“Risk Management”, yes, but for whom?

Any good financial investment advisor, depending on the age of his clients, would clearly give them different recommendations.

Sir, therefore, even when FT Special Report “Risk Management” specifies it is about “Financial Institutions”, full transparency would require it to clearly specify for whom.

The Basel Committee’s risk weighted bank capital/equity requirements too much favours what’s perceived (or decreed) as safe, e.g., public debt, residential mortgages and highly rated borrowers/securities, and too much fears what’s perceived riskier, e.g., loans to unrated small businesses and entrepreneurs. With that it is managing the risks of us older, like your journalists, than the risks of our children and grandchildren.

In reference to that holy intergenerational social contract he often spoke about, what would Edmund Burke opine about the Basel Committee?

Sir, Jesus Christ invited the Apostle to "put out into the deep" for a catch: "Duc in Altum" (Lk5:2) "When they had done this, they caught a great number of fish" (Lk5:6). The Basel Committee gave the banks of our Western world great incentives to fish from “safe” shores. And look where this has taken us.

PS. Not long ago I had a dialogue with ChatGPT on this issue.

https://perkurowski.blogspot.com/2024/09/ai-openai-chatgpt-as-grandfather-should.html

PS. And, of course, as you well know, this is not the first time that I have opined on the Basel Committee regulations, an issue that according to Martin Wolf I am obsessed with.

https://teawithft.blogspot.com/2009/10/please-free-us-from-imprudent-risk.html

When will supposedly sophisticated papers like Financial Times wake up to the horrors of current bank regulations?

Sir, Ray Soifer writes: “No wonder banks’ shares generally trade at a discount to their stated book value. No one really knows what their true net asset value is — too often, not even the management.” “Picture of risks in banks’ portfolios is still fuzzy” January 17.

Of course! How could it be otherwise? Banks are currently most certainly paying more for consultants to understand their regulator’s risk/required capital management, than what they pay for the risk management of their own portfolio. Because, how is one to understand risks in banks’ portfolios when the risk weights used by regulators are, to top it up, portfolio invariant, since to do these portfolio variant would be, as they confess, too difficult for them to do?

Could it be because when something is too out of line, it is sort of easier to attribute an intelligent motive to it? Sir, again it all reminds me so much of Chance gardener a.k.a. Chauncy Gardiner

@PerKurowski

Is Ermotti suggesting UBS tinkers with risk measuring, like Volkswagen tinkered with pollution emissions measuring?

Sir, I refer to your most important editorial in over a decade, “Banking cannot prosper within a culture of fear”, September 24.  A more correct title would be: “Our economies cannot prosper when bank regulators have been overtaken by a culture of senseless fear”.

You, who proudly proclaims a “Without fear”, seem to at long last have to come to grips with the fact that risk-taking is much needed in order to avoid even worse risks. Sadly, you should at the latest, have written that in June 2004 when Basel II was announced.

Then silly risk adverse regulators, who clearly had never read The Parable of the Talents, imposed a culture of fear of “The Risky” by excessively embracing “The Safe”. Its risk-weighted capital requirements, clearly instructed banks to avoid taking risk on The Risky, by giving them permission to leverage incredibly, much riskier, with what is perceived ex antes as safe.

And you write: “Sergio Ermotti, the chief executive of UBS, has been so bold as to urge his staff to embrace risk-taking again”. Great, and of course I agree full heartedly with him. That is our responsibility towards those coming after us. God make us daring!

Unfortunately, Ermotti can urge his staff to embrace-risk taking as much as he wants, that will still not happen, not as long as the credit-risk weighted capital requirements remain in place. That is of course unless Ermotti is now suggesting that UBS tinkers with risk measuring, along the way Volkswagen tinkered with emissions measuring.

PS. On a personal note I wish of course you would have had the decency to at least acknowledged that this, Basel’s dangerous regulatory risk aversion, has been the leitmotiv in the over thousand of letters I sent you, which you preferred to ignore. The letters though are still all out there on my http://teawithft.blogspot.com, for the world to see.

PS. When bankers grow old and begin to fade away... what would they regret the most, the risk they took or the ones they did not dare to take?

PS. Here I have a brief YouTube explanation, in red and blue, of our crazy bank regulations.

@PerKurowski

Our risk with banks has nothing to do with risks of their assets, and all with how banks manage risks of their assets

Sir, Tim Harford writes: “It’s particularly easy to fool ourselves when we already think we have the answer”, “Take a guess at JFK’s age in 1963” February 21.

Indeed, but it is even worse when we think we have the answer, but we are answering the wrong question.

Look for instance at what inspired bank regulators to create the pillar of current bank regulations; the risk-weighted equity requirements for banks: “more-risk-of the bank assets-more-bank equity and less-risk-less-equity” does it not sound so logical, does it not sound so right?

Yet the problem was regulators never posed themselves the right question. What they should have asked is: “What is the risk bankers will either not perceive the risks with bank assets or manage these correctly?” which is something that has clearly little to do with the risks of bank assets.

Look for instance at Martin Wolf. In July 2012 he wrote: “As Per Kurowski, a former executive director of the World Bank, reminds me regularly, crises occur when what was thought to be low risk turns out to be very high risk." And yet Wolf is incapable to take it from there, so as to accept that perhaps current bank regulations, with respect to perceived credit risk, are 180 degrees off target

Simon Samuels, bank regulators’ own ‘risk culture’ is as bad as it gets

Sir, Simon Samuel’s holds that “the driver of bank failure is not insufficient capital but rather a bad ‘risk culture’”, “A culture ratio is more important than a capital ratio”, November 25.

Absolutely, just like it is not the risk of the assets that a bank has on its books that matters, but how the bank manages those risks.

And in this respect no ‘risk culture’ has been as bad and damaging than that of bank regulators who came up with portfolio invariant ex ante perceived credit risk weighted equity requirements for banks.

With it they gave incentives for banks to accumulate dangerous high exposures against little equity in assets like loans to Greece or AAA rated securities.

And with it, by making it easier and cheaper for the “infallible” sovereigns and the AAAristocracy to access bank credit, and thereby much harder to do so for the peasants, our small businesses and entrepreneurs, they also imposed destructive financial feudalism 

Simon Samuels would do good looking at what he himself and his colleagues are up to in the Financial Stability Board, and in the Basel Committee, since only excessive hubris could explain them thinking themselves able to play risk managers for the banks of the world.

The genie in the Basel Committee’s Aladdin lamp… is as dumb as genies can come

Sir, I had no idea of the existence of the “state of the art risk and order management system” described interestingly by Tracy Alloway in “Genie not included in BlackRock´s Aladdin” July 12.

Of course “none of these tools are meant to supplant the basic human intelligence required to make informed investment decisions”… but they do. Perhaps, in order to avoid unnecessary introduction of systemic risk, there should be fairly low limit to how much of the market can be served by the same risk modeling tool.

But again it surprises me how Alloway can write such an insightful article, and still not comprehend that the Basel risk-weights which determine the capital banks need to hold, amounts to an Aladdin lamp with a residing genie as inept as they can come. Imagine, just for a starter that genie believes that what is risky for banks and bankers is what is perceived as risky… how dumb is not that?

And distorting the allocation of bank credit following the advice of that genie is as dangerous as it comes for the real economy.

PS. Tracy Alloway on Wall Street, how many shares are traded in the Dow Jones index? Could the increase in its value be a function of shrinkage of its base?

Too much longing for stability creates the perfect storm conditions for instability

Sir, Samuel Brittan refers to “artificial suppression of volatilities in the name of stability” “The follies and fallacies of our forecasters” May 27. That is precisely what as an Executive Director of the World Bank I was referring to when, in May 2003, in pre-Basel II days, I told a large group of regulators gathered for a risk-management workshop at the World Bank, the following: 

“There is a thesis that holds that the old agricultural traditions of burning a little each year, thereby getting rid of some of the combustible materials, was much wiser than today’s no burning at all, that only allows for the buildup of more incendiary materials, thereby guaranteeing disaster and scorched earth, when fire finally breaks out, as it does, sooner or later. 

Therefore a regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, could be a much more effective regulation. The avoidance of a crisis, by any means, might strangely lead us to the one and only bank, therefore setting us up for the mother of all moral hazards—just to proceed later to the mother of all bank crises.”

The regulators did not understand what I was talking about… mostly because they wanted so much to believe in forever stable banks.

PS. As you can see here, the link to Brittan’s article is gone.

Another FT Special Report on Risk Management in Finance that did not mention the risk of regulations

Sir, you publish a special report titled “Risk Management: Finance” March 22. In it not once do you refer to the fact that the current supreme financial risk managers of the world are the banking supervisors in the Basel Committee, and who so arrogantly assume it is their right to set Ground Zero for the rest of the risk managers.

With their risk-weights in Basel II, these inept nuts, and there really is no other word for them, decided that the banks returns on capital could be dramatically increased, by allowing leverages of more than 60 to 1, as long as they kept doing operations related to an officially confirmed no risk situation, a triple A credit rating.

Paul Davies explains “why there is now a greater understanding that there is little guidance to be found from the past when preparing for the future”. But that is only so because most still refuse to look at the recent past, and understand from it than bank regulators cannot discriminate as they did, and do, by means of capital requirements for banks based on perceived risks, without creating monstrous systemic risk.

Brooke Masters writes “now that regulators have moved to impose tougher capital and liquidity requirements, attention is turning to other systemic risk”, which ignores that it was not the lack of toughness of the capital requirements that mostly caused the disaster but the way how they discriminated. What better evidence is there that the 8 per cent capital requirement in Basel II for what is rated BBB+ to BB- has proven more than sufficient and that it is only in the area covered with AAA to A ratings where problems have surged.

Richard Milne writes “Follow the line of debt to spot the coming crisis” and refers to a possible bubble in the public sector, while not saying one word about the fact that banks can lend to the public sector with infinitesimal capital requirements, as long as these sovereigns are rated AAA to A.

But worst of all, the special report again fails to mention the fact that the market’s risk management already clears for perceived risk of default, which includes of course the credit ratings, by means of deciding the risk premiums to be charged in each case, and making all the alternatives investments equal. And so that when the regulators then come and intrusively layer on their own risk biases on the banks, the only thing they are doing is distorting the financial markets, and becoming themselves the greatest source of systemic risk.

About lights and regulations

Sir in “Regulating finance” February 18 you refer to “But the light is here”.

A fixed lamppost giving light is regulation, a regulator illuminating with a lantern where he thinks bank should go (like allowing for a 62.5 to 1 leverage whenever there was a AAA rating involved) that’s pure intervention. When will you grasp the difference between those lights?

The regulators took us back to the dark ages!

Sir, though I agree with most of John Kay’s “Could Napoleon have coped in a credit crunch?” October 29, I protest when he says that “The financial innovation that was once the means of spreading risks is now an unmanageable source of instability.” The source of instability was not the financial innovations per se; the prime source of instability was that those financial innovations were rated triple-A and that we so much believed in the ratings.

In Against the Gods Peter L. Bernstein (John Wiley & Sons, 1996) wrote that the boundary between the modern times and the past is the mastery of risk, since for those who believe that everything was in God’s hands, risk management, probability, and statistics, must have seemed quite irrelevant. Now and as far as I am concerned, when the bank regulators put so much faith into the credit rating agencies, they inadvertently took us back to the past.