Are identified non-performing loans truly riskier to bank systems than those many still out there waiting to be identified as such?

Sir, Arthur Beesley reports that “ECB’s Single Supervisory Mechanism, a watchdog created in 2014 to oversee eurozone banks, is pressing Irish lenders to achieve a 5 per cent NPL ratio in line with European norms”,“Irish banks step up efforts to shed bad debts” August 22.

Of course it is in general terms good when banks clean up their balance sheets but, I must ask: Why should identified non-performing loans be more risky to a country’s financial stability than those loans that could be about to be identified as such?

“A 5 per cent NPL ratio in line with European norms” That sounds precisely like what deskbound regulators might invent in order to show everyone they’re working hard. How much better would it not be for all if these regulators took some time off in order to take a course on the meaning of conditional probabilities; I mean so that could move away from that simpleton idea of risk weighting the capital requirement for banks based on the risks that are perceived.

“There’s a very healthy demand for loan assets on Irish property,” said Owen Callan, equity analyst at Investec in Dublin…[so] it’s not a bad opportunity to get rid of some of these loans in what is a very strong market.”

Great! But if that was not the case, should Irish banks anyhow have to obey regulators sitting in Fankfurt am Main inventing general rules that should apply to all European banks, independent of their particular realities… like they did when they assigned a 0% risk weight to Greece?

Sir, I would never have voted for Brexit but, each day that goes by and I see how EU authorities do not confront the real EU challenges; like how to handle the absence of a foreign exchange adjustment mechanism lost with the Euro; and instead promote themselves with all type of small issues that are better handled by local authorities, I get the feeling it might have not been such a crazy vote.

@PerKurowski

Here are two recommendations to Raghuram Rajan on how to get India’s banks to become functional banks

Sir, I refer to David Keohane’s and James Crabtree’s “India’s central bank struggles to ensure lenders pass on interest rate cuts” April 22.

There are references to a “broken down process of monetary transmission through which the wishes of the central bank are transmitted to the real economy”, and to “a banking system frozen by high rates of bad loans”.

The following is what I would advice Raghuram Rajan to do, if he really wanted banks to become functional financing efficiently the real economy.

First, get rid of stupid Basel bank regulations that, with their different equity requirements based on credit risks, so distort the allocation of bank credit. These introduce a regulatory risk-aversion that has no place anywhere, but much less in a developing country, since risk-taking is the oxygen of any development. In its place put for instance an 8 percent equity requirement on all bank assets, and throw out forever, the portfolio invariant credit-risk equity requirements. Of course that could create a big need for fresh bank equity, and so…

Second, in order to take away the dead weight caused by the bad loans, and to help to fill any new bank equity needs, the central banks should proceed like Chile did during its financial crisis. Namely capitalizing all the banks by purchasing their non-performing loans, against the commitment by the banks to repurchase these assets from the central bank with their retained earnings, before any substantial dividend payments to their shareholders could be made.

You would then have well capitalized banks, ready to give credit on non distorted terms to for instance “risky” SMEs and entrepreneurs, and simultaneously been made so much safer that, presumably, they would have to pay less interest rates to depositors, and in the medium or long terms less dividends to shareholders. Not bad for a couple of hours work eh?

@PerKurowski

Greece and Europe, allow your banks to function like banks again…look how Chile did it.

Martin Wolf writes: “It is Greece’s fault. Nobody was forced to lend to Greece.”, “Mythology that blocks progress in Greece” April 22.

Perhaps not forced. But regulators produced irresistible temptations, like allowing banks to leverage their equity, and the support they receive from society, more than 60 to 1 when lending to Greece, comes extremely close to forcing. Put a plate with a good chocolate cake in front of children, and see what happens.

And then Wolf writes: “The ECB should not lend to clearly insolvent banks”… And I ask, why not? To have ECB competing with pension funds and widows and orphans for whatever little “safe” assets there is left does not make any sense.

Now if the ECB did like Chile did in 1982-83; capitalizing all banks by purchasing their non-performing loans; against an agreement that banks would not pay dividends until they had repurchased these loans from the ECB, then Greek banks would be fit to operate again as banks.

Of course, for the Greek banks to be helpful to the real Greek economy. you would have to get rid of the credit risk weighted equity requirements for banks, those which impede that banks will give credit to those who most could do good by receiving bank credit, like to the SMEs and entrepreneurs.

Whatever, to solve Greece’s problems, more zero risk weighted loans to the sovereign, in order for government bureaucrats to allocate the resources derived from bank credit, will just not cut it… no matter how much haircut on Greece’s debt you accept.

And “the Centre for Economic Policy Research notes that excessive debt hangs over the entire eurozone, not just Greece.”

Yes indeed, and that is why I would suggest applying the Chilean solution all over Europe.

Europe, allow your banks to finance the riskier future, and keep them from only refinancing the safer past.

PS. This was written before I discovered that, in the case of Europe the regulations were even worse than Basel II's. The European Commission adopted Sovereign Debt Privileges which assigned a 0% risk weight to all their sovereigns. That meant banks could lend to Greece without holding any capital at all. Holy moly! To top it up Eurozone sovereigns are indebted in a currency that de facto is not a real domestic (printable) currency for them.

@PerKurowski

Greece, Europe, to keep your banking sector afloat, and in good spirits, look to Chile.

Sir, Wolfgang Münchau writes: “So to default “inside the eurozone” one only needs to devise another way to keep the [Greek] banking system afloat. If someone could concoct a brilliant answer, there would be no need for Grexit.” “A Greek default is necessary but Grexit is not” April 20.

I am sorry. I do not think the problem of banks is limited to the Greek ones. All European banks must surely have problems with excessive long-term exposures at low rates to what is perceived as “safe”, and to which they are seriously undercapitalized because of the risk-weighting… and any little tick up in interest rates could wipe out all their equity.

In my mind what Greece (and the rest of Europe) most need now is an ambitious recapitalization of banks plan that brings their equity up to around 8 percent for all assets… inclusively against sovereign debt. None of that risk-weighted assets nonsense that only confuses.

Chile might be the role model for how to proceed. Banks there were recapitalized by the Central Bank issuing local credit, in order to buy all the nonperforming loans of the banks. And the banks in their turn agreed to repurchase all non-performing loans, plus to pay some interests, out of retained profits... before resuming any dividend payments.

In fact that is what ECB should be doing with its QEs. To have ECB competing with pension funds and widows and orphans for whatever little “safe” assets there are left does not make much sense.

@PerKurowski