Bank regulators could derive valuable lessons from pension scheme difficulties.

Sir, Jonathan Ford while discussing Carillion’s pension schemes writes: “deficit repair should reasonably leave space for the company to foster future growth, and thus preserve the ongoing viability of the sponsor.” “Carillion’s pension crisis defies any magic legal cure” February 26.

Absolutely. But does that not apply to bank regulations too? As is the risk weighted capital requirements give banks huge incentives to stay away from financing the “riskier” future, like entrepreneurs, in order to refinance the safer present, like houses.

And Ford adds: The worst outcome would be one that simply encouraged trustees to “de-risk” schemes further by purchasing highly priced gilts to protect themselves against mechanical increases in short-term liabilities caused by falling market yields — a pro-cyclical practice known as “liability-driven investment”.

In essence that is what the risk-weighted capital requirements do. They doom banks to end up gasping for oxygen in dangerously overpopulated safe-havens against especially little capital, leaving the riskier but perhaps more profitable bays unexplored.

Ford argues: “It’s not clear though what any “tough new” rules could have done to help this messy situation.”

I know too little about Carillion but, what I do know, is that pension funds in general, government’s included, have been way too optimistic when estimating potential real rates of return in the order of 5% to 7%. 3% would be more than enough of an optimistic real rate of return, given the so many unknown factors out there.

@PerKurowski

The safest route for UK might be to take to the seas in a leaky boat, abandoning a safe haven that is becoming dangerously overpopulated.

Sir, Martin Wolf writes: “A significant generational divide has opened up. Those aged 22-39 experienced a 10 per cent fall in real earnings between 2007 and 2017. They were also particularly hard hit by the jump in average house prices from 3.6 times annual average earnings 20 years ago to 7.6 times today. Not surprisingly, the proportion of 25-34 year olds taking out a mortgage has fallen sharply, from 53 to 35 per cent.” “A bruising Brexit could shipwreck the British economy” November 17.

Sir, I would argue that has a lot to do with the fact that banks are allowed to leverage much more their equity when financing “safe” home purchases than when for instance financing job creation by means of loans to “risky” SMEs and entrepreneurs.

Because that means banks can earn much higher expected risk adjusted returns on their equity when financing home purchases than when instance financing job creation by means of loans to SMEs and entrepreneurs… and so they do finance much more home purchases than risky job creations.

But Martin Wolf does not think so. He thinks bankers should do what is right, no matter the incentives. I think that is a bit naïve of him.

The way I see it, one of these days all the young living in the basements will tell their parents. “We’ve been cheated. You move down and we move upstairs.”

And it will be hard to argue against that. My generation has surely not lived up to its part of that intergenerational holy social contract Edmund Burke wrote about. 

Wolf ends with “The UK has embarked on a risky voyage in a leaky boat. Beware a shipwreck”. No! I would instead hold that its bank regulators made it overstay in a supposedly safe harbor that is therefor rapidly and dangerously becoming overcrowded.

“A ship in harbor is safe, but that is not what ships are for”, John A Shedd.

Sir, I have no idea if Martin Wolf has kids but, if he had, would his kids have grown stronger if he had rewarded them profusely for staying away from what they believe is risky? I don’t think so.

PS. If Brexit goes hand in hand with a Baselexit, Britain will at least to better than now.

@PerKurowski

To save the banks the regulators must admit their huge mistakes, and rectify these urgently and intelligently

Sir, Philippe Bodereau, the global head of financial research at Pimco writes: “To prevent… equity volatility [to] temporarily destabilise a large institution the European Central Bank must convince the equity market that rates will not go deeper into negative territory, capital requirements will not spiral higher in perpetuity and regulators will not move the goalposts on asset quality again.” “European banks’ crisis of earnings cries out for a quick Italian job” July 19.

I disagree because that is at best a very temporary solution. The banks and their shareholders in general, though specially the European, cry out for a real explanation of what is happening, and so that they can regain the trust in the future of banking.

This because the truth is that the current risk weighted capital requirements, those which allow banks to leverage their equity and the societal support they receive more with what is perceived as safe than with what is perceived as risky, are entirely unsustainable, for two reasons.

First, though they might allow banks to earn high risk adjusted returns on equity on what’s safe for quite some time, in the long run they will cause banks to dangerously overpopulate “safe” havens, which is precisely the stuff major bank crises are made of.

Second, as they impede the “risky”, like SMEs and entrepreneurs, to access sufficiently bank credit, the real economy will begin to suffer, and there is not a chance banks can expect to survive with a real economy in tatters.

Substituting a significant leverage ratio for the risk weighting, would eliminate the distortions.

That said it has to be done intelligently, so that the economy does not suffer an excessive credit squeeze. One way could be allowing banks to hold the capital originally required on all their current assets and have the new ones apply solely to any new assets.

Since that would, on the margin, reduce the demand of banks for safe assets such as loan to sovereigns, that would, on its own, help to avoid getting deeper and deeper into negative territory.

I would also suggest European finance ministers to look at Chile’s intelligent way of extricating its banks from very similar difficulties in 1981-1983

@PerKurowski ©