Regulators, shareholders and clients, do not have a vested interest in banks holding little capital; only bankers do, because of their bonuses.

Sir, Sheila Bair discussing ongoing pressures in the US to reduce bank capital levels, especially for the big banks, correctly opines: “Tough capital rules are a competitive advantage, not weakness. Studies show that well-capitalised banks do a better job of lending than more leveraged rivals. Thick capital buffers keep the banking system functioning through economic cycles. Every dollar reduction in bank capital weakens the public’s protection against big failures.” “The US must hold firm on bank capital rules”, October 2.

That is the argument that should prevail and the more it is understood that those who mostly stand to win by low bank capital requirements, are just the bankers themselves, as the less equity there is a need to compensate, the higher can the bonuses be.

To that I would perhaps add what I wrote in an Op-Ed in 2001, “Today, when the world seems to be asking much for bank mergers or consolidations, I wonder if we on the contrary should be imposing on banks special reserves depending on their size. The bigger the bank is, the worse the fall, and the greater our need to avoid being hurt.”

In 2003, in a workshop for regulators at the World Bank I repeated, “Knowing that “the larger they are, the harder they fall,” if I were regulator, I would be thinking about a progressive tax on size. “

But what is sadly almost completely left out in the debate is that, no matter how high or how low the capital requirements are, different requirements, especially when like the current risk weighted ones do are based on risks perceived and mostly already cleared for, dangerous distortions in the allocation of credit to the real economy could result.

Again, for the umpteenth time risks, even if perfectly perceived, cause the wrong actions if excessively, or insufficiently considered.

In that respect my first recommendation on any bank regulation reform would be to get rid of the risk weighted capital requirements for banks. They stand out as one of the worse piece of regulations ever.

What was the 2007-08 crisis (and Greece’s tragedy) made off? Exclusively, 100%, by assets ex ante perceived (or decreed) as safe, and against which banks needed to hold especially little capital.

@PerKurowski

Ask European SMEs and entrepreneurs if they believe Europe is overbanked?

Sir, I refer to Claire Jones’ and Martin Arnold’s “Bankers signal alarm over Eurozone lenders” October 10.

If were an SME or an entrepreneur, not being able to access the opportunity of the bank credit I need for me to have a chance to fulfill my dreams, I would be furious and desperate if hearing Sergio Ermotti, chief executive of UBS say “Europe is in a huge overcapacity situation, with a combination of private sector and public sector banks and quasi-public sector banks that have been allowed to compete”. 

Gary Cohn, president and chief operating officer of Goldman Sachs is also quoted with, in comparison to Europe and elsewhere with that the US banking sector was “in the best shape ever”. Nonsense, the real strength of any banking sector is a 100% function of the strength of the real economy they depend upon; and few would hold that the US and world economy “in the best shape ever”. That type of affirmation can only come from someone who believes the real economy should be serving the banks, and not caring one iota for need of the banks serving the real economy.

And Nigel Vooght, global head of financial services at PwC, the consultancy is quoted with”: “Banks need to wake up and start to react, because they are an integral part of society, but they don’t have a divine right to be here . . . All the banks are trying to switch from an interest rate-based model to a fee-based model.”

I totally disagree. Banks have, thanks to regulators, not been pursuing “an interest rate-based model” but an interest rate-based capital minimization model. If they are to be an integral part of society, switching from interest rates to fees will just not cut it. Banks need to realize that their fundamental role is to allocate credit efficiently as possible to the real economy, and that’s just not possible using different capital requirements based on ex ante perceived credit risks. 

@PerKurowski ©

Regulators must now help banks escape the business model of capital minimization their distortive regulations created

Sir, Richard Blackden, while discussing European banks, writes: “Their return on equity (RoE) — a common measure of a lender’s performance — has been hit by regulators’ demands that they hold more capital.” “European banks still out in the cold” October 4. 

If banks had to hold the same amount of capital against any asset (as they de facto used to), then banks could do traditional banking, which was investing without distortions in the assets that offered them the highest risk adjusted margins.

Currently banks can’t do that because, with the risk weighted capital requirements, the risk adjusted margin of an asset, has now to be placed in perspective of how much capital is required against it. And so banks have become used to maximize their risk adjusted returns on equity, not so much by banking in the traditional sense, but by minimizing capital.

Of course just generally increasing capital requirements, while leaving a part of the risk weighting distortions in place, makes it much harder for the banks and the markets to understand and adjust to new realities.

Therefore, the faster regulators rid the banking sector of the risk weighting distortions, and impose one single capital requirements for all assets, the better for banks and, even more important, the better for the real economy.

I am sure investors would love to invest in banks that were made to operate and compete as banks in the traditional sense.

This world were you can now read about a bank’s common equity tier one ratio being for instance 10.8 per cent; something which could seem indicative of a leverage of less than 10 to 1; only to find out the real leverage could for example be over 30 to 1; and this only because some regulators wanted for him and you to have better information, is too damn confusing for any normal investor that could have wanted to have some bank shares, in his conservative portfolio.

@PerKurowski ©

Banks, like Deutsche, to survive, need to move out of that artificial regulatory world of equity minimization

Sir, I refer to David Marsh’s narrative on Deutsche Bank’s troubles “German banking woes reflect shattered ambition and Schadenfreude” October 3.

There Marsh writes: “Throwing off its traditional conservatism, Deutsche Bank has moved into a realm of risk-taking where recklessness has ridden roughshod over rectitude”

Not exactly so. Deutsche Bank, like many, really like most banks, was moved into the=at artificial world created by regulators of avoiding risk-taking, since then it needed less capital, since then it thought it could earn the higher expected risk adjusted returns on equity that the market had been made to believe it should expect.

Before there is full understanding of the distortions that the credit risk weighted capital requirements for banks cause, there is little chance of finding sustainable solutions for the banks (and for the real economy).

Sir, there are many Deutsche Banks in waiting, just that they don’t know it, they just keep dancing to that lousy music the Basel Committee and the Financial Stability Board plays to them. As I have written to you many times before, banks must begin to maximize their returns on equity with banking, not with bank equity minimization.

@PerKurowski ©

How could regulators, and FT, believe that banks, if given the chance, would not to try to minimize capital?

Sir you write: “At present, large banks are allowed to use their own internal models to calculate risk-weighted assets — a crucial measure for determining the amount of capital they are required to hold. Yet over time, banks’ RWA as a proportion of total assets have been drifting down. There is a strong suspicion that this is not just due to making safer loans.” “Europe must address its banks’ enduring malaise” September 30

Of course not! What suspicion? How could regulators, and FT, believe that banks would not try to maximize their risk adjusted returns on equity by minimizing the equity they were required to hold? The big banks, with their own Supercalifragilisticexpialidocious risk models; the smaller banks, by abandoning lending to those with Basel’s standard approach requiring them to hold more capital, like SMEs and entrepreneurs.

There are two ways for a bank to maximize its return on equity. One is minimizing the equity they need to hold, the other is lending or investing in assets deemed risky, at interest rates that are higher than would be normal, to make up for the fact there is more capital involved, but thereby also making the risky riskier. Sir, if you were on a bank Board which one would you prefer?

Sir, the Basel Committee’s, the Financial Stability Board’s and your own naiveté, is just startling.

@PerKurowski ©

To get our banks back to where we need them to be, we need a complete brand new set of regulators

Sir, since Patrick Jenkins misses out on the very important question of how our banks got here, it is hard for him to understand where they should go. “FT Big Read: Banking: Too dull to fail?” September 9.

We got here because regulators, without doing any type of research, concocted the loony theorem that bank crises were the result of excessive exposures to what was perceived as risky; and therefore imposed risk weighted capital requirements for banks; more perceived risk, more capital – less risk, less capital.

That immediately resulted in that banks, instead of maximizing their returns on equity by means of banking with reasoned audacity, or as Deirdre N. McCloskey would probably phrase it, by banking with courage and prudence, maximized their ROEs by minimizing equity.

And so the real problem is that banks can’t find the way out of their predicaments, unless we get ourselves a brand new set of regulators. Some who know about Voltaire’s “May God defend me from my friends [the AAA rated], I can defend myself from my enemies [the below BB- rated]”; and who know about John A Shedd’s “A ship in harbor is safe, but that is not what ships are for.”

And we need that to happen fast! If we want our kids and grandchildren to have jobs in the future; and if we want to have a real economy sufficiently healthy to help pay for our retirements, dumb regulatory risk aversion imposed on banks is about what we least can afford

Would the UK, and the Western World have become what it is with utilities like banks? Of course not!

PS. Jamie Dimon has still not yet convinced me he is a real banker and not just one of those bank equity minimizing bankers.

@PerKurowski ©

Banks had and have little capital, not because of SMEs, but because of what perceived, decreed or concocted as safe.

Attracta Mooney writes “Rules introduced to shore up bank balance sheets left lenders reluctant to lend large sums to SMEs” “Fund houses take on banks over lending” September 8.

That is so wrong but, knowing you FT, you will do nothing to correct that impression.

Banks need to shore up their balance sheets, not because of SMEs, but because of too much lending against too little capital requirements, to what was perceived, decreed or concocted as safe.

Since the introduction of risk weighted capital requirements for banks with Basel I in 1988, and especially since Basel II of 2004 assigned different risk weights within the private sector, for instance 20% for what has an AAA to AA rated and 100% to what has no credit rating, banks were given huge incentives to lend to The Safe and became thereby reluctant to lend to The Risky, like the SMEs.

I pray one day banks get back to their business of earning their returns on equity by lending with reasoned audacity, instead of by minimizing their equity

Meanwhile, clearly shadow banks will have their day!

@PerKurowski ©

PS. Oops… sorry Attracta Mooney: “Rules introduced to shore up bank balance sheets left lenders reluctant to lend large sums to SMEs”, is correct.

My mistake was that I read it as some “specific new discrimination” had been introduced against the “risky” SMEs, something which Basel III did not, but Basel III (especially the leverage ratio which raised the minimum floor) and the crisis, have indeed intensified the discrimination that came from before. And here was my take on that Drowning Pool problem.

PS. Oops… sorry again Attracta Mooney: Again I must accept I was wrong. When writing my first commentary I had completely forgotten the liquidity requirements for banks enacted by Basel III. Of course these also affected the SMEs' fair access to bank credit.

For sturdy returns on equity, banks must abandon their dangerous road of maximizing returns by minimizing equity.

Harriet Agnew and Patrick Jenkins write: “This manner of doing business in which a handful of influential individuals could orchestrate the markets [1986]… In today’s terms would be completely illegal” “Big Bang II What’s next for the city?”

What? A handful of individuals orchestrated the markets more than ever when, for instance with Basel I in 1988, for the purpose of setting the capital requirements for banks, they decreed the risk weights of the Sovereign to be 0% and that of 100% We the People 100%.

And the authors quote Pierre-Henri Flamand with: “Brexit may mean a reverse Big Bang for the UK’s relationship with Europe… But it could mean Big Bang II for its relationship with the rest of the world. Brexit could improve the City’s prospects of doing business in parts of the world such as Asia and Africa where the growth is”

And on that I agree, but only if the banks go back to being banks making returns on equity by means of reasonably audacious banking, abandoning that dead-end road of maximizing returns by minimizing equity.

If they don’t then I guess we will have to endure other types of Big Bangs, like the on I was referring to when in 1999 I wrote: “The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause the death of the last financial dinosaur that survives at that moment.”

Since they introduced that systemic risk, risk weighted capital requirements for banks, and even after the 2007-08 crisis insist on keeping it, I still fear that a truly Bad Big Bang is closer than any Big Bang II.

In short, if the City wants to maintain or even gained competitiveness, then it must recreate itself in a non-distorted way. Escaping the the influence of the Basel Committee is much more important for Britain and its banks (and for all other nations) than any Brexit or no Brexit.

@PerKurowski ©