High bankers bonuses results from having to remunerate very little shareholders’ capital

Lex writes: “More than 700 high earners last year in Deutsche Bank were paid a weighted average of €1.9m a year”. July 11.

What would they be paid if the bank needed to hold 10% in capital against all assets? The equity minimization is the prime driver of high bonuses. 

@PerKurowski

The Basel Committee stupidly made banks substitute savvy loan officers with equity minimizing financial engineers

Sir, John Plender, reviewing Philip Augar’s “The Bank That Lived a Little” writes: Not so long ago banking was a relatively simple business whose main focus was on deposit-taking and lending. Then in the 1980s everything changed as a powerful tide of deregulation swept through the industry… courtesy of Ronald Reagan and Margaret Thatcher”, “Head rush”, July 7.

Was it “deregulation” or plain missregulation? The main change that was introduced in banking, in 1988, with the Basel Accord, was the risk weighted capital requirements for banks. 

That meant that from there on, the risk-adjusted returns on bank equity were not to be maximized by savvy loan officers, but by equity minimizing financial engineers.

And clearly “increasing amounts of risk in relation to dwindling cushions of capital” allowed the bonuses of bankers to be so much higher.

Has banking “turned into an ethics-free zone”? Yes, but blame the regulators for much of that. Now, 30 years later, I would think there is no room to put the blame on Ronald Reagan or Margaret Thatcher. 

Frankly, since FT has not dared to ask regulators why banks have to hold more capital against what is dangerous perceived as safe than against what is made innocous by being perceived as risky, as I see it, FT is so much more responsible for all this mess.

@PerKurowski

There’s never a wrong time to begin correcting bad bank regulations, such as the current ones.

Sir, Rana Foroohar writes: “Financial crises always start the same way” and refers to “Over-confident financiers [and] lax regulators”, “The wrong time to weaken bank reform” May 21.

The 2007/08 crises resulted from overconfident regulators, those who believed so much in the capacity of credit rating agencies that, if private sector assets were rated AAA to AA, banks were allowed to hold these against only 1.6% in capital, meaning they were allowed to leverage a mindboggling 62.5 times. The financiers on their hand, much more than overconfident, were lax and did not have it in them to resist the temptations of such regulatory generosity.

Sir, just think about how much sufferings and how many unrealized dreams could have been avoided had only the following four simple questions been asked of the Basel Committee’s about their risk weighted capital requirements for banks. 

1. What? Do you really know what the real risks for banks are? If you do, why are you not bankers?

2. What? Don’t you see that allowing banks to leverage differently with different assets will lead to a new not-market-set of risk adjusted returns on equity. Are you not at all concerned this could dangerously distort the allocation of credit to the real economy?

3. What? Do you think that what’s perceived risky, that which bankers adjust to by means of lower exposures and higher risk premiums, is more dangerous to the bank system than what they perceive as safe?

4. What? A 0% risk-weight of sovereigns? That could only be explained by their capacity to print currency in order to get out of debt. But is that not also one of their worst possible misbehaviors?

The saddest part though is that 30 years after that faulty regulation was first introduced with the Basel Accord in 1988, these questions are still waiting for an answer.

Sir, there is never the wrong time to start correcting for such bad regulations. You could argue that the introduction of a leverage ratio is doing that. Indeed, but as long as the risk weighted capital requirements remain these will be influencing credit decisions where it most counts, on the margin.

And it is only getting worse. Foroohar writes “larger banks with assets ranging from $250bn to more than $2tn… will now be able to reclassify municipal bonds as “high quality assets”, making it easier for them to game the liquidity coverage ratio.” What does that signify? Those municipalities will get too much credit in too easy terms… just like Greece.

@PerKurowski

Banks now invest based on the risk-adjusted yields of assets adjusted for allowed leverages; that distorts the allocation of credit to the real economy.

Sir, Lawrence Summers, when writing about the challenges Jay Powell will face as Fed chairman mentions “Even with very low interest rates, the normal level of private saving consistently and substantially exceeds the normal level of private investment in the US” “Powell’s challenge at the Fed” February 5.

Not too long ago, markets, banks included, invested based on the risk adjusted yields they perceived the assets were offering. Some more sophisticated investors also looked to maximize the risk adjusted yield of their whole portfolio.

But, then in 1988 with Basel I, and especially in 2004 with Basel II, the regulators introduced risk based capital requirements for banks. As a consequence, banks now invest based on the risk-adjusted yields adjusted for the leverage allowed that they perceive the assets offer. As banks are allowed to leverage more with safe assets, which helps to increase their expected return on equity, they now invest more than usual, and at lower rates than usual, in “safe” assets like loans to sovereigns, AAA rated and mortgages. And of course, banks also invest less than usual, and at even higher rates than usual, in loans to the “risky” like entrepreneurs and SMEs.

That has helped to push the “risk free” down, and also explains much of the lowering of the neutral rate. Since the regulators now de facto block the channel of banks to the “risky” part of the economy, there is a lot of private investment that simply is not taking place any longer.

It is sad and worrisome that neither the leaving Fed chairman, Janet Yellen, nor the arriving one, Jay Powell (nor Professor Summers for that matter) can apparently give a clear direct and coherent answer to the very straight forward questions of: “Why do regulators want banks to hold more capital against what’s been made innocous by being perceived as risky, than against what’s dangerous because it’s perceived as safe? Does that not set us up for slow growth and too-big-to-manage crises?

http://perkurowski.blogspot.com/2016/04/here-are-17-reasons-for-why-i-believe.html

@PerKurowski

The financial-elite’s reluctance to ask bank regulators for clear explanations, seriously threatens the west’s liberal democracy and global order

Sir, Martin Wolf asks and answers: “What has created sharp (and usually unexpected) slowdowns? The answers have been financial crises, inflation shocks and wars” “The world economy hums as politics sour” January 10.

Indeed, but currently our economies are also suffering a slow but steady state slowdown as a consequence of the insane risk weighted capital requirements for banks, which were created in the name of making banks more stable. It all boils down to the following:

If a “safe” AAA rated offered a correct risk adjusted net interest margin to a bank, a loan to it could, according to the Basel Committee’s Basel II of 2002, be leveraged 62.5 times but, if that correct risk adjusted net interest margin was offered by a “risky” unrated entrepreneur or an SME, then a loan to these could only be leveraged 12.5 times.

As a direct result bank credit has been used to finance “safer” present consumption; to inflate values of mostly existing assets; and way too little to finance “riskier” future production.

In summary it amounts to having placed a reverse mortgage on our past and present economy, in order to extract all of its value now, not caring one iota about tomorrow, and much less about that holy social intergenerational contract Edmund Burke spoke about.

But Wolf could argue that this is evidently not true because: “Yet the world economy is humming, at least by the standards of the past decade. According to consensus forecasts, optimism about prospects for this year’s growth has improved substantially for the US, eurozone, Japan and Russia”

Sir, it’s all a debt financed economic growth. Like a family having a great Christmas by racking up debt on their credit cards. How much of the enormous recent growth of debt everywhere has gone to finance future builders like entrepreneurs and SMEs? The answer is surely a totally insignificant fraction.

Wolf here anew identifies threats: “The election of Donald Trump, a bellicose nationalist with limited commitment to the norms of liberal democracy, threatens to shatter the coherence of the west. Authoritarianism is resurgent and confidence in democratic institutions in decline almost everywhere.”

Sir, sincerely, what is all that compared to the fact that the world’s financial elites, either because it is not in their interests, or because lacking self confidence they are afraid they might have overlooked something, do not have the gut to firmly ask regulators: “Why do you want banks to hold more capital against what has been made innocous by being perceived risky, than against what is dangerous because it is perceived safe?”, and not accepting any flimsy nonsensical answer veiled in sophisticated voodoo technicalities.

Martin Wolf has moderated numerous important conferences on financial regulations, but not one has he dared to ask that simple question. Could it just be because he is scared he would then not be invited again as a moderator? Or is it that he just doesn’t get it.

And Sir, you have really not been living up to your motto either. Shame on you!

PS. And all that risk adverse regulations for nothing, since, as I have told Wolf and FT time after time, major bank crisis, like that of 2007/08, never ever result from excessive exposures to what is ex ante perceived as risky.

http://perkurowski.blogspot.com/2016/04/here-are-17-reasons-for-why-i-believe.html

@PerKurowski

When bank regulators allowed banks to earn higher returns on equity by avoiding the “risky”, they violated a fundamental social contract

Sir, you write “Unemployment rates are low in the UK and US, but many of the new jobs are more precarious than the old ones they replaced… [so] the US and EU need to do more to encourage investment, and to deter anti-competitive behaviour and, as important, encourage competitive pressure on complacent incumbents.” “A better deal between business and society” January 2.

If one allowed banks to leverage more, and thereby obtain higher risk adjusted returns on equity when lending to what is perceived safe, than when lending to what is perceived risky, it would require ignorance, or total lack of concern, to believe banks will finance as much as usual small unrated companies and new entreprenuers.

But that is what regulators with their risk weighted capital requirements did and so it should be no surprise that “Despite low financing costs, private investment — the vital seed for long-term growth — remains insipid.” I am not talking about an “out-of-date regulatory models” that could be reformed, but about a fundamentally mistaken regulatory model.

You want “A better social contract… built on the idea of a humane, mutually beneficial interdependence between” employers and employees. Sir, who could argue against that? There’s always room for that.

But, how many times have I begged you to put the weight of the Financial Times behind asking the regulators: “Why do you want banks to hold more capital against what has been made innocous by being perceived risky, than against what is dangerous because it is perceived safe?”

But for some internal reasons of your own, perhaps even a petty one, you have refused to do so. In my book, just like when regulators regulated banks without caring about the purpose of these violated a social contract, you also violate your social responsibility as journalists by not intermediating opinions between your readers and those officially responsible for the decisions being questioned.

@PerKurowski

The outsized bank revenues and the crash were caused by the monstrous huge leverages authorized by their regulators

Sir, Patrick Jenkins writes: “The outsized revenues and profits that banks and other financial groups made in the run-up to the crash, much of it inflated by mis-selling and manipulation, have given way to lower income” “Banks can become an engine of productivity instead of a brake” July 11.

Jenkins just does not get it. “The outsized revenues and profits that banks and other financial groups made in the run-up to the crash” were the direct result of regulators allowing banks to leverage their balance sheets tremendously. For instance Basel II of 2004 authorized banks to leverage 62.5 times to 1 if an AAA rating was present, and a lot of times more when lending to a “safe” sovereign. Had banks been allowed to leverage with all assets only 12.5 times, as Basel’s 8% basic capital requirement implied, there would not have been outsized bank revenues and profits, nor the crash. Capisci?

How could banks become an engine of productivity again? Stop discriminating against the “riskier” future and in favor of the “safer” present.

@PerKurowski

Italy, there are very important lessons from the bank crisis that regulators do not want you to learn.

Sir, Ferdinando Giuglano writes: “banks with more equity and fewer bad loans on their books are better-equipped to lend to dynamic start-ups, which will drive economic growth in the future” “Italy resists Brussels’ tough love on banks” January 18.

That sounds so right, but unfortunately it is not. “banks with more equity and fewer bad loans” will still prefer to go for what their equity could be leveraged more with because that is how they maximize their expected risk adjusted returns on equity. And that means lending to what is perceived, decreed or concocted as safe and not to usually risky dynamic start-ups.

Giuglano also writes: “Italy’s lenders are saddled with around €350bn in non-performing loans — the product of the economic crisis and a stream of poor lending decisions.”

How sad that there is no research on the origins of those performing loans. It would be extremely useful to see which problem loans result from which cause in order to understand what happened. Without having access to any data I would bet that the loans perceived as safe, and against which banks had to hold little capital, represent the largest percent of poor lending decisions, and the loans that might be consider risky are those suffering the most from the economic crisis… among other because banks, scarce of capital, are forced to get out of these.

There are things about bank regulations that regulators do not want us to learn. And as a consequence, we still suffer from the mistakes.

Sir, I see Giuglano is a commentator for La Repubblica. Would he help me ask his Italian bank regulators the following very simple and basic questions? Depending on their answers Italy might want to sue the Basel Committee for Banking Supervision on the grounds of very negligent regulatory behavior. 

@PerKurowski

That banks have strengthened is pure wishful thinking, as most of it is the result of weakening the real economy.

Sir, Brooke Masters’ writes: “Eight years after the financial crisis, we were all getting bored with bank stress tests. Most of the institutions are so much stronger and better capitalised than they were” “UK’s tough stance on banks contrasts with global mood” December 3

That’s not really so. Most of the strengthening is the result of banks shedding “risky” assets in favor of safe, so the other side to that coins is having in the medium and long term run made the real economy weaker.

As I have complained about for years, current stress tests only look at what is on the balance sheets of banks, ignoring completely the aspect of what should have been there.

With respect to “imposing “output floors” on the models. These would effectively raise capital requirements for some banks by pushing up the value of their risk-weighted assets”, the real question is, how could regulators be so naïve so as to think those risk models were not going to be tweaked? Lower risk determination, means lower capital requirements, means higher leverages, means higher expected risk adjusted returns on equity.

With respect to “floors unfairly penalise banks with unusually safe assets, such as those who keep a lot of low-risk mortgages on their books”, the question is when will banks keep on favoring the “safer” construction of basements were the jobless young can live with their parents over the “riskier” lending that could allow the young to find the jobs they need in order to become responsible parents too?

Sir, you want strong banks? Keep them on a tight capital leash without distorting what they do? You want weak banks? Make them operate only in what is safe and help them with their returns on equity by being very accommodative allowing high leverages.

@PerKurowski

The Main-Street understanding world’s MPCs most need, is that of the discriminated against bank borrowers, like SMEs

Sir, Huw van Steenis writes: “The private sector’s demand for loans, banks’ profitability, capital adequacy and risk aversion — all these affect not only financial aggregates but also financial wealth and the real economy through a variety of channels. Overlooking how banks function means the models that central bankers have relied upon are, by construction, overly simplistic fair-weather versions only.” “Time to put financial frictions at the heart of central bank models” November 1.

Of course, central banks must wake up to the frictions and distortions caused by the risk weighted capital requirements for banks. Though that is probably not what van Sttenis refers to, because, if he did, he should be very careful. He might wake up bankers, his bosses, from their realized wet dreams of earning the highest risk adjusted rates of return on equity, when financing what’s perceived as the “safest”

But Van Steenis also writes: “Every MPC should have members who have a real-world understanding of the plumbing of financial intermediaries. It’s time to put financial frictions into macroeconomic models.”. And Sir No! Careful there! “Huw van Steenis is the global head of strategy at Schroders”; and the Main-Street understanding Monetary Policy Committees around the world most need, is that of discriminated against bank borrowers, like SMEs and entrepreneurs.

@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 ©

Much of those interest margins banks now obtain financing what’s perceived safe, used to belong to pension funds.

Sir, I refer to Mary Childs and John Authers’ “Canada quietly treads radical path on pensions: Retirement funds are pushing beyond bonds and stocks in search of better returns” August 23.

Please hear me out. Before the introduction of the risk weighted capital requirements, banks spread out their credits to those who offered them the best risk-adjusted margins, while subjecting the size of the exposures to the same perceived credit risk. Taking risks, with reasoned audacity, was the business of the banks. In comparison, avoiding risks, and looking for certain minimum returns, was the business of pension funds.

But, with the risk weighted capital requirements that allow banks to leverage much more their equity with what is perceived as safe than with what is perceived as risky, banks began maximizing their returns on equity by minimizing the equity they needed to hold, something which meant going for what was perceived, decreed or concocted as safe.

As a result the bankers were able to realize their wet dreams of huge perceived risk adjusted returns on equity for playing it safe.

But that de facto meant that banks occupied the investment space pension funds use to occupy, and so now we have that pension funds have to go out there and take the risks banks used to take.

Sir, you can be damn sure that if banks needed to hold the same capital against all assets they would not be swamping the safe havens, and pension funds would not have to be “facing the challenge of [so] low returns on traditional assets”

This is all so foolish. Why can’t we allow banks to be banks and pension funds to be pension funds?

This is all so dangerous. If banks do not finance risky SMEs and entrepreneurs the real economy will stall and fall, and then even the safest will not buy retirement tranquility (or jobs for our children and grandchildren).

FT, more bank credit to “safer” grown-up trees, and less to “riskier” green-shoots, must result in lower productivity

Sir, you write “There can be few problems that are so important and yet command so little consensus about their source and solution as the general slide in productivity growth across the world’s economies”, “The puzzle that baffles the world’s economies”, May 30.

And yet you refuse to echo my concerns that the risk-weighted capital requirements for banks, which allow banks to earn higher risk adjusted returns on equity on what is ex ante perceived, decreed or concocted as safe, than on what is perceived risky, creates serious distortions in the allocation of bank credit.

I have I written at least on 100 letters to you on that issue? How many have you ignored? All!

@PerKurowski ©

Martin Wolf, the uncertainty of whether those who govern us really know what they’re doing is always upon us.

Sir, Martin Wolf writes: “Productivity is not everything, but in the long run it is almost everything… But the prospects for productivity are…the most important uncertainty affecting the economic prospects of the British people. Is it reasonable to expect a return to buoyant pre-crisis productivity growth? Will productivity continue to stagnate? Or will it end up somewhere in between?” “The age of uncertainty is upon us” March 18.

Mr. Wolf, for the umpteenth time, obsessively, I do not understand how you and so many other can so obsessively ignore that if you tell banks they can leverage their equity more with what is safe than with what is risky; so that they can earn higher expected risk adjusted returns on equity with what is perceived or deemed to be safe, than with what is risky; that then banks will foremost be refinancing the safer past while ignoring too much the credit needs of the always riskier future. And since then productivity is not been given the chances it deserves, the prospects for its improvement must be really lousy.

“The age of uncertainty is upon us”? Please when did we have an age of certainty?

Current regulators regulate banks without having defined their purpose, and base those capital requirements for banks that should cover for the unexpected, on the expected credit risk. Those facts evidence the major uncertainty we always face, namely whether those who govern us have the faintest idea of what they’re doing.

@PerKurowski ©

It would be helpful if Martin Wolf finally realizes the dangers the risk weighted capital requirements for banks pose.

Sir, now, more than 12 years after Basel II was approved Martin Wolf writes: “If one ignores the vanishing trick of risk-weighting, the true leverage of many large banks remains at more than 20 to one.” “Banks are weak links in the economic chain” February 17.

But, of course, the real question though is, why have regulators ignored the dangers “the vanishing trick of risk-weighting” poses? Not only can that risk weighting that was envisioned to provide better and more comparable information on banks confound the markets more; it also provides banks with an versatile instrument to game the regulations; and, worst of all, it distorts the allocation of bank credit to the economy.

On that last, the distortion, Wolf might at long last begin to wake up as he writes: “Banks are highly leveraged plays on economies. If economies are sick, banks are likely to be sicker.” So now let us hope that from that he could deduct that the way bank credit is allocated to the real economy carries real significance to the health of the economies and the banks.

And then, Hallelujah, Martin Wolf finally accepts “that banks are exposed to almost everything”. That should allow him to understand the idiocy of re-weighing for basically the only risk that banks with interest rates and amounts of exposure already clear for, while leaving the whole universe of other risks a bank faces out of the regulatory equation.

Sir, as you well know by now I will with much interest follow where Wolf goes to now because it would of course be very useful if the leading economic commentator of the Financial Times opened his eyes to what has and is really happening with our banks.

Currently, by regulators allowing banks to earn higher risk adjusted returns on equity financing on what is perceived or deemed as safe than on what is perceived as risky, banks have stopped financing the riskier future and settled on refinancing the safer past… and that cannot be good for anyone, least so for our children and grandchildren.

And of course, all for nothing because major bank crisis never ever result from excessive exposures to something ex ante perceived as risky.

@PerKurowski ©

What bank regulators do not yet understand and do not yet discuss, is truly scary stuff

Sir, John Vickers who chaired the Independent Commission on Banking (ICB) writes: “A central lesson of the crisis of 2008 was that banks had woefully inadequate equity capital” “The Bank of England must think again on systemic risk” February 15.

That is dangerously imprecise! The central lesson of the crisis was that banks had woefully little capital against assets that had ex ante been perceived or deemed very safe as a result of woefully wrong regulations.

The regulators allowed banks to hold much less equity against safe assets; which allowed banks to leverage much more their equity with safe assets; and which allowed banks to earn higher risk adjusted returns on equity on safe assets than on risky assets.

And the fact that regulators are still not able to comprehend that it is not their role to regulate based on what assets a bank has, but based on how banks manage those assets, is just scary.

And the fact that regulators are still not able to digest the truth that the assets that are really dangerous to the stability of the banking system are not the risky but those perceived as safe, is just scary.

And the fact that the distortions in the allocation of bank credit to the real economy that risk weighted capital requirements produces are not yet even discussed, is just scary.

@PerKurowski ©

Rod Stewart, it would be hard for you to find your way back home, it has been castrated.

Sir, Martin Wolf opines: “The battle over Brexit matters to the world” February 10. But does that matter the most to Britain?

Rod Stewart in “Way Back Home” remembers his childhood with: “And we always kept the laughter and the smile upon our face. In that good-old-fashion British way with pride and faultless grace”

And his song ends with Winston Churchill reciting in the background: “We shall fight on the beaches. We shall fight on the landing grounds. We shall fight in the fields, and in the streets. We shall fight in the hills, we shall never surrender”

But Rod, for your info, Churchill’s England has indeed surrendered to risk aversion, thanks to its bank regulators.

In Britain the banking sector represented so much. And just to think about the reasoned and astute daring of their merchant banks should make any Britt proud.

But you have a Britain that now allows foreign bank regulators in the Basel Committee, to allow its banks to hold less equity against what is perceived as safe than against what is perceive as risky; and therefore Britain now allows its bankers to make higher expected risk adjusted profits when lending to “the safe” than when lending to “the risky”; which of course is de-testosteronizing, or outright castrating Britain’s banks.

Therefore much more important for Britain than a Brexit, is a Baselexit, which means ignoring all those regulators who ignore that: “A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926

@PerKurowski ©

The huge bonuses paid to bankers were enabled by lousy regulators, and were not the result of free market capitalism

Sir, John Plender writes: “Like the robber barons, today’s bonus-hungry bankers have shown once again how capitalists excel at giving capitalism a bad name”, “Capitalists excel at giving themselves a bad name” January 25.

No! Free market capitalism would never ever have enabled the payment of extraordinary high bonuses to bankers… because in free market capitalism banks would have had to hold much more equity than what banks currently hold, and so therefore not only would the risk adjusted returns on equity be lower than what has been seen, but there would also have been less left over for bankers’ bonuses.

With Basel II regulators allowed banks to hold extremely little capital (equity) against assets perceived as safe… for instance only 1.6 percent when lending to the AAArisktocracy. That allowed banks to leverage extraordinarily the explicit and implicit support given by society, for instance by deposit insurance schemes… while having to provide a decent return on very little equity… which left of course a lot of margin to pay the huge bonuses.

The real question is how come these extremely lousy regulators are getting away with what they did and are doing… having even been promoted for it.

@PerKurowski ©

Ordinary holders of bank shares had little idea that their investment was leveraged a speculative 50 to 1.

Sir, Daniel Davies, with respect to the lower returns on equity that result from higher capital requirements, holds that bank executives should tell investors: “You loved this business when it had equity-to-asset ratios of 2 per cent and a 16 per cent RoE. Why do you hate it now that it has 5 per cent equity to assets and a 9 per cent RoE?”, “Banks should not fixate on double-digit returns” January 13.

Let us be clear of that 2 percent equity to asset ratio signifies 50 to 1 equity leverage, and one of 5 percent, 20 to 1.

Does he really think shareholders loved the 16 percent RoE had they been truly aware that the bank management was leveraging his investment a mindboggling speculative 50 to 1… and taking home great bonuses because of that?

Does he really think shareholders would be satisfied with a 9 percent RoE if they really internalize the significance of banks now leveraging their investments 20 to 1, in times when any official assistance operations requires shareholders and creditors to first sustain important losses… in order for the management to keep taking home great bonuses?

Shareholders, like many other, were and are still misled by all those low leverages reported as a result of not using gross assets but using risk weighted assets instead.

Go back some years and you will, even in FT, find that the great majority of articles mention 10 to 1, or even lower leverages, quite often even ignoring to mention the risk weighing of assets, that which so much diminished the asset on which the leverages were calculated.

Would I be satisfied with a 9 percent RoE? Yes, perhaps for a bank leveraged 10 to 1… and with the bonuses to be paid to the managers decided by us, the shareholders. 

@PerKurowski ©