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.

We need banks that profit by taking reasoned risks; and that have capital to cover for a good chunk of the unexpected.

Sir, I refer to Dan McCrum’s and Thomas Hale’s “Stagnation saps enthusiasm for Europe’s banks” August 6.

It includes contradictory statements like “the financial architecture appears solid” and “most people accept there is enough capital in the system now. Not just investors, but regulators as well” with that of “a rounding error of just 1 per cent on European asset values would wipe out More than a third of European bank equity, the all-important number determining ability to absorb losses.”

The ex ante perceived risk-weighted capital requirements for banks has introduced total confusion into banking. Not only with respect of these having reasonable equity, but also with respect to their business. Over the last decades, banks have looked to maximize their returns on equity much more by reducing the capital required, than by analyzing gross risk/reward ratios as such. And that must come to an end.

First EBA’s recent stress tested European banks indicated that they were leveraged almost 24 to 1, and that makes them clearly undercapitalized, not so much in terms of the expected, but in terms of the unexpected, which is what bank equity should be there for.

And secondly, we urgently need banks to assume their more traditional role of earning their profits by taking reasoned risks in the real economy… that economy in which a unit of capital is a unit of capital, independently of it being invested in something safe or something risky.

To avoid risks, especially when currency does not carry negative interest rates, a mattress seems to suffice. And for the society (taxpayers) to support banks that make their profits by avoiding taking risks, and not by helping it to build future, is stupid.

Some tweet sized conclusions:

The last decades banks have earned huge returns on equity mostly by minimizing equity, that has to stop.

European banks are severely undercapitalized, not that much in terms of the expected, but in terms of the unexpected.

Banking should be about helping society to take risks, not avoiding these. For that mattresses suffice.

Bankers capable of reasoned audacity are magnificent. Equity reducing bankers, are, at best, absolutely tedious.

Just looking at their dumb risk-weighted capital requirements, bank regulators should be disgraced by society.

@PerKurowski ©

Europe, if you want to avoid death by attrition, you need to trust your bankers more than your bank regulators.

Of course it is tragic when banks collapse because of too much risk taking, usually on something they perceive as absolutely safe. Then, there is a big setback and lot of tears. But, in the long run, because your banks have also taken some constructive risks on those perceived as risky, like medium and small businesses, entrepreneurs and start-ups, net of this setback, you have at least moved forward.

But, when your current bank regulators concocted their capital requirements based on perceived credit risk, not only did they assure that banks will take even larger risky exposures on what was perceived as absolutely safe, but also that your banks would not be taking the sufficient constructive risks on the risky, something which therefore sets your economies on the road of attrition. And, so when the inevitable collapse occurs, when once again something perceived ex ante as absolutely safe turns out ex post to be very risky, not only will the pain be larger, but the setback will also be a net setback.

And Sir, set in this perspective, all usual discussions about what the ECB should or should not do which do not include getting rid of the current bank regulations, like that of for instance Wolfgang Münchau’s “Draghi is running out of legal ways to fix the euro” of August 18, are, forgive the expression, like pissing somewhat outside the pot… excuse me I mean outside the chamber pot.

I cry for you Europeans, if you can’t see where the Basel Committee’s and the Financial Stability Board’s obsessive risk aversion substituting for reasoned audacity is taking you.

Let me be absolutely clear, something else bad might have happened to your banks but absolutely not what happened to them, had there been no risk-weighted capital requirements which allowed banks to earn much higher risk-adjusted returns on their equity on assets like AAA rated securities, infallible sovereigns like Greece or real estate like in Spain.

Let me be absolutely clear, had there been no bank regulations the banks would never, at least knowingly, been allowed by the markets to leverage remotely as much as they were allowed to do by the regulators.

Regulation ordering brutish and silly risk avoidance by banks, only guarantees a sluggish future.

Sir, when you allow banks to hold much much less capital when lending to The Infallible than when lending to The Risky, this allows banks to earn much higher risk adjusted expected returns on equity when lending to the former than when lending to the latter.

And so those actors who we find on the margins of the real economy and who we most need to have access to bank credit, namely medium and small businesses, entrepreneurs and start ups, will get the least of it. And since the future is built upon risk taking and not upon risk avoidance that is the most important cause for “Why the future looks sluggish”. 

That does of course not diminish some of the other explanations put forward by Martin Wolf on November 20. When Wolf correctly writes that we need to “facilitate capital flows to emerging and developing countries” he shows he has failed to understand that there are many emerging opportunities waiting to be developed in developed countries, only because of these bank regulations.

Sir, when Wolf concludes “It will be better to risk mistakes than accept the costs of an impoverished future” he shows some indications of being on the right track but, in his world, he clearly prefers the public sector to take risks, for instance with “a surge in public investments”, before banks doing so.

And I do not. I firmly believe in the banks being the prime agents appointed by society in order to, with reasoned audacity, take the needed risks on its behalf.

But in order for our bankers to take risks on The Risky, we must of course get rid of regulation which de facto prohibits them to do so.

PS. Sir, just to let you know, I am not copying Martin Wolf with this, as he has asked me not to send him any more comments related to the capital requirements for banks, as he has already understood it all… at least so he thinks.

What’s wrong with you FT? Are you daft? How many times do I have to explain it to you?

Sir, in “Three threats to Europe’s recovery” August 10, you write “Europe’s main problem remains in its banking system. Impaired balance sheets are preventing lenders from extending credit to businesses, choking off growth”.

What’s wrong with you? How many times do I have to explain it to you? The real and complete story goes as follows: Impaired balance sheets of banks, facing capital requirements which are much lower for what is perceived as “safe”, than for what is perceived as “risky”, are preventing lenders from extending credit to businesses and choking off growth.

And why are those bank balance sheets impaired? Because they built up too large exposures to what was perceived as risky? No! Because they built up too large exposures to what was ex ante perceived as “absolutely safe” but that ex-post turned out to be risky and so caught them standing there naked, with their pants down, and no capital to speak off.

And I tell you FT, there will never ever be a sustainable sturdy growth in Europe again, as long as bank regulators discriminate in favor of “The Infallible” and against “The Risky”. Europe was not built on dumb risk-aversion but on smart and daring risk-taking, call it reasoned audacity if you want.

Sorry but “audacity” is not longer a concept that defines the US, or Europe.

Sir, you title your editorial about Obama’s second inauguration as “The audacity of experience” January 22. Sorry but I do not think that “audacity” is a concept that could currently be used in the context of describing the US (or Europe for that matter) 

Look at the following three quotes from Obama’s speech: 

“Together we discovered that a free market only thrives when there are rules to ensure competition and fair play.” 

“Our celebration of initiative and enterprise, our insistence on hard work and personal responsibility, these are constants in our character.” 

“America’s possibilities are limitless, for we possess all the qualities that this world without boundaries demands: youth and drive, diversity and openness, of endless capacity for risk and a gift for reinvention” 

And then explain to me how on earth “free market”, “ensure competition and fair play”, “celebration of initiative and enterprises” and “endless capacity for risk”, can exist in a country where its banks are ordered to hold more capital when lending to “The Risky” than when lending to “The Infallible”? 

No way Jose! Our nations, or at least our banks, are currently ruled by risk-adverse baby boomers that really do not care one iota for promoting “The Infallible” of tomorrow by taking the necessary chances on “The Risky” of today. 

Our governments, or at least our bank regulators, are loudly shouting out “aprės nous le deluge”, and unfortunately our young are too busy to take notice. They will pay dearly for it.

We need reasoned audacity, not unreasonable risk-aversion. “God make us daring!”

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Must Michele Obama explain the causes and dangers of obesity to Ben Bernanke and bank regulators ? And to FT?

Sir, in your “Bernanke’s gamble is no free lunch”, September 22, you mention the possibility of QE’s diminishing returns, which would lead us into uncharted waters. Of course, QEs, and other stimulus, are dangerous, if not productive and self-sustainable. It is as easy as that. 

Sadly though, the QEs and other more traditional stimulus are now all bound to be unproductive, since banks, because of the way they are regulated, will mostly re-channel any new funds into holding assets perceived as “not-risky”, as these do not require from the banks much of that now so very scarce bank equity. 

What is missing in the debate, and FT's silence on that is almost embarrassing, is the fact that an economy needs “risky” loans to generate both its vitality and its flexibility. Inducing our banks to take cover in what is ex ante deemed as “not-risky”, only guarantees a type of economic flabbiness as well as a structural fragility. 

It is all like sending the kids out to play telling them “You can only eat the pastries ("infallible" sovereigns) and the well certified by your Aunt Moody hot dogs (AAA-rated), because I do not really know who cooked the vegetables (small businesses and entrepreneurs)”. 

Sir, must we call on Michele Obama to explain to Ben Bernanke and bank regulators (and FT) the causes and the dangers of obesity? 

For the umpteenth time, please understand that we need those perceived as “risky” to have access to bank credit, on terms free of regulatory discrimination.

Witless risk-adverse bank regulators are unwittingly destroying our economies. We urgently need regulators and bankers capable of "reasoned audacity"!