Are bankers stopping their regulators from boarding a ‘listening bus’, scared these might wake up and then wake them up?

Sir, Gillian Tett asks: “can lofty chief executives ever find a way to get out of the C-suite and view life from a completely different perspective?” “Jamie Dimon’s ‘listening’ bus? Get on board”

Sir, of course it is good that Jamie Dimon, or anyone else for that matter, tries to listen to different opinions, though a bus is not really needed for that. 

But much more important than Jamie Dimon doing so it would be for the lofty besserwisser bank regulators to walk down Main street in order to learn more about banking, and life.

Then they might begin to understand that it is not what bankers perceive as risky which is dangerous to the bank system, it is what they perceive as safe.

But, being able to hold assets perceived as safe against so little of bank equity, meaning obtaining the highest returns on equity with what’s “safe” and not having therefore to venture into riskier terrains, sounds like a banker’s wet dream come true. Therefore perhaps it is bankers, like Dimon, whom all block regulators from leaving their desks, except for some controlled visits to Davos and Jackson Hole.

PS. As the less equity that needs to be compensated the more room there is for big banker bonuses, I am really not referring to an insignificant wet dream

@PerKurowski

Philip Augar, the ‘banking crisis of 2008’ did not dent at all Milton Friedman’s ideas that “sowed the seed of shareholder value”

Sir, Philip Augar quotes Milton Friedman with: “that business is not concerned ‘merely’ with profit but also with promoting desirable ‘social’ ends . . . They are — or would be if they or anyone else took them seriously — preaching pure and unadulterated socialism….” “to make as much money as possible” for the owners, “while conforming to the basic rules of society”, “A call for boards to overturn the status quo” January 4.

And he follows up with “This sowed the seed of shareholder value... It took the banking crisis of 2008 and the ripple effect of financial disaster to expose the flaws of the theory”

What is Augar talking about? Banks, in order to make the highest risk adjusted profits, just followed the “basic rules of society”, in this case set by their regulators who, with their risk weighted capital requirements for banks told them: “Go out and make your biggest risk adjusted profits on what is perceived or decreed as safe”

And that is precisely what banks did, initially making huge profits, but also creating dangerously excessive exposures to “the safe” like AAA rated securities and loans to sovereigns who had been assigned a 0% risk weight, like Greece; which exploded.

I cannot understand how Augar can argue that has dented Milton Friedman’s thesis. If anything it clearly demonstrates the dangers of having some very few define and impose “the basic rules of society”.

He opines “boards need to develop a mindset that challenges rather than seeks to justify the status quo” That is correct, but does that not include papers like the Financial Times too?

Sir, why has FT not dared to challenge the status quo by for instance demanding regulators to give a straight simple answer, not disguised in incomprehensible technicalities, to the question of “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”?

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

@PerKurowski

If you really want banks to make green investments, allow bank to hold less capital against these than for instance against residential mortgages.

Sir, Suleika Reiners, Senior Policy Officer for Financial Reform, Institute for Financial Services, Germany writes: “banks need more equity, not less, in order to fulfil their key responsibility — namely to cushion risk, including for green investment. Lending for long-term endeavours such as large-scale renewable energy projects particularly deserves high-risk weightings” “Banks need more equity to boost green investment”, January 4.

Boy, has she got it all upside down. I have nothing against higher capital requirements for banks, unless these are imposed so irresponsibly so that the while bank credit machinery freezes. But, in order for banks to really boost green investment, they should be allowed to hold less capital against these investments than against other assets, so that they can earn a higher risk adjusted return on it.

Just look at how much they are financing residential housing, only because that’s perceived safe by regulator safe, and who therefore allow banks to hold little capital against the mortgages.

Reitners refers to “a study by the University of Cambridge in association with the United Nations Environment Programme Finance Initiative [that] has proved that stricter equity requirements are an insignificant factor in influencing the bank’s pricing of the loan or its willingness to lend.”

I have not read that study but, if those are the results, I am sure it contains major design flaws.

Sir, you refusal to discuss the distortions produced by risk weighted capital requirements, perhaps so as not to disfavour your bank friends, is partly to blame for the continuation of misconceptions as those expressed here by Suleika Reiners.

I don’t like the idea of distorting the allocation of bank credit to the real economy but, if we have to do it, let that at least be in pursuit of higher objectives than a simple risk avoidance, which will anyhow not isolate us from bank crises.

God make us daring!

@PerKurowski

Financial liberalism died when the Basel Committee establishment concocted the risk weighted capital requirements for banks

Sir, Joe Zammit-Lucia writes: “True liberals have always understood the need for continual reform as stagnating systems inevitably get progressively captured by powerful interests. Liberalism dies when it becomes the Establishment, itself captured by vested interests and an apologia for the status quo” “True liberals understand the need for reform” December 29.

What better example of that than when the regulatory establishment, gathered in the mutual admiration club of the Basel Committee decided to protect with lower capital requirements for banks the lending to the safer status quo than any lending to a riskier future.

Bankers loved it, because that allowed them to fulfill their wet dreams of being able to achieve the highest risk adjusted returns on equity on what is perceived as safe; and lower capital requirements naturally opened up much more space for their own bonuses.

Regulators, dumb enough to take ex ante perceived risks to represent real ex post dangers love it, because they think they are making banks safer.

And the world stagnates because of that risk aversion, and turns statist as regulators risk-weighted sovereigns with a 0%, thereby subsidizing public borrowings.

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

@PerKurowski

How a great bankers’ game show, got to be disastrously distorted by the Basel Committee.

Sir, I refer to Tim Harford’s interesting and fun article discussing probabilities based on Monty Hall’s ‘Let’s Make a Deal’ game shows: “Stick-or-switch inspires an onion of a puzzle” October 7.

In order to try to shed light on what I find so utterly disturbing with current bank regulations, let me then try use the example of an imaginary weekly-televised game among bankers, in which the contestants has to pick one of two boxes.

Box1 contains one 3 year $1 million loan to someone very safe at a very low interest rate.

Box2 contains one hundred 3 year ten thousand $ loans to many riskier borrowers but at much higher interest rates.

Which box would the banker contestant pick?

If he could analyze the second box in detail, the answer would clearly depend on if those higher interest rates seemed sufficient to cover the increased risk.

If the risk adjusted value at the end of the 3 years seemed the same for both boxes, or Box 2 produced only a slightly higher value, the ordinary risk adverse banker would surely go for “safe” Box1. Otherwise he would, he should, pick “risky” Box2, because that is precisely what bankers do… or at least did.

But that was not how bank regulators wanted that game to be played.

Considering bankers were not risk adverse enough, they wanted the contestants to pick Box 1 many times more and avoid Box2 much more; and to that effect they introduced risk weighted capital requirements.

That rule meant that if the banker picked “risky” Box2, while waiting for the 3 years result, he had to hold more capital (equity) than if he picked “safe” Box1.

As a result bankers would, from that moment on, prefer Box1 to Box2 much more; with what should have been expected consequences.

First to keep the game show going, many more boxes of the “safe” Box 1 type were needed, something that also meant the producers had to offer lower interest rates on the “safe” loans.

And in order to keep the audience interested, so that a Box2 had also a chance to be selected, the game show host also had to make sure to compensate the additional capital required, with still higher interest rates on the loans in Box 2; something which de facto made these loans even riskier.

What was the end result? Too many loans and too low rates were given to the “safe” and too few or at too high rates were given to the “risky”

For the bank system and for the real economy this was a disaster. Bankers would choke on “safe” loans to sovereigns, AAA rated borrowers or mortgages (causing crisis type 2007-8); and the economy would suffer from the “risky” SMEs or entrepreneurs lack of access to competitively priced credit (causing low growth).

Are we to appreciate these regulators interference? I don’t! 

@PerKurowski

President Trump. Bankers have already way too much representation. Give the much-needed “risky” borrowers more voice

Sir, I refer to Sam Fleming’s and Alistair Gray’s “Bank’s president is latest alumnus to be tapped for a senior White House job” December 10.

Current bank regulations overtly favor banks earning much higher expected risk adjusted returns on equity when lending to something perceived as safe, than when lending to something perceived as risky, like to SMEs and entrepreneurs.

That of course delights bankers but the other side of the coin, is that the real economy is not getting its credit needs efficiently satisfied.

Therefore Trump would do a lot better assuring the perspective of “borrowers” is more represented in his government, than the clearly overrepresented perspective of bank lenders.

PS. I would love for Trump to convene the regulators and ask them a set of questions that they refuse to answer to someone as powerless as me… that is unless perhaps I threaten them with going on a hunger-strike.

@PerKurowski

Europe, if you do not remove current risk weighted capital requirements for banks, no stimulus will really help.

Sir, Reza Moghadam from Morgan Stanley writes: ECB should switch from buying sovereign bonds to funding the removal of troubled assets from European banks…[that] would do more to alleviate the constraints on economic recovery than sovereign bond purchases ever could. “How to redirect easy money and encourage banks to lend”, December 6.

Of course that would help, but only for a while. If you do not remove the risk weighted capital requirements for banks, those which distort the allocation of bank credit to the real economy, and which therefore impede any stimulus like QE or a European type Tarp to reach were it can do the most good, you’ll soon be back on the cliff, albeit higher up.

Sir, the lower the capital requirement, the higher the leverage of equity, the higher the expected risk adjusted return on bank equity be. Therefore you cannot be so naïve as to expect a banker like Moghadam to say one world that would imply higher capital requirements for anything. In fact, by allowing banks to earn the highest risk adjusted returns on what is perceived as safe, the Basel Committee has made the bankers’ wet dreams come true.

When will you invite someone, like me, who speaks out for the access to bank credit of the “risky” SMEs and entrepreneurs? Or are these beggars for opportunities, those who could help open new gateways to the future, just not glamorous enough for you?

@PerKurowski

Senator Elizabeth Warren, what about the staggering bad bank regulations that came out of the Basel Committee?

Sir, Patrick Jenkins writes: “Today, Mr Stumpf will face an inquisition at the Senate banking committee. It promises to be a hostile experience — no-nonsense committee member Elizabeth Warren is not known for her love of the banking sector and has already talked of Wells’ “staggering fraud”. “Wells Fargo chief ’s high noon is Senate committee grilling” September 20.

I’ve got no problem with any “grilling” of bankers, give it to them! But, Senator Warren, in all fairness, do not turn it all into another simpleton Bank-Bashing fair, We the People need it to be much more. If anything, look at how the bank regulators set up all the incentives for bankers to do wrong.

Why on earth should we expect bankers to be saints and resist the temptations? Aren’t they supposed to maximize their risk adjusted returns on equity?

What am I talking about? THIS

http://subprimeregulations.blogspot.com/2016/09/if-ever-allowed-following-would-be-my.html

PS. And Senator Warren, why would you agree with those who decreed inequality?

http://subprimeregulations.blogspot.com/2016/03/decreed-inequality.htm

@PerKurowski ©

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 ©

Banks, to get out of their dead-end street, must make a convincing case they can prosper holding much more capital.

Sir, James Shotter, Laura Noonan and Martin Arnold write: “At yesterday’s close, investors were implying that the biggest bank in Europe’s most stable economy [Deutsche Bank] is worth €17.7bn, just a quarter of the book value of its assets.” And then we read of efforts to better that by reducing operations and cutting down on risk weighted assets. In other words being placed in an Incredible Shrinking Machine. “Big Read: Deutsche Bank: Problems of scale” July 29.

Because of the risk weighted capital requirements, banks were set on a road of increasing returns on equity by diminishing the capital they needed. And, on that road they lost many opportunities, like lending to “risky” SMEs and entrepreneurs. And they also ended up in dangerously over-populated safe-havens that, when compared to the “risky”, suddenly offer lower real-risk adjusted returns. They now are in a dead-end street.

So, if it was me, I would try to make the strongest case possible to my shareholders that there are good and safe returns on equity to be obtained by ignoring Basel regulations. “Give us 12 percent in equity, against all assets, so as to allow us pursue the undistorted highest risk-adjusted returns out there.”

Sir, I have of course no idea if that is a viable strategy for any individual bank, such as Deutsche Bank. Most banks are caught between a rock and a hard place. They need to ask for much capital, but that much capital might be so much, that they could scare away everyone. Anyhow, I would not like to work in a bank that is going to stretch out the suffering by asking for more capital, again and again, little by little. To get it all and get over it would benefit everyone, including current shareholders.

Is that impossible? Not really, here “one of the bank’s top 20 investors” is quoted with “The problem for Deutsche is that it has got to the stage where if it continues to cut assets, it is going to lose a significant amount of revenues”.

And on a different issue, the litigations and fines banks face, I repeat what I said over the years. 

When we all know that for the banks’ good and for our economies’ good banks need more capital, to extract fines paid in cash is irresponsible and masochistic. All those fines should be paid in shares.

@PerKurowski ©

#BoE #FSB Mark Carney why do you bank regulators discriminate so much against us SMEs and entrepreneurs?

Sir, Mitul Patel with reference to that “The Bank of England’s Monetary Policy Committee will formally meet on Thursday for the first time since the EU referendum result” expresses many valid concerns. “Question marks remain as BoE grapples with monetary policy poser” July 12

But the following question is in my mind of much larger importance:

Mr. Mark Carney, you as the chair of the Financial Stability Board must be well versed on the subject of bank regulations, and so could you please explain to us SMEs and entrepreneurs the following?

We, who are usually perceived as risky, usually perceive much less bank credit and pay much higher risk premiums than those perceived as safe. And so, why do banks, when compared to the capital they need to hold against those perceived as safe, need to hold much more capital against loans to us.

Since banks can then leverage their equity, and the support they receive from taxpayers much more with assets perceived as safe, than with loans to us, we now have a much harder time to provide the banks with competitive risk adjusted ROEs. And so we get even less bank credit or have to pay even higher interest rates.

And to top it up we cannot understand where you all got the idea that banks could build up the excessive and dangerous exposures that could threaten the bank system, with small and high interest rate loans to borrowers like us.

So Sir, can you explain it all for us? Why should our access to bank credit be curtailed? Are we not useful to the real economy?

Thanks,

Will Mark Carney dare to take that question, or will he as I once heard Robert McNamara recommend: “If they make you a question you don’t like just answer the question you wanted to hear”?

@PerKurowski ©

Low capital requirements for banks lead, automatically, naturally, to high bonuses for bankers

Sir, Diane Coyle writes: “If the chief executive of a company seriously tells me, as a shareholder, that he will not put in as much effort as he otherwise would unless I link his pay to a handful of metrics, I have every reason to be doubtful about hiring him to do the job” “Burger flippers deserve bonuses, bankers do not” May 26.

That is absolutely right; as long as the shareholder was putting in enough efforts himself… otherwise he might better shut up in silent complicity.

If you make the argument that the bankers are helping to convince the regulators that the shareholders of a bank need to put in very little equity, and therefore the shareholders are made more irrelevant, then it is much easier to understand why bankers have been able to get away with what they are doing.

Bank equity, allowed to be highly leveraged, especially on what is perceived as safe, has produced great returns, which have kept bank shareholders happy and in a complacent mood.

Ask the banks to triple their capital, or at least put up 10 percent of equity against absolutely all assets, and then you might begin see some bonus restricting relations developing between bank managers and the shareholders of banks.

@PerKurowski ©

Does BoE’s core mission not include assuring bank credit is allocated as efficiently as possible to the real economy?

Sir, I refer to the letter written by Andrew Bailey and Sir Jon Cunliffe of the Bank of England titled “Proposals designed to fulfill BoE’s core mission”.

“They write “BoE’s proposals about the appropriate capital requirements for the UK’s banks are the product of two years of careful reflection and stress-testing, and are designed to fulfil our core mission of making the banking system safe and sound.”

But then we read about equity requirements expressed as percentages of “risk-weighted assets” and I must again ask the following:

Is not also part of the core mission of BoE assuring that bank credit is allocated as efficiently as possible to the real economy? I ask this because risk weighted capital requirements, by allowing banks to earn higher risk adjusted returns on equity on assets ex ante perceived as safe than on risky assets, distorts horrendously the allocation of bank credit to the real economy.

And by the way, by distorting that credit allocation they will make the real economy unsound and thereby, sooner or later, also threaten the safety of the banking system.

And by the way, just as an aide memoire, I remind them of that no major bank crisis ever result from what is ex ante perceived as risky, these are always the consequences of excessive exposure to something that ex ante was perceived as safe but that ex post turned out to be risky.

@PerKurowski ©

Too much fighting for a safe haven dissipates its safety and turns in into a dangerously overpopulated haven.

Sir, Tim Harford writing on the “dissipation of economic rents” holds that “They’re frustrating, because value is being frittered away in the competition to secure them… the entire value on offer will be consumed by the race to grab it.” “How fighting for aprize knocks down its value”

How come it is seemingly so hard for Harford and other economists to apply the same concept to the “dissipation of credit safety”?

If regulators allow banks to hold less capital against what is perceived as safe, which means they can leverage more with these assets, and which means they will earn higher expected risk adjusted returns on assets perceived as safe than on assets perceived as risky … then they will hold more and more of safe assets perceived as safe… until the safety of these assets dissipates.

Harford asks: “Can anything be done about … rent-dissipating behaviour?” and answers “One approach is to tax it.” 

Since dissipating credit security is the result of a regulatory subsidy in favor of safety, in that case an easier and more sustainable solution would be just to get rid of dumb regulators, those who think that what is ex ante perceived as safe is more dangerous to the banking system than what is perceived as risky. 

@PerKurowski ©

Martin Wolf there is a slow moving but sure regulatory destruction of our economies, and that is a guaranteed disaster

Sir, Martin Wolf writes: “If one wants to worry, there is plenty to worry about. Yet, from the economic viewpoint, what matters is not so much whether the world will be well managed: it will not be. What matters more is whether a disaster will be avoided… The cumulative chance that at least one of all such disasters will occur is greater than the chance that any one of them will do so. Nevertheless, the likelihood that none of them will occur is surely bigger”, “Why economic disaster is an unlikely event” January 6.

Wolf ignores the ongoing slow moving but sure destruction of the economy that results from the distortion in the allocation of bank credit introduced by regulators by means of the credit risk weighted capital requirements for banks. In terms of what our banks can do for our real economies, these have been castrated.

If the stress testing of banks had, besides looking at what is on their balance sheets, looked for what should be on and is not, the technocrats would have discovered the growing absence of credit to the risky SMEs and entrepreneurs, those that on the margin are responsible for moving the economy forward in order not to stall and fall.

How do I know that? Well, if banks are allowed to leverage more on assets perceived as safe than on assets perceived as risky; and thereby earn higher risk adjusted returns on equity on assets perceived as safe than on assets perceived as risky, that is doomed to happen.

How does Martin Wolf not know that? I haven’t the faintest. From what he answered me on one occasion, it would seem he thinks bankers should resist the temptation to maximize their returns on equity. That is a strange thesis, especially when that maximization results from holding assets perceived as safe. Make the most on the safest sounds like a banker’s dream come true.

@PerKurowski ©

The sky might not fall on America, yet, but credit-risk phobia sucks the Home of the Brave’s vitality

Sir, you write “Cheer up, the sky is not falling on America’s head” January 2.

Sir, if bank regulators suddenly gave banks great incentives to avoid lending to those perceived as risky, like the SMEs and entrepreneurs, and to concentrate on lending to the sovereign and the AAA rated, would you still hold that all was fine and dandy in the Home of the Brave?

I ask because that is precisely what has been going on since1988 when regulators came down with a serious and dysfunctional credit risk-phobia that made them impose risk weighted capital requirements on banks.

In Basel I the risk weight of the sovereign (government) was set at zero percent, while America’s private sector was risk weighted at 100 percent. And then in 2004, with Basel II they split up the private sector in a range that went from a 20 percent risk weight for the AAAristocracy, and up to 150 percent for any borrower rated below BB-.

And that meant that banks now earn higher risk adjusted returns on what is perceived as safe than on what is perceived as risky. With such regulations that hinder the opportunities of the risky to have fair access to bank credit, it is clear that America would never have become the economic powerhouse it got to be. 

And similar things could be said about the entire Western world. Sir, it never stops to amaze me how determined you have been not to reference the distortions in the allocation of bank credit to the real economy that the Basel Committee has produced.

@PerKurowski ©

Martin Wolf: Sovereigns = 0% risk weight; citizens = 100%. Are not regulations relevant to sovereign bond markets?

Sir, Martin Wolf discusses lengthily the history and possible future of the current low yields of sovereign bonds, “The wary retreat of the bond bulls”, May 20.

Surprisingly, or perhaps not so surprisingly, Wolf fails to even mention the absolutely extraordinary development that took place with the signing of the Basel Accord in 1988. In that accord, regulators, decided unilaterally and with no explanations given, that for purposes of the equity banks needed to hold, the sovereigns were assigned a risk weight of zero percent, while the citizens, those who really constitutes the backing of a sovereign, were risk-weighted with 100 percent.

That of course meant that those interest rates which were used as proxies for the risk-free rate, became subsidized risk-free rates and are not at all comparable to what existed before 1988.

That of course meant that banks would earn immensely higher risk-adjusted returns on equity when lending to the sovereign than when lending to the risky.

In November 2004 in a letter published in FT I wrote: “Our bank supervisors in Basel are unwittingly controlling the capital flows in the world. How many Basel propositions it will take before they start realizing the damage they are doing by favoring so much bank lending to the public sector (sovereigns)?” More than a decade later I still ask the same question and many still prefer to ignore that.

@PerKurowski