To rise to the level of incompetence, “The Peter Principle”, has clearly been applicable in the case of current bank regulators

Sir, Sir Cary Cooper of Alliance Manchester Business School, when commenting on Tim Harford’s Undercover Economist column “We should not let bad managers stick around” (July 21), and the Peter Principle writes: “When promoting staff, many place disproportionate importance on a good run of form/current performance over their talent and skills to do the job they’re being promoted to. A good backbench politician won’t necessarily make a successful minister.” “Don’t allow ambition to cloud our talent judgment” August 4.

Indeed, and that is exactly what has happened to our bank regulators. One thing is to be a banker and carefully analyze the risk for the bank, and another, completely different, is to be a regulator having to analyze the risks of the bankers not being able to correctly analyze or respond to risks.

In this respect all current regulators, who could have been doing reasonably well analyzing individual small banks, when they still keep on thinking that what is perceived as risky is more dangerous to the bank system than what is perceived as safe, they have clearly risen to their level of incompetence.

PS. By the way, talking about business schools, why have they all kept mum on this? Could it be that all there wanted to be bankers and enjoy the big bonuses that could be paid when there is so little equity that needs to be remunerated? Or is it that they just don’t want to be seen as bankers’ party-poopers.

@PerKurowski

Lucy Kellaway is sure lucky a Basel Committee for Transport Supervision does not regulate her cycling.

Note: I just added a PS that might explain the letter better.

Sir, I refer to Lucy Kellaway’s “I want to get back on my bike in spite of the dangers” April 25.

The Basel Committee for Banking Supervision decided banks need to hold more capital, which is like a sort of tax, whenever they lend money to something risky, like to SMEs and entrepreneurs; and this even though banks charge higher risk premiums and give smaller loans whenever engaging with the risky.

And so it does because even though “the risky” are clearly riskier individually to banks, the BCBS ignores that it is those perceived as safe but that could turn out risky, which represent much greater danger to the banking system. 

So lucky Lucy Kellaway, that a Basel Committee for Transport Supervision does not regulate her cycling. Because, if it did, she would be taxed by much more than the “to avoid car doors and lorries turning left [and] wear all the safety gear” she taxes herself with when riding a bike.

And that because, like the BCBS, a BCTS could similarly regard cycling as much more dangerous than any other means of transport, even though most other means of transport, for instance cars, certainly cause more deaths in London than those “more than a dozen cyclists die each year” Kellaway refers to.

So if Lucy Kellaway had to pay a BCTS cycling tax, she might not get back on her bike, and she would then feel “angry, depressed, cynical, possibly prone to heart attacks and musculoskeletal disorders”… a bit like the banks and our economies end up feeling after being submitted to BCBS’s dumb rules.

PS. An alternative explanation is that the Basel Committee for Transport Supervision would pay Lucy Kellaway and the rest of Brits a subsidy in order for them to safely travel immobile on their bottoms and avoid the risks of cycling. Would Britain be better for it?

@PerKurowski ©

Risk of cyber-attack weighted equity requirements for banks make much more sense than the credit-risk weighted

Sir, I refer to Gillian Tett’s “Will cyber attacks mean the light go out?” April 25.

In it Tett describes the possibility of some huge unexpected losses that could happen to banks or to borrowers. And unexpected losses is precisely against which for instance banks, should be required to hold equity.

Instead our current regulators in the Basel Committee require banks to hold equity against the expected losses reflected in the perceived credit risks. As if the unexpected would be a function of the expected? Now how dumb is not that?

But perhaps there is a relation, though not the one the regulators see. The truth is that the safer something seems, the worse could be the consequences of something unexpected.

@PerKurowski

The Basel Committee's bank regulation's Achilles heel

The real unusual economic ill we suffer, is that of regulators ordering our banks to be risk adverse.

Sir, Martin Wolf argues for “Radical cures for unusual economic ills” November 26.

And therein he identifies the illness as the “chronic demand deficiency syndrome”, meaning “the private sector has failed to spend enough to bring output close to its potential without inducements of ultra-aggressive monetary policies, large fiscal deficits, or both.

But “to bring output close to its potential”, is sort of a half-baked aspiration for an economy, as it always need to strive to expand its potential.

And usually that signifies also to expand the economy’s potential more than what other economies can expand theirs… unless of course you subscribe to a somewhat Piketty like thesis that we must stop doing so in order for other to have a chance to catch up.

And, expanding the potential of an economy, can only be the result of risk-taking; never of that risk aversion which has been introduced by bank regulators, by means of their portfolio invariant credit risk based capital (meaning equity) requirements for banks.

But, unfortunately, just like the geocentric experts of the past could not get their hands on the realities of a heliocentric world, Martin Wolf belongs to those who confuse the world of ex-ante perceived risks, with the world of ex-post realized dangers; and therefore cannot understand that real banking risks do not revolve around what is perceived “risky”, but always around what is perceived as “absolutely safe”.

Wolf, referring to Lord Turner’s recommendation of “nationalizing the creation of money now delegated to often irresponsible private banks”, considers that as a “probably more effective way… to create money in order to expand demand”.

What a laugh! The truly real irresponsible have been the bank regulators like Lord Turner who, with such immense hubris, thought themselves capable of being the good risk managers for the world.

And now Martin Wolf, seemingly getting a bit desperate also argues that “Unproductive savings should be discouraged” and so “tax savings instead”. So let me end here by just asking: who is going to decide what is unproductive saving and what is not… is it Martin Wolf and his bank regulating buddies? I pray, for the sake of my grandchildren, for that not to happen.

PS. Why is Lord Turner lately so often referred to only as Adair Turner? Is he ashamed of his title? If so, relieve him, and take it away.

Investors driven out of safe investments by bank regulations and QEs, are they yield-hungry or just yield-starved?

Sir, Tracy Alloway and Michael MacKensie write that “Sales of US corporate bonds reflect a worrying lack of ratings differentiation” and they title that “Yield-hungry investors overlook credit risk” September 19.

All Fed’s QE’s, as well as the risk-weighted capital requirements for banks, as well as the upcoming liquidity requirements for banks, as well as much other risk-adverse regulations, only end up crowding out normal investors from what is deemed as “absolutely safe”, that which used to be said belonged to widows and orphans. 

And in that respect I wonder if “yield-hungry” is really the correct description of investors who seem more to have been yield-starved by official governments actions.

But also, let us not forget to ask ourselves… when can the extremely safe havens become so extremely dangerous crowded, so that suddenly the risky waters outside are actually safer?

And, is it not sad to read that increased corporate leverage is not resulting from increased real economic activity but only from “the combination of share buybacks dividend increases and M&A activities? I bet some years from now some authorities will once again try to explain that to us as just the result of “unintended consequences”… let us not be fooled by that… at least to me they are guilty, until they proved beyond any reasonable doubt it was not their intentions… or they plead insanity :-).

Do we need to use force to make Mario Draghi and ECB to accept urgently needed structural reforms in bank regulations?

Sir, Claire Jones and Peter Spiegel report that ECB’s Mario Draghi has called for Brussels to “Use force to secure economic reform” meaning “structural reforms… they believe would strengthen longer-term growth prospects”, July 10.

ECB should be ashamed of itself. If there is any structural reform that is urgent that is getting rid of those crazy risk-weighted capital requirements for banks which are hindering credit to reach those we most need to have it now, namely medium and small businesses, entrepreneurs and start-ups.

And I guess the main reason for the ECB not to be pushing for that is it would signify Mario Draghi admitting have been part to one of the most monstrous regulatory mistakes ever.

There’s a world of difference between ex ante perceived risks and ex-post realized risks.

Crony journalism is also a public bad

Sir, in “The world’s hunger for public goods”, January 25, Martin Wolf holds that extreme financial instability is a public bad; and which presumably has to mean that correctly understanding the reason for it, should be a public good. 

Nonetheless, over many years now, the explanation that I give for the current crisis, as an individual who provided some of the clear and earliest documented warnings, even in FT, and which I thought I could make public through sending letters to FT, has been silenced. For what reasons, I do not know… but it could perhaps be explained in terms of crony journalism. 

Nonetheless, here is an explanation again, for the umpteenth time. 

If a banker after analyzing a borrower’s creditworthiness decides to limit the amount of the loan, and charge higher interests to compensate for the perceived risks, the borrower might try to renegotiate better terms, but he would not consider it unfair, as it would be the result of natural market discrimination. 

But, when bank regulators also force the bankers to further limit their loan to the borrower, and increase even more the interest rate charged, all because they require the bank to hold more capital when the officially perceived risks are higher than when they are low, as they do, then we enter into the world of the nannies, the world of artificial regulatory risk discrimination; which only leads to the kind of unfairness that exasperates the inequalities. 

As a result of this regulatory risk discrimination we now have a crisis of financial instability that threatens to take the Western world down; all because of excessive bank exposures to what is officially perceived ex-ante as not risky – for instance, triple-A rated mortgage-backed securities or “infallible” sovereigns and a growing bank underexposure to what is officially perceived as risky – for instance, lending to small businesses and entrepreneurs. 

The parents need to discuss this issue urgently with their financial nannies, before it is too late and the economy has turned terminally sissy and terminally unfair. 

PS. Occupy Basel! http://bit.ly/dFRiMs

PS. http://www.cityam.com/forum/holy-moly-banks-were-drugged-basel-s-rulebook

A quiz for the candidates to Managing Director of IMF

Sir, as a humble contribution for the selection of the best Managing Director of the IMF may I submit the following little quiz the candidates should answer:

Q1. Which type of bank clients can generate such a massive exposure so as to trigger a systemic bank crisis?

a. Those perceived as risky (small businesses and entrepreneurs)
b. Those perceived as not risky (triple-A rated)

Q2. The needs of which clients do we most expect our banks to attend to?

a. Those perceived as risky with no access to capital markets (small businesses and entrepreneurs)
b. Those perceived as not risky and with access to capital markets (triple-A rated)

Q3. The Basel Committee allows for much lower capital requirements for banks (five times less) when lending to those perceived as not risky (triple-A rated). Based on your previous answers, which would be your most likely opinion?

a. I fully agree with the Basel Committee
b. The Basel Committee might have got it all completely upside down.

Note: The responses of “b, a, and b” would qualify the candidate to proceed to further tests.

And where are the smart principles for regulating regulations?

Sir, John Kay directs his “A smart business is dressed in principles not rules” January 12, to the people in Basel dealing with the regulations of banks. To that I would indeed add the following:

Bankers, as a principle or as rule, should believe they can master quite adequately default risks. Who wants to deal with a banker who does not?

The regulators, as a principle, and as a rule, should always answer the bankers “No you can’t… and besides there are so many other risks to be considered than just avoiding defaults”

It is bad enough when regulators fall for the sales pitch of bankers, but so much worse when regulators arrogantly decide what is the risk that should be regulated and try themselves to be the masters of that risk, with or without the help of credit rating agencies.

Currently the regulators who failed conquering simple risks of defaults are now tackling more God-like events like pro-cyclicality. God help us! Where are the smart principles for regulating regulations?

Again, for the umpteenth time, don’t control for credit risks, it is best handled by the market, without interference.

Sir, Gillian Tett with respect to the “hardwiring” in regulations of the credit rating agencies that is not working writes that “the rub for the regulators … is that “nobody has any clear idea how to create a workable alternative to judge credit risk”, “Rating agencies stuck in a bind as eurozone pressures mount” December 17. That is absolutely wrong and I have hundreds of letters to FT to prove it.

Since the market already clears for credit risk, by means of risk-premiums charged, what regulators should do is absolutely nothing. Anything they would invent, like the risk-weights they imposed, only confuses and muddles the market, and leads to crisis like the current which was provoked by extremely low capital requirements for banks when investing in triple-A rated securities or lending to Greece or Irish banks, because regulators thought these were not risky… even though regulators should have known that it is precisely what is perceived as not risky by regulators and bankers alike, what is always the most risky for the system.

Yesterday I visited the Newseum in Washington and in doing so the question of how journalist silence ideas just because these seem to simple for them and they prefer the complicated convolutions of experts came to my mind. Not once has FT been willing to publish what I like here have argued for years now.

More than the destination it is the road travelled that counts

Sir, Prof Eric De Keuleneer suggests that “Bank just might have too much equity” December 13. That is oversimplifying it. Banks are required absolutely too little capital, zero to 1.6 percent, when lending to what is perceived as having a low risk of default, and therefore, strictly in relative terms, much too much capital, 8 percent, when lending to what being perceived as riskier, like the small businesses or entrepreneurs who are indispensable to the economy as a whole.

In that respect what should be done is to temporarily reduce the capital requirements for what is perceived as risky, to whom bankers will presumably still not lend excessively to, much less without more careful studies, so as to make the journey to “sufficient bank capital” a less discriminatory venture.

I support of course to De Keuleneer´s recommendation that “the credit rating agencies should be used less and with less authority”; that is an absolute must if we want to return our bankers from that world where they do not need to have an opinion of their own but are satisfied with monitoring the opinions of others.

More than making them safer, we need the banks to be more useful.

Sir Stephen Cecchetti affirms that the current proposals from the Financial Stability Board (FSB) and the Basel Committee on Banking Supervision (BCBS) that will impose higher capital and liquidity requirements on the banks is “A price worth paying to make banks safer”. It is just the same old story! When will we hear about making the banks more useful, or at least less useless?

Cecchetti correctly mentions that “lower capital means higher returns on equity but a smaller buffer against loan defaults and investment losses”. He ignores though the fundamental problem that the lower capital requirements are applied discriminating in favor of what is perceived ex-ante as having lower risks… and therefore increasing the returns of what is perceived ex-ante as having lower risks… and therefore pushing the banks to excessively invest in what is perceived ex-ante as having lower risks… precisely the stuff that financial and bank crisis are made of.

Eliminate the discrimination in the capital requirements and banks will start lending more to the small business and entrepreneurs who though most likely to be perceived ex-ante as more risky are also most likely to hold in their hands more of our future generation of jobs…which will thereby make our banks more useful.

More than two years after and they haven´t got it yet!

Sir, this financial crisis was caused primarily because regulators by means of imposing different capital requirements for banks depending on the perceived risk of default created huge incentives for the banks to excessively pursue what was AAA rated.

In what Brooke Masters and Megan Murphy describe about the new Basel rules, “Suspense over”, August 19, evidences that the regulators, more than two years after the crisis got on its way, do still not understand the problems that their arbitrary regulatory discrimination causes.

In the proposed regulations there are some steps toward lowering the overall leverage possibilities of a bank, but there is not one word about eliminating the discrimination that, on the margin, where it counts, decides so much about where and at what cost bank credits go.

The odious and arbitrary regulatory discrimination of risks must stop… now!

Sir Jeffrey Sachs in “It is time to plan for the post-Keynesian era” June 8, in his list of proposals, ignores the fundamental change that must occur in our financial regulations.

It just cannot be that our regulators allow banks to lend to fancy AAA rated sovereigns with zero capital requirements, or to sovereigns rated like Greece the last five years with only 1.6 percent of capital, while requiring the banks to hold 8 percent in capital when lending to the small businesses and entrepreneurs.

That odious and arbitrary regulatory discrimination must end now; the coward market discriminates more than enough when pricing for risks; and our financial regulators should immediately be removed as they seem absolutely incapable to understand that there are other risks in life than “the risk of default”.

Do not tax Gekko-style risk-taking.

Sir Gillian Tett writes about “That secret desire for burst of Gekko-style risk-taking” March 20 and that must lie very close to the heart of anyone looking for a speedy recovery.

May I suggest she reads the following table derived from the Minimum Capital Requirements for the Banks issued by the Basel Committee under the Standardized Approach in order to cover for Credit Risk:

Rating of the ......Required Bank...... Allowed
Corporation ......Equity $100 Loan ...Leverage

AAA to AA- ..........$ 1.60 ....................62.5/1
A+ to A- ...............$ 4.00 ....................25.0/1
BBB+ BB- .............$ 8.00 ....................12.5/1
Below BB- ............$14.00 ...................8.33/1

From it she should be able to conclude that the regulators have imposed, on the core of our financial system, the commercial banks, a de-facto tax based on a loosely defined “default risk” and as measured by the credit rating agencies.

When as now bank equity is scarce and very expensive this de-facto tax on risk, which is charged on top of whatever the market commands for assuming higher risks, is extremely high. So, if you want Gekko-style risk taking? Start by not imposing special taxes on it.

Pushing for a green recovery requires also reducing the conflicting market signals.

Sir Joseph Stiglitz and Nicholas Stern write “Providing a strong, stable carbon price is the single policy action that is likely to have the biggest effect in improving economic efficiency and tackling climate change”. Since it is always harder to bailout from a financial crisis than from a climate change crisis, although I come from an oil country I agree. “Obama’s chance to lead the green recovery”, March 3.

But these green market signals would be more effective were we capable of reducing some of the competing signals, for instance those present in one of the most important drivers of world capital namely the minimum capital requirements for the banks as defined by Basel.

Currently for a bank to make a 100 dollar loan to a corporation the banks currently need to have an equity that ranges from a minimum of 1.6 dollars to 12 dollars, a whooping 7.5 times the minimum, which depends on the risk assessments produced by the credit rating agencies.

Since bank equity is scarce, and expensive, especially now, this means that besides what the market would normally be charging for assuming a high perceived risk, the regulators have imposed an additional de-facto tax on risk. This would be great if “default risk of a corporation” was all that mattered. But what about the default risk of our planet? What if most investments in projects destined to fight the risk of climate change presented more risk than projects that increased the risk of climate change?

What if the securitized finance of car purchase financing gets an AAA rating while the project to install a solar panel only achieves a rate below BB-? Is it logical then that the financing of a solar panel needs 7.5 times more bank equity? I don’t think so!

The credit rating agencies were not just innocent bystanders

Sir, Vickie Tillman, Executive Vice-President of Standard & Poor Ratings Services, in “Rating firms do not capture risk in one measure”, March 2, writes, “credit ratings are opinions about future default risk and do not address the many other risks that have affected debt securities in recent months and accounted for the bulk of losses reported by financial institutions … policymakers should review regulations that may inadvertently encourage undue reliance on ratings. If rating opinions are used as benchmarks of creditworthiness – which, incidentally we have never encouraged – other benchmarks and factors should be considered as well.”

Does this mean that I have wrongfully been accusing these poor credit rating agencies, that they are only innocent bystanders and that they have nothing to do with this crisis that is going to result in so much misery for the world? Of course not!

Granted, the primary responsibility lies with the regulators who enabled the regulatory framework that incited this crisis and then with those investment bankers who took advantage of the system failures but in no way should we allow the credit rating agencies to go free of any historic guilt; as we should neither allow those financial newspapers that still have the gall calling the credit rating agencies “indispensable” something that even the credit rating agencies would not dare to do, to wash their hands.

Knowing the purpose of our banks is never redundant.

Sir Tony Jackson begins his “Banks’ crisis of identity leaves depositor in trauma”, December 15, asking “What are banks for?” and adding the comment “In normal times the question would seem redundant”.

The question is indeed valid, but not at all redundant, since even in the most normal of normal times, one would have hoped that our bank regulators should have had to answer it, to all of us, before they regulate. They did not!

One of the worst things with the current crisis is the total absence of a “was it at least worth it?” and this is a direct consequence from not having discussed, in any way shape or form, for many decades, the exact question Tony Jackson poses, namely “What are banks for?”

When we allow regulators to regulate according to their whims we deserve what we get. In this case the regulators were allowed to play out their bedroom fantasies of a world with no bank-failures and for which they implanted a sort of ridiculous set of minimum capital requirements based on some vaguely defined risks of default, and then empowered the credit rating agencies to measure those vaguely defined risk.

For starters that for a society some default risks are worth taking while others are not, was a consideration that did not even cross the regulators minds.

But what are Britain’s banks to do for Britain

Sir Martin Wolf “What to do with Britain’s banks”, December 12, is evidence that the most immediate task at hands for the regulators who “represent the interest of these risk-bearers of last resort” should be to start giving thoughts on what Britain’s banks should do for Britain.

Ironically the current bank regulations fabricated by the Basel Committee had the sole purpose of avoiding bank failures, and which is why the regulators imposed minimum capital requirements based on vaguely defined risks of default and empowered the credit rating agencies to measure these risks, and we see were all that nonsense got us. The worst part of this financial nightmare turned reality is that most countries have so little to show for it.

An explosion of public and consumer debt, as if we all had placed a reverse mortgage on the world, is nothing to write home about. Our worst risk now is that the regulators in Basel and many influential opinion makers with them are incapable of understanding that the purpose of our banks is really not to avoid risks but to take the right risks on behalf of society since those are the only risks taxpayers could be asked to pay for.

Instead of avoiding risks we must embrace the right risks

Sir, Lawrence Summers writes "The pendulum swings towards regulation" October 27. He is right but, when reminding us of the "need to ensure that the pressure to increase spending is directed at areas where it will have the most transformational impact", he should be aware that this also requires the pendulum to swing away from the regulations. Currently the single objective pursued by the regulators, with their strict minimum capital requirements for the banks based on default risks and the empowerment the credit rating agencies as the supreme risk overseers has nothing to do with transformational impact but, ironically, only with avoiding a financial crisis.

Lawrence Summers also holds that "we need to reform tax incentives that encourage risk taking, regulate leverage and prevent government policies and prevent government policies that give rise to a toxic combination of privatised gains and socialized losses." He sounds so right, but he is so wrong. The privatization of gains and socialisation of the losses has nothing to do with the regulations per se but with the lack of the know-how and the political will of how to react when the regulations fail. And, specifically on risk, what we most need is to encourage the right risk taking as it is the oxygen of human and economic development, while avoiding creating disastrous risks in areas like housing and that, almost by definition, should be among the least riskiest parts of our economy.