Current bank regulations are evidence free rather than evidence based

Tim Harford suggests, “Pick a topic that matters to you”, “How to survive an election with your sanity intact” November 16.

Ok. Bank regulations. And Harford argues, “Politics… is now evidence-free rather than evidence-based”. Indeed but so are current bank regulations. 

What has caused all big bank crises was something ex ante perceived very safe that ex post turned out very risky… in other words incorrect risk assessments.

But instead of basing the capital requirements based on this empirical evidence, regulators concocted risk-weighted capital requirements based on credit risks being correctly perceived. And so they assigned a meager 20% risk-weight to dangerous AAA rated, and 150% to the so innocous below BB- rated. 

If I were a regulator I would consider my role to guard against the possibility that bankers could perceive risks incorrectly, instead of, like the Basel Committee has done, betting our bank systems on bankers always being correct. Sir, wouldn’t you too?

Harford suggests, “When someone expresses an opinion, whether you agree or disagree, ask them to elaborate. Be curious.”

Unfortunately, when thousand of times I’ve asked the question “Why do you believe that what’s perceived as risky by bankers is more dangerous to our bank systems than what they perceive as safe?” that has not generated much curiosity. What it has generated is a lot of defensive circling of the wagons. “There again goes Kurowski with his obsession”

Harford also reminds us of Alberto Brandolini’s “bullshit asymmetry” principle, “The amount of energy needed to refute bullshit is an order of magnitude bigger than to produce it.” With soon 3.000 letters to FT on the topic of “subprime banking regulations”, I can sure attest to that being true.

https://teawithft.blogspot.com/search/label/subprime%20banking%20regulations

@PerKurowski

Does not common sense dictate that in good times we want our banks to be weary about what they perceive as safe? Does not what’s seen as risky take care of itself?

Joe Rennison writes: “Investors and rating agencies have warned that companies might struggle to refinance huge debt burdens, resulting in downgrades from triple B into high yield or “junk” territory.” “BIS sounds alarm on risk of corporate debt fire sale” March 6.

What does that mean? Namely the risk that ex ante perceptions of risk might, ex post, turn out really wrong.

Also, “Bond fund managers could then have to sell the bonds as many are bound by investment mandates barring them from holding large amounts of debt rated below investment grade. ‘Rating-based investment mandates can lead to fire sales,’ warned Sirio Aramonte and Egemen Eren, economists, in the BIS quarterly review released yesterday.”

And what does that mean? Clearly procyclicality in full swing! Just like the insane procyclicality caused by the risk weighted capital requirements for banks.

Sir, does not common sense tell you that in good times we want our banks to be weary about what they perceive as safe, as what they perceive as risky takes care of itself? And in bad times, do we not want our banks not to be too weary of the risky, and burdened with having to raise extra capital when it could be the hardest for them?

Sir, so what are regulators doing allowing banks to hold less capital against what they in good times might wrongly perceive as safe, and imposing higher capital on what they would anyhow want to stay away from, especially in bad times?

Sir, for literally the 2,781 time, why does not the Financial Times want to dig deeper into unavailing what must be the greatest regulatory mistake ever? 

Are you scared of then not being invited to BIS’s Basel Committee’s and central banks’ conferences? “Without fear and without favour” Frankly!

@PerKurowski

Should we prohibit divergent perceptions of credit risk? No and yes!

Sir, Martin Wolf writes: “In a recent paper, Marcello Minenna of Con-sob (Italy’s securities regulator) argues that divergent perceptions of credit risk across member states reinforce divergent competitiveness in goods and services. This puts businesses in peripheral countries at a persistent disadvantage, which becomes worse in times of stress.” “The ECB must reconsider its plan to tighten” March 6.

So should we prohibit divergent perceptions of credit risk? No and Yes!

Absolutely no! The existence of divergent perceptions of credit risk is crucial for an effective allocation of credit.

Absolutely yes! Bank capital requirements based on divergent perceptions of credit risk guarantees an inefficient allocation of credit.

The truth is that businesses in peripheral countries are less at disadvantage for their countries being perceived risky, than for the regulators, or other authorities, considering that there are others much safer. The risk weight for the Italian sovereign, courtesy of the EU authorities is 0%, while the risk weight of an Italian unrated entrepreneur is 100%. Need I say more?

Wolf opines, “The painful truth is that the eurozone is very close to the danger zone [as] the spectres of sovereign default and ‘redenomination risk’ — that is, a break-up of the eurozone — may re-emerge”. Indeed, and the prime explanation for that is precisely the 0% risk weights assigned to its sovereigns, those de facto indebted in a currency that is not denominated in a domestic (printable) currency.

We’ve just celebrated the 20thanniversary of the Euro. The challenges its adoption posed were well known. What has EU done to really help confront those challenges? Very little to nothing! In truth, with its Sovereign Debt Privileges, they have managed to make it all so much only worse. Sir, considering that, for someone who truly wanted and wants the EU to succeed, it is truly nauseating to see the daily self-promoting tweets from the European Commission.

@PerKurowski

Instead of for known unknowns or unknown unknowns, regulators require banks to hold capital against believed knowns

Sir, Ray Soifer writes: “Dennis Kelleher (Letters, April 19) is right that we do not really know how much capital is necessary to prevent catastrophic bank failures. Indeed, we will never know, because not all the risks faced by financial institutions are “known unknowns”. Some of them will always be “unknown unknowns” until after the fact. Thus, there will always be need for effective supervision and market discipline: the other two legs of Basel’s “three-legged stool”.” “Unknown risks explain need for bank oversight” April 22.

But our bank regulators came up with the brilliant idea that banks should hold capital against what could be seen as perceived known knowns. With their risk weighted capital requirements they doubled down on those perceptions of risk that already influenced decisions on the amount of exposure the bank wanted to hold, and the interest rate to be charged.

So what is perceived safe, which can then be held with less capital, now signals even more safety; and what is perceived as risky, which requires more capital, signals even more riskiness.

Sir if you make the “safer” safer and the “riskier” riskier, do you really think the banks will allocate credit efficiently to the real economy? Of course not!

The “safe” like sovereigns, AAA-risktocracy and housing will get too much access to bank credit; and the “risky” like SMEs and entrepreneurs too little.

“Need for effective supervision” By whom, those who do not understand the distortions they are causing?

“Need for market discipline” What market, that who is now so utterly confused by the risk weighing?

The craziness of this capital requirement regulation is unbelievably large… and therein lays the major obstacle. I hear you: “They can’t be so dumb”. Yes Sir, don’t doubt it, they can!

Sir, “Without fear and without favour” dare ask regulators the following questions:

http://subprimeregulations.blogspot.com/2016/12/must-one-go-on-hunger-strike-to-have.html

@PerKurowski

Math teacher Lucy Kellaway, before leaving FT, please explain to bank regulators the difference between a sum and an average

Sir, Lucy Kellaway stuns us announcing she will be leaving FT in order to teach some inner London students math. “It is almost goodbye from me and I want you to join me”, November 21.

Though I am not sure why she can’t write articles and teach math at the same time, her readers will sure miss her and her students most certainly welcome her.

That said, and given she must obviously know math and have some pedagogical proficiency explaining it, I sure wish that, before leaving, she would have a go at explaining to current bank regulators, the difference between a sum and an average.

In banking, the amount of credit and the interest rate charged on any credit is basically the result of the average bankers risk aversion to any average perception of risk. Were bankers to add up their risk aversion, then just the safest of the safest might get some tiny piece of credit and all slightly riskier would be totally left without.

Which is why, when bank regulators, to the bankers’ risk aversion to perceived risk, added by means of the risk weighted capital requirements for banks their own risk aversion to basically the same risk perception, they distorted all common sense out of the allocation of bank credit to the real economy.

For more than a decade I have tried to explain this to regulators, with no luck. Perhaps Lucy Kellaway would be able to find better words. We sure need our bank regulators to understand the simple fact that any risk, even if perfectly perceived, causes the wrong responses, if excessively considered.

@PerKurowski