity. Banks have to put up at least some capital (equity) while government bureaucrats need not to risk a dime of their own.

@PerKurowski

Is the Basel Committee´s mistake a taboo in FT?

Sir, Aline van Duyn and Nicole Bullock report “Banks braced for knock-on effect of credit ratings” April 29. There, and though they refer to issues such like that the ratings of the banks could suffer because of the close relation with the risks of their respective sovereign, and of outright losses if selling sovereign debt at a loss, amazingly they do not say one single word about the increase in capital requirements for the banks those downgrading in the credit cause, retroactively.

All bad that can happen when lenders have followed high credit ratings and these are suddenly downgraded, are currently compounded by the fact that the regulators use exactly the same credit ratings when establishing the capital requirements for banks. This was the biggest mistake of the Basel Committee, and of which I have written to you countless times. Has it now even become a taboo to discuss that in FT?

How long are regulators allowed to persist with their foolishness?

Sir I refer to so many news, about when a downgrading of credit ratings cause much havoc, like for instance Nicole Bullock´s report on April 19 “Muni bond risks grow after S&P’s DeKalb cut”.

It is high time to ask our regulators some basic questions like when they believe banks incur in the risk of lending, when they make a loan or when the borrower is down-rated. Of course, when they make the loan!

And so I ask how long should we allow the regulators to insist on a foolish system with retroactive corrections, based on credit ratings, and which makes the difficulties encountered with a client that turned out to be worse than he was originally rated even more difficult, and not a system of upfront capital requirements independent of ratings.