More than “safer” we need to make our financial system more “functional”

Sir, as an Executive Director in the World Bank, 2002-2004, during the Basel II discussions, with respect to big banks I said: “Knowing that “the larger they are, the harder they fall” if I were regulator, I would be thinking about a progressive tax on size”. 

And, so of course I find Mark Roe’s and Michael Tröge’s proposal of “How to make the financial system safer”, March 25 quite interesting.

That said many questions come to mind.

First, if there is a tax on liabilities, who will pay for it the most, borrowers by means of higher interests, or depositors by means of lower interests?

And, since what equity holders are really out after is high returns on their equity, and these are much obtained through leverage, it would not seem like these taxes would be able to sufficiently substitute for regulations that limits bank leverage.

But the authors also state: “Until now, regulators have largely used command and control mechanisms to make banks safer: requiring them to have more capital, banning or reducing their riskiest activities, and punishing reckless behavior after the fact”. And on that I must comment.

What regulators have NOT done is requiring banks to have more capital to reduce risky activities; what they have done is allowing banks to have very little capital for what was perceived as “absolutely safe” not risky activities… and that is what really has created the big risks.

And so when the authors write that “Banks understandably do not like regulators getting involved in their strategic decisions” it shows they have not yet understood what has been going on.

On the contrary, banks have LOVED regulators for getting more and more involved with their strategic decisions… to such an extent of having even adopted the banks risk models of capital allocation.

No it is we, the not bankers, we who want safe and functional banks, we who do not want the regulators to get involved with banks’ strategic decisions. Let the banks do what they want in order to prepare for any expected risks, and expected losses, because that is truly all they can do.

The regulator’s role on the contrary is to make sure there is some bank capital to take care of the unexpected risks, of the unexpected losses, of the risks of banks not being able to do good strategic decisions, and for that it is almost a sine qua nom, that the regulators stay away as far as possible from the influence of banks.

Right now, as a result of regulators layering their risk perceptions on similar banker’s risk perceptions, we have an unsafe and utterly dysfunctional banking system incapable of allocating credit efficiently to the real economy. And so, before doing anything more creative let us just correct for that.

And also, more than bankers devising “fiendishly complicated transaction to work around the rules”, the reality might be regulators designing innumerable rules for the bankers to work around.

The Western world is being brought to its knees by mad bank regulators.

The Western world is the result of risk-taking in all shapes and forms… “God make us daring!”, ends one of the psalms sung in its churches. 

And so when regulators, with their capital requirements, decided to give the banks additional incentives to embrace what was perceived as “not-risky” and further avoid the “risky”, like small business and entrepreneurs, only so that banks would not fail, they stuck a dagger in the very soul of the Western world. 

And besides, they used a lousy dagger that could not stop banks from failing, because it is precisely when banks embrace too much something that is perceived as absolutely not risky, when they fail, en masse. 

And Mario Draghi is one of those Western-world-slayers regulators who do not yet even understand he is very much responsible for “L’economia castrata”. Therefore, Sebastian Mallaby’s heading “This will not be enough, Mr. Draghi”, August 8, would have been more precise stating “Nothing Mr. Draghi does, will be enough” 

Survival of Europe has to begin by rescuing the possibilities of its risk-takers to take risks, and that begins by firing the nannies in the Basel Committee and in the Financial Stability Board, and renaming the latter immediately the Financial Functionability Board.

Again, can we please have a Financial Functionability Board?

Sir, Gillian Tett writes, “After all a financial system in which transactions are secured on assets is likely to be a healthier system than one which is largely – or patchily – unsecured”, “Cyber finance takes its collateral thinking test”, August 6. Why is that so, how on earth does Ms. Tett know that? 

Ms. Tett, like most, is stuck in a Financial Stability Board mentality of let us castrate the banks so that they do no harm. She, like most, is seemingly incapable of understanding that giving the banks incentives to go for the officially not risky and avoid the risky, was a primary cause for this crisis. 

The healthiest banking system will always be the one helping to produce the healthiest economy. In this respect we urgently need a Financial Functionability Board, able and willing to understand also the risks of risk-avoidance, so as to stop the regulators from digging us further in this hole of “L’economia castrata” where we find ourselves.