Loony risk-weighted capital requirements block entrepreneurs’ access to fair credit.

Sir, Eric Schmidt writes“Right now, the UK, the EU and the US share a growing problem: we are experiencing a market failure in the way we support entrepreneurs.” “Our narrow view of entrepreneurs squanders talent”, November 28. 

Absolutely! But some market failures are government produced. 

If a bank lends to someone wanting to buy a house, something perceived as safe, the regulators allow it to hold much less capital that if it lends to an entrepreneur, something perceived as risky. 

So if a bank lends to someone wanting to buy a house, something “safe”, it will be able to leverage its capital much more than it can do if it lends to an entrepreneur, something

So if a bank lends to someone wanting to buy a house, something “safe”, it will be able earn much higher expected risk adjusted returns on its equity than it can do if it lends to an entrepreneur, something “risky”. 

But was it always this way? Of course not! This happened when bank regulators introduced the risk weighted capital requirements for banks. That which is based on that truly loony concept that what bankers perceive as risky, is more dangerous to our bank system than that what bankers perceive as safe. 

Since then millions of credit requests have been either negated or if approved, have had to support a higher than needed interest rate. 

Schmidt also writes about the need to “drop the tunnel vision promoted by many academic and professional specialisations”.

Absolutely! I have often argued that had there been: 

a plumber or a nurse disturbing the regulators’ group-think with an innocent question like “what has caused big bank crises in the past?” 

or a professional that had taken a course in conditional probabilities, 

or someone (incorrectly) quoting Mark Twain with “A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain”, 

or a golfer asking “why would you assign more handicap strokes to good players taking these away from lousy players like me?”, 

then the 2008 crisis would not have happened… and Lehman Brothers would still be alive and kicking.

God make us daring!

@PerKurowski

If only bank regulators had taken their clues from fixed odds betting terminal regulators.

Sir, Henry Mance and Camilla Hodgson write about the reduction of The government announced last year that it would reduce “the maximum stake on fixed-odds betting terminals — such as roulette — from £100 to £2 to tackle problem gambling.” “Problem gambling shake-up set to be brought forward” October 15.

Of course that will operationally distort fixed odds betting terminal playing, slowing it down, but by keeping the odds as designed for the game, meaning every bet having exactly the same probability adjusted payout, it will not alter the nature of it. 

We can only wish our current bank regulators had used a similar route because these, by allowing banks to leverage assets differently based on their perceived (or decreed) credit risk, actually determined that banks would obtain higher risk adjusted returns on equity on assets perceived as safe than on assets perceived as risky… and that has clearly distorted the whole nature of banks, when fulfilling their expected role of allocating credit efficiently to the real economy. How long would the game of roulette have survived such regulations?

In terms of betting on horses at the racetrack that would be like handicap officials taking off weights from the stronger and faster horses and placing these on the weaker slower ones. How long would horseracing tracks survive such distortions?

In terms of our ordinary golf that would be like handicap officials giving more strokes to the better players than to lousy players like me. How long would our golf clubs survive such distortion?

What’s going to happen to our bank systems? If these regulations persist, they are going to implode on some especially excessive exposures, to what is especially perceived (or decreed) as safe, against especially little capital. No doubt about it!

@PerKurowski

No casino roulette game would survive a Basel Committee kind of manipulation of the winnings of different bets

Sir, Adam Kucharski writes: “When math students at MIT discovered a lottery loophole in 2005, they formed a company — By the time the lottery was discontinued, they had… brought in a pre-tax profit of $3.5m.” “Investment and betting require similar skills — and luck” May 6.

The expected payout for every bet in roulette is exactly the same, and that’s why roulette has not been discontinued. So how long would Kucharski expect roulette to last if some regulators decided to multiply by some factor the winnings on the low paying “safe” bets, so that player could play for a longer time? Not long eh?

But that is exactly what bank regulators did when they allowed banks to leverage their equity more with what was perceived, decreed or concocted as safe, like when playing a color, than with what was viewed as risky, like when playing a number.

And so when Kucharski writes: “The boundaries between luck and skill, and gambling and investment, are not defined by industry or activity, but rather by the person playing, and who they are playing against”, we need to add, “and by the regulators”… especially if the regulators with hubris think they can distort for the better.

Unfortunately the bets of the banks are much more important than the bets in a casino. A bank, when it does not play a “risky” number, is in effect not giving loans to risky SMEs and entrepreneurs, those who might find the way of helping us to move forward the economy, so as it does not to stall and fall. And the banks, when they play too much the safe bets, AAA ratings, housing finance and sovereigns like Greece, then they will dangerously overpopulate safe havens, and cause crisis like the 2007-08 crash.

PS. Sports? What would be of golf if the handicap commission awarded the great players more strokes than what the lousy ones like me got?

PS. Sports? What would be of horseracing if the handicap commission reduced the weight the fast running horses had to carry, as a reward, and increased that of the slower horses, in punishment.

@PerKurowski ©

Let us hope the golf handicap system does not fall into the hands of something like the banks' Basel Committee.

Sir I refer to Anjum Hoda’s “The Bank of England´s fixation with price stability has cost us all” August 26.

Hoda puts squarely the blame for current problems, like weak wage growth and banking crisis, on “central bank’s decisions to price money incorrectly- a mistake that led to disjointed, mutually unsupportive outcomes in the capital and in the labour markets”.

I do not know sufficiently to hold an opinion on what role that played, but I do firmly believe that much more culpable were the risk-weighted capital requirements for banks, based on perceived risks already cleared for, which profoundly distorted the allocation of bank credit.

Since after soon a thousand letters to you trying to explain it I have not been able to do so, and though I do not know whether Anjum Hoda or you play golf, let me use its handicap system to illustrate what is going on.

The golf handicap system allows good and bad players to compete. Of course, now and again, the handicaps do not reflect the real golfing abilities of the players, just like credit ratings sometime misses the credit risk.

But what would happen if a Basel Committee for Golfing, because those with higher handicaps could be cheating themselves into some unjust winnings, decided to copycat their colleagues in the Basel Committee for Banking Supervision and instruct the following:

All those with handicap between 13 and 18 will have their handicap automatically reduced with 9 strokes, those between 7 and 12 with 6, and those between 1 and 6 with 3 strokes. 

Would that solve it? No, the unfortunate “unexpected consequence” of it would be that only scratch players were to be able to play golf competitively. Just like risky small businesses and entrepreneurs cannot currently compete in a fair way for access to bank credit, since that credit is now given primarily to the credit risk scratch players, namely the “infallible sovereigns”, the members of the AAAristocracy and house purchase financing.

PS. August 14 FT published a special report on Golf. In it Roger Blitz in “Sport stuck in a rut has to get a grip on its future” wrote “A single [governing] body would appear a logical outcome for an increasingly global game”. Let us golf lovers pray it does not fall in hands similar to the Basel Committee… since our breed would die out so much faster.

The bank crisis and the Basel Committee banking regulations explained to a golfer

Once there was a golf Club with a somewhat narrow golf course and where, even though the members were very careful, sometimes the hooking or slicing of the golf balls into adjacent holes, caused some serious accidents.

The Club’s Board was ordered to find a solution. To that effect the elected members of the Board consulted with some Experts and asked for recommendations. The Experts told the Board “most of the slicing and hooking is the product of bad players and so, if you want to solve this problem, you need to get rid of them”. Knowing this idea would not be received with much enthusiasm, and could in fact pose a direct threat to their reelection as members of the Board, they all decided to immediately delegate the “how” to a Committee of Experts.

The Committee of Experts decided that they needed to appoint some Golf-Player Rating Agencies (GPRAs) to rate the real quality of the players and thereafter created a parallel handicap adjustment requirement that effectively eliminated the bad players… without these even noticing it. According to their ratings, the AAA rated players had their normal handicap increased by 5 strokes, while the players rated B- or worse had their normal handicaps officially reduced by 5 strokes.

It worked! Though, just initially… Since having to play with a very low handicap was pure hell for a bad player, most of the bad players rapidly decided to change clubs and, as a result, the Club gained immense recognition for having the best players and being the safest club in the country… and the Committee of Experts was wildly acclaimed for having true experts. We will never ever have more accidents in our Club… was the Board’s self congratulatory message at the year’s end… four years ago.

But life is life, even among golfers, even in a golf club… and so the membership of the Club started changing. For instance, many great golfing has-beens around the country were attracted by a system that so clearly could help to pro-cyclically prolong their golf-life, just like many never-able-to-be-good players were also attracted by the possibility of joining a club renowned for having exclusively good golf players… and so they all started to read up and converse with the GPRAs about what was necessary in order to be conveniently rated.

There was such an avalanche of enquiries that the GPRAs got confused and overworked and started to make mistakes… to such an extent that the Club rapidly became overcrowded with dubiously rated golf-players. This would, of course, not have meant anything in the old days, but, since everyone had been duly informed that the accidents had been forever eliminated and that therefore there was no need for being careful… the accident rate shot up and rapidly turned, three years ago, into a pandemic disaster that threatens even the survival of the Club… and aggravated by the fact that the beginners and the decent-bad players, those who really are the heart and soul and economical support of a golf club, want nothing to do with a club that has a handicap system that so harshly discriminates against them, and have therefore joined other clubs.

But, golfing friends, the saddest part of this story is that since the logic of “getting rid of bad players and allowing only good players” sounds so very attractive and so very logical, the Board has not even today understood what they did wrong and so they insist on using exactly the same Committee of Experts to come up with better solutions. And the Committee of Experts is currently studying only refinements of their original handicap adjustment requirement formulas because, as “experts”, they cannot under any circumstances acknowledge that they were so fundamentally wrong.

And, unfortunately, the local media is not sufficiently "without fear and without favour" to dare to really fundamentally question the wisdom of the local Club´s Board or of the Committee of Experts.