Should bank shareholders really want lower capital requirements for what’s perceived as “safe” than for what’s “risky”?

Sir, Simon Samuels writes, “it may soon be time for shareholders to place their bets on how they like their banks — skinny on capital but with a ton of rules designed to cramp their riskier activities, or fat on capital with the freedom to take more risks… should [bank] shareholders celebrate or fear more lenient regulators?”, “Shareholders’ dilemma on financial regulation” April 17.

That is a faulty or at least incomplete description of the problem.

Current capital requirements are lenient for what is perceived, decreed or concocted as safe, and more severe for what is ex-ante perceived as risky. And that means, in one word, DISTORTION.

As a consequence banks will not be allocating credit efficiently, so the real economy will stall and fall, something that has severe consequences, at least for the bank shareholders’ grandchildren.

Also, though low equity against assets perceived as safe might in the interim produce high risk adjusted returns o equity, sooner or later the bank will, GUARANTEED, end up holding dangerously large exposures to something ex ante perceived as safe but that ex post suddenly turns out to be very risky.

I can understand some bank managers going for maximizing their bonuses in the short run, at whatever cost, they don’t have to give back their bonuses when shit hits the fan; but I cannot understand a bank shareholder who, aware of the regulatory distortions, find this acceptable.

Samuels ends with “shareholders should focus less on the rules the regulators set and more on how managers navigate their business. To quote Warren Buffett: “Banking is a very good business, if you don’t do anything dumb.”

On the contrary, as is, the regulators must focus on the rules the regulators set because these rules, this interference, is the greatest source of dangers for their banks and for everyone’s economy.

Sir, what good does a great run on bank profits do you if at the end of the day you find yourself standing on top of some worthless rubbles?

PS. Sir, do not forget that, amazingly, these risk weighted capital requirements are portfolio invariant.

PS. THE QUESTIONS

@PerKurowski

Bankers, by limiting the voice of their parents to the 4 to 8 percent capital range, find it easier to write their own bonuses.

Sir, I sympathize deeply with much of the arguments presented by Lucy Kellaway in a “Lesson from kindergarten on executive bonuses” June 2.

That said I am not sure the analogy to her challenges as a mother is so accurate in this case, since I have the feeling that she does indeed still influence quite a lot the bonuses of her kids. And, that is not the case of banks.

The bankers, the kids, have been able to convince the regulator that the voice of their parents, the shareholders, should be very limited… to the 4 to 8 percent range. And the result of it all is that bankers are in essence very much capable of setting their own bonuses, which is something I am sure Lucy Kellaway would rightly fear if her kids could do.

Let us give banker’s parents more voice!

With respect to increasing bank capital we need banks and regulators to be partners, not enemies.

Sir I refer to Gina Chon and Camilla Hall’s “Fed looks beyond bank’s financial targets” March 27.

As a result of regulators falling for the risk-weights’ trick, banks are now, ate least when compared to pre-Basel Committee history, dramatically undercapitalized. It behooves everyone in the economy to see that capital increased substantially so that bank credit is not unduly blocked.

I have no idea of what the Fed saw in Citibank when performing its stress testing and that caused it to reject its capital plan for dividends and share buybacks, but I do know that if the word “punishment” describes it appropriately, the Fed is on the wrong track.

If the real economy is going to get out of this mess… and it is a mess… the Fed and the banks must be partners in finding lots of new bank capital in a credible way. And bank capital will not be raised sufficiently by mistreating the shareholders of banks… nor by fooling some investors into buying Coco bonds, suspecting the probabilities for these to be converted, are knowingly underrepresented.

In fact the Fed and other regulatory authorities must tread on the issue of Coco bonds with extreme care, less they also be liable for withholding information and misrepresentation. And for this I refer to “Flurry of Coco bonds sends yields tumbling” by Christopher Thompson.

If I buy a Coco today and become converted into a bank shareholder three years from now I guess I cannot complain... but what if that happens three weeks from now?

Should directors do “good” things for their shareholders without informing them?

Sir, I do not really understand John Kay’s “Directors have a duty beyond just enriching shareholders” June 5.

Does Mr. Kay suggest that the proposal of not using all available legal means to avoid paying taxes could receive the same type of enthusiastic response at a shareholder’s meeting, than one of keeping the workforce happy, or one directed to help reduce the environmental impacts of the company? I doubt it.

Or is Mr. Kay suggesting that the directors should pay more taxes than needed and keep this information silent, for their shareholders’ own good? Should they receive a bonus based on how much undisclosed good they have done for their shareholders too?

European Parliament, to put a lid on bankers’ bonuses, try stop mistreating weaker bank borrowers

Sir, here is what I would say to the members of parliament in the Strangers’ Bar of the UK House of Commons, if there when as Martin Wolf describes them discussing the European Parliament’s efforts to cap banker bonuses, “The curious case of Brussels and the bankers’ bonuses” March 2. 

The main reason for high bankers’ bonuses is that they now do not have to share the revenues as much as they used to with shareholders, and the reason for that is that banks are now not required to have any substantial amounts of capital, that is as long as their exposures can be considered “absolutely safe”. 

And so I would ask the regulators to increase the capital requirements, especially for what is perceived as “absolutely safe”, because there, as we all know, is where also the dangers of any too dangerously high bank exposures are always to be found. 

But it seems the regulators do not want to increase those capital requirements, and the only possible explanation, besides of course that of them being daft is that they have been lobbied too generously by bankers and “infallibles” alike. 

But much worse than causing high bank bonuses, is the way how those capital requirements distort the markets; and how, by favoring lending to what is perceived safe, whether for real or only Potemkin type safe, discriminate so odiously against the bank borrowings of all others de facto classified as “The Risky”, no matter how decent and worthy. 

And so UK should state: We do not want to cap bankers’ bonuses the way the European Parliament currently suggests, because that just prolongs the distortion of the markets as well as the senseless regulatory favoring of the haves, the history, the old, “The Infallible”, thereby discriminating against the have-nots, the future, the young, “The Risky”. 

And then for good measure, the UK should also propose that as one should perhaps not go too fast on tightening the capital requirements, one can meanwhile put a cap on how much in annual total compensation per banker is allowed to be a tax deductible expense… and that would take care of solving a couple of problems, while even reducing the distortions.

And then to wrap it up, going for the killing, I would ask: “European Parliament, given how banks have profiting the last decades, is it really so smart to reduce banker´s bonuses only to increase the dividends per bank share? Is it the interests of bank shareholders you are defending?

FT, if rightly concerned with bonus cap, why not with other regulatory caps?

Sir, you are not being consistent. In “Bonus cap is a bad omen for Britain” February 19, you rightly argue that “politicians are a poor substitute for the markets… A cap on the ratio of variable to fixed pay… removes a tool for managers to control risk”.

But when regulators allow different capital requirements for banks based on perceived risk, and thereby are effectively substituting for the markets, and capping the returns on bank equity for assets perceived as risky when compared to assets perceived as infallible, and thereby discriminating against borrowers perceived as risky favoring those as safe, then you keep totally mum about that.

With that attitude are you not favoring bankers more than their shareholders or their borrowers and, if so, is that really living up to your own motto?

We need more widows and orphans as shareholders of our banks

Sir, the capital of my homeland (Caracas, Venezuela), used to, for over a hundred years, have its electricity needs well serviced by a private company run by electrical engineers, and its shareholders were mostly widows and orphans. But then came the financial engineers and took it over, and leveraged it to the tilt, and the consumers were not longer its prime focus of interest, the speculative shareholders were. How we wish we could have the old company back. In this particular case that seems impossible because it has since then been taken over by the Petrostate. 

I mention this because John Gapper, though mentioning “the targets for returns on equity” leaves aside the issue that different shareholders might have different targets, “The financial incentives to behave badly will endure” September 13. For instance, if capital requirements for banks were substantially increased, that would of course diminish the returns on bank equity, but that could also help to make banks safer investments, and with that attract the widows and orphans who could be happy with lower but safer returns. 

As a client of any utility, whether electricity or banking, I would like its shareholders to be widows and orphans, and so should the regulators.

Could there be value to be unlocked in the one-year ownership of shares clause?

Sir you are so right in that the recent minimalistic step taken by the SEC to allow the true owners, the shareholders, to name who should be at the Board of their companies was “A much needed victory”, May 22.

What I cannot comprehend though is how the SEC can get away with the one year of ownership criteria... how on earth does one year of ownership change ownership? Could there now be an opportunity to sell the shares but keep them in your name, so as to offer the one year ownership on record? I mean in this severe crisis one has to look under every stone for any value to be unlocked.

Martin Wolf did right opening the cage!

Sir who could have thought a year ago that we would read Martin Wolf say “Why regulators should intervene in bankers pay”, in the Financial Times, January 15, and agree that he has a valid point; that the system cannot stand to see many franchises of public confidence so savagely exploited by so few. Mind you, on a much different scale, that is exactly how we ended up turning over Venezuela into the hands of an instigator of hate.

Perhaps what we now need is a new layer of progressive taxes specially designed for those who earn more than 100 times the income per capita of the country. The argument seems also applicable to the area of intellectual property rights. When we the society agreed to award patents and invest money defending these so that new inventions would follow, we never did it in order to help the general managers of those patents to earn salaries like hedge funds managers or bankers.

But also what could be most needed, in this case for all, instead of new regulations, is to restore the power of the shareholders since as long as management can decide their own salaries, the market constraints have really not a chance to operate. There’s a fiction making its rounds in the world that the big salary checks are all well deserved and well earned. Who do you think put a spin on that theory?