Risk weighted capital requirements for banks expresses a venomous lack of confidence in the future

Sir, Martin Wolf writes “the financial crises that destroyed globalisation in the 1930s and damaged it after 2008 led to poverty, insecurity and anger. Such feelings are not conducive to the trust necessary for a healthy democracy. At the very least, democracy requires confidence that winners will not use their temporary power to destroy the losers. If trust disappears, politics becomes poisonous” “Capitalism and democracy are the odd couple” September 20.

No! Free flowing not encumbered by crony statism capitalism is about as democratic it can be.

But one of the pillars of current bank regulations is that when banks lend to or invest in something perceived as safe they are allowed to leverage more their equity than if that is done with something perceived as more risky. That means banks can obtain much higher risk adjusted returns on equity financing the safer present than financing the riskier future.

The 2008 crisis resulted from too much exposure against too little capital to “safe” AAA rated securities, or to sovereigns decreed safe, like Greece.

The minimal response of the real economy to all stimuli, like QEs, is in much the result of “risky” SMEs and entrepreneurs not having a competitive access to bank credit.

To top it up a zero risk-weight of governments with one of 100% of citizens has nothing to do with democracy and all to do with statism brought in through backdoors.

“Democracy says all citizens have a voice; capitalism gives the rich by far the loudest.” Indeed but self appointed besserwisser regulators gave “the safe” more voice than “the risky.”

Wolf’s article ends with “After the crisis, hostility to free-flowing global finance is strong on both right and left”.

Mr. Wolf, that hostility was preceded, and caused, by that insane regulatory hostility against free-flowing bank credit, about which you have decided to keep mum on.

@PerKurowski

Before redistributing wealth, we owe it to the poor to give them the best opportunities to make it rich on their own

Sir, Deborah Hardoon of Oxfam, when commenting on the latest World Bank study writes: If world leaders want to stamp out extreme poverty they need to ensure that the poorest get a fairer share of economic growth. “Poorest receive an even smaller piece of the pie” October 5.

No one could argue with that. And yes, quite often there is no alternative than to redistribute income and wealth; though in that case, in order to keep the redistribution profiteers at bay, I much rather prefer a Universal Basic Income scheme.

But, before any redistribution, we must exhaust all possibilities for the poor to have the opportunity to achieve, on their own, a fairer share of the economy. And that, besides for instance the chance to having the best education possible, includes having fair access to bank credit, something which they are currently denied.

The risk weighted capital requirements for banks; less capital for what is safe; like the past, the rich, the sovereign, the AAArisktocracy - and more capital for what is risky; the future, the poor, the unrated We the People, only decrees inequality.

Anyone once informed about this, and that then keeps quiet on such odiously discriminating bank regulations, becomes to me a suspect of following a business or political model that depends on growing inequality. Impossible? Am I exaggerating? I don’t think so. I come from a country, Venezuela, where we have actually heard some government affiliates arguing “we need to keep them poor so as not lose control over them”.

PS. Let me in on a little secret; the more poor that become rich, the better for us all!

@PerKurowski ©

Global and local inequality is much driven by dumb bank regulations. World Bank and IMF should do something about i

Sir, Branco Milanovic, with respect to “global inequality” writes: “While for national statistics and inequality measures, there is at least a national government that citizens can blame for high inequality, there is no comparable body globally.” “Putting a number on global inequality is long overdue" September 19

Oh no! For quite a lot of that inequality, I totally blame the Basel Committee on Banking Supervision. With its risk-weighted capital requirements for banks, which favor the access to bank credit of the “Safe”, the developed, the rich, the past, it is basically decreeing inequality.

The interesting aspect with that global inequality driver is that it also causes inequality on a local national level. Just try to figure out how many millions of SMEs and entrepreneurs, all around the world, have been denied access to bank credit because of this regulation.

And yes both the World Bank and the International Monetary Fund have a role to play correcting this.

The World Bank, as the world’s premier development bank, knowing that risk taking is the oxygen of any development, should send bank regulators clear signals to the effect that nothing is as dangerous as excessive risk aversion.

And the IMF, in charge of worldwide financial stability, should also tell regulators to stop being silly, since no major bank crisis has ever resulted from excessive exposures to something ex ante perceived risky. 

PS. And FT should stop covering up for dangerous and failed bank regulators.

@PerKurowski ©

One inequality is so bad for growth that it should enter the Guinness Book of Records.

Sir, Chris Giles discusses the point of view of OECD and IMF with respect to the relations between inequality and economic growth, “Inequality is unjust — it is not bad for growth”, August 19.

Giles correctly writes: “Vigorously promoting competition…simultaneously boosted efficiency and fairness” and “attacking vested interests and the economic rents that allow the fortunate few to gain at the expense of others is a fruitful avenue for policy.”

But Giles, sadly, finds again no reason to mention the access to bank credit, one of the most fundamental ingredients of any pro-growth and pro-equality agenda, and how bank regulations completely distorted it. Here follows a short recap:

The basic capital requirement banks had to hold against assets in Basel II of June 2004 was 8 percent.

The risk weight for an AAA to AA rated sovereign (which means money managed by government bureaucrats) was 0%, so that the effective capital requirement was 0%, so banks could leverage infinitely when lending to such governments.

The risk weight for an AAA to AA rated private sector borrower (the AAArisktocracy) was 20% so that the effective capital requirement was 1.6%, so banks could leverage more than 60 to 1 when lending to this AAArisktocracy

The risk weight for a borrower without a credit rating was 100%, so that the effective capital requirement was 1.6%, so banks could only leverage 12.5 times to 1 when lending to for instance SMEs and entrepreneurs.

That meant that banks could leverage their equity and the implicit support they receive from taxpayers immensely more lending to “The Safe” than when lending to “The Risky”.

That meant that banks could earn much higher risk-adjusted returns on their equity when lending to “The Safe” than when lending to “The Risky”.

That meant banks would lend more and at lower relative rates to “The Safe” and less at higher relative rates to “The Risky” thereby curtailing the opportunities of those who have not yet made it.

And that had banks dangerously overpopulating supposedly safe-havens like the AAA rated securities backed with mortgages to the subprime sector and Greece; which caused the very bad for growth financial crisis; while simultaneously, equally bad for growth, negating the fair access to bank credit, the opportunity, to those tough we need to get going, most especially when the going gets tough.

The number one reform that needs to take place, for growth and equality to have a fair chance, is to get rid of the credit-risk weighted capital requirements for banks; and this even if it requires to temporarily lower the basic capital requirement for banks.

However the problem with that is that it would require all experts of OECD, IMF and all other having anything to do with bank regulations to explain, the why of this distortion in the allocation of credit to the real economy… and the why of their utterly long silence on it…

And of course, on the silencing part, FT and the likes of Chris Giles, are also among those having some explaining to do.

PS. Basel III, by tightening general capital requirements for banks has, on the margin, even increased some of the distortion the credit-risk weighting cause. 

@PerKurowski

Either the Financial Times and bank regulators, or little I, is utterly mistaken. I guess time will soon tell

Sir, on October 25 you title your editorial “The risk that QE will generate inequality”… even though you must know that’s what’s most probable. Shame on you!

And you also end by categorically stating: “Quantitative easing has been a bold and innovative experiment. Its outcomes were always uncertain, and some may have been unfortunate. But central banks have been right to do what they did.”

I am not entirely disputing that, but, over the last decade, I have sent to you, and to your reporters, over 1500 letters where I have argued the following:

The pillar of current bank regulations is credit-risk-weighted capital (equity) requirements for banks; which signify more ex ante perceived risk more equity - less risk less equity; which allows banks to earn much higher risk-adjusted returns on their equity when lending to “the infallible” than when lending to “the risky”... totally distorts the allocation of bank credit to the real economy.

And that causes banks to lend too much at too low rates to “the infallible”, and too little and at too high relative interest rates to “the risky”, like to medium and small businesses, entrepreneurs and start-ups. And, so by impeding the fair access to bank credit, it blocks equal opportunities, and therefore drives inequality.

And therefore, while those capital requirements for banks remain in effect, much of the liquidity provided by QEs is wasted, because it is not allowed to flow, by means of bank credit, to where the real economy would need it the most.

Sir, I guess we have since a long time ago arrived at an impasse. Either big Financial Times and bank regulators, or little I, is utterly mistaken. I guess time will soon tell.

If I am proven wrong, I will put on a dunce cap, take a picture of me, and post it, with my most sincere apologies to you and to bank regulators, on my TeaWithFT.blogspot.com.

If instead you are proven wrong... do you have it in yourself to do something similar?

Or is it that notwithstanding your motto "Without favor and without fear", you just do not dare to think of the possibility that the bank regulators could be so fundamentally mistaken?

PS. To introduce the virus of risk aversion into the banks of a Western World which has become what it is thanks to risk-taking, is, as I see it, pure financial terrorism.

PS. That financial terrorism has blocked the creation of millions of jobs that would have benefited our young.

NOTE: I am a happy husband, father and grandfather, with no scandalous past.

I have a long and I quite successful carrier as a financial and strategic private and public sector consultant and, in 2002-2004, I was an Executive Director at the World Bank.

I have studied in Sigtuna SHL Sweden, Lund University, IESA Caracas, London Business School and London School of Economics.

Since 1997 I have published over 800 Op-Eds in some of the most important newspapers in Venezuela.

I have had many letters and articles on banking regulations published around the world. And few can claim having warned in such precise terms on impending banking disasters as I did between 1997 and  2007. 

And I stake all my professional reputation, and the loving trust my family has shown me, on the fact that current bank regulators of the Basel Committee, and of the Financial Stability Board, have been wrong. Not a pardonable 15 degrees wrong, but an unpardonable 180 degrees totally wrong.

Fed’s Janet Yellen, as a leading equal opportunity killer, has no moral right to speak about inequality.

Sir, I refer to Robin Harding’s “Yellen risks backlash after remarks on inequality”, October 18.

There we read of “the high value Americans have traditionally placed on equality of opportunity”… that “Ms Yellen’s speech was about equality of opportunity”… about “the rise in inequality using recent Fed research and then laid out four “building blocks” for economic opportunity in the US: [among these] business ownership” … and that “owning a business [was an] important routes to economic mobility.

For over a decade I have argued that forcing those who are perceived as “risky”, and who therefore already have to pay higher interests and have lesser access to bank credit, to have to pay even higher interests and get even less access to bank credit, only because regulators think banks need to hold more capital when lending to them than when lending to the “absolutely safe”, is an odious discrimination and a great driver of inequality… a real killer of the equal opportunities the poor deserve in order to progress.

And of course, let us not even think of what the Fed’s QE’s have done in terms of un-leveling the playing fields. The fact is that had it not been for how the financial crisis management favored foremost those who had the most, Thomas Piketty’s "Capital in the Twenty-First Century”, would have remained a manuscript.

Sir, to hear someone who so favors regulatory risk-aversion, daring to speak about American values, in the “home of the brave”, in the land built up on the risk-taking of their daring immigrants… is just sad.

PS. To me it is amazing how bank regulators in America can so blitehly ignore the Equal Credit Opportunity Act (Regulation B)

When and if taxing the wealthy, because of inequality, remember that governments are part of the problem.

Sir, Thomas Piketty proposes to “Save capitalism from the capitalists by taxing wealth” March 29, and of course there’s nothing wrong with those having the most in society carrying the heaviest load… especially when it comes to finance opportunities.

But, as Piketty also admits, much of the reason for the growing unequal capital is that “the political process [is] so tightly captured by top earners”… and so governments are part of the problem, and can therefore not be trusted with efficiently distributing those revenues.

For instance, if the purpose is to fund education, I can think of many systems whereby funds from the wealthy can go directly to pay for the costs of less wealthy students, with no one getting their hand in the tilt for political or other purposes.

In other words, when redistributing economic wealth, we must make sure we are not increasing excessively the might of wealthy governments, since that can create and even worse sort of inequality, which could endanger capitalism even more.

Personally, before going after the wealthy, I would prefer to tax at a higher rate all those who benefit from special relations… be it monopolies, protected intellectual property or similar… because even in the case of wealth there are some which are better earned than others.

PS. And let me take the opportunity to remind of the need to get rid of that odious opportunity killer, and that odious inequality driver, that risk based bank capital requirements represent… and which of course has nothing to do with capitalism and all to do with regulatory foolishness.

When fighting inequality, in a sustainable way, it is more important to distribute opportunities than to redistribute income.

Sir Jonathan Ostry, a deputy director of the research department of the IMF holds that some recent research indicates that “Redistribution is associated with higher and more durable growth” “We do not have to live with the scourge of inequality” March 4.

Indeed that might be so but, before redistributing income, making sure opportunities are equally distributed, is much more important when fighting inequality, at least in a sustainable way.

For instance there are some ludicrous risk based capital requirements for banks that by favoring the “infallible sovereigns” the housing sector and the AAAristocracy, discriminate against the access to bank credit of “the risky”, mostly the medium and small businesses, the entrepreneurs and start-ups.

Unfortunately, both the World Bank and the IMF have been totally silent on this inequality driver for much too long.

If Ostry really wants to help out, then he should recommend IMF’s research department to look into the reasons for all major bank crisis in history. That research would be extremely helpful, since it would certainly indicate that the Basel Committee for Banking Supervision is going after the wrong “risky”.

Towards a counter cyclical Basel?

Sir, the financial system is there to safeguard savings, to generate economic growth by channeling investments, and to promote equality by providing full and free access to capital and opportunities.

Currently, our bank regulators headquartered in Basel are primarily concerned with the first goal, that of avoiding bank collapses, and how could it be otherwise, if you have only firemen on the board that regulates building permits.

Now, one of these days, the financial system, neatly combed and dressed in a tuxedo, but lying more than seven feet under in the coffin of financial de-intermediation, is going to wake up to the fact that it needs the presence of others in Basel. At that moment, perhaps we might start hearing about flexible capital requirements, moving up to 8.2 % or down to 7.8% by region, in response to countercyclical needs.

Meanwhile it’s a shame that even their first goal might turn out to be elusive, since although the individual risks have fallen with Basel regulations, the stakes have increased, as those same regulations accelerate the tendency towards fewer and fewer banks. 

PS. This letter that, while being an Executive Director of the World Bank I sent to the Financial Times. It was not published. But, because of its importance, I included it in my book Voice and Noise of February 2006