Chile can also set a great example for the developed world.

Sir, in “Chile can set an example for the developing world” FT, March 10, 2022, you refer to “the risk of European levels of debt”

With bank capital requirements mostly based on perceived credit risks, not on misperceived risks or unexpected events, like a pandemic or a war in Ukraine, you can bet that, at any moment, many banks will stand there naked, precisely when they’re most needed. 

When that happens Chile could set a great example for the developed world… and FT could provide much help with a Big Read that describes better than I can, how Chile so intelligently managed their huge 1981-1983 bank crisis.

The main elements of Chile’s plan were, in general terms:

a. The purchase of risky/defaulted loans by the Central Bank by means of long-term promissory notes accruing real interest rates and with a repurchase obligation out of the profits of the banks' shareholders before those promissory notes came due, plus some limitations on the use of their operative income… e.g., limits on bonuses. 

b. A forced recapitalization of the banks, in those pre-Basel days one capital requirement against all assets, and in which any shares not purchased by current shareholders, would be acquired by the Central Bank, and resold over a determined number of years. 

c. And finally also an extremely generous long-term plan for small investors to purchase equity of banks. 

Just think about where e.g., Deutsche Bank could be, if the Bundesbank and Germany’s Federal Financial Supervisory Authority (BaFin), had applied a similar mechanism during the 2008 crisis?

Here's more details on Chile's handling of its bank crisis

PS. Not the first time I suggest this

@PerKurowski

For inflation, where the money supply goes, matters a lot too

Sir, I refer to Martin Wolf’s “The monetarist dog is having its day”, FT February 23.

Yes, the money supply impacts inflation, no doubts but, when it comes to how much, that also depends on where that money supply goes.

If central banks inject liquidity through a system where, because of risk weighted capital requirements, banks can leverage more, meaning easier obtain higher risk adjusted returns on equity with Treasuries and residential mortgages, than with loans to small businesses and entrepreneurs, does that not favor demand over supply?

It does, and you should not have to be a Milton Friedman to understand that sooner or later that can only help inflate any inflation.

Wolf holds that “Central banks must be humble and prudent” Yes, and that goes for bank regulators too.

“Humble” in accepting there are huge limits to their knowing what the real risks in an uncertain world are; and “prudent” as in knowing bank capital requirements are mainly needed as a buffer against the certainty of misperceived credit risks and unexpected events, and not like now, mostly based on the certainty of perceived credit risks.

@PerKurowski

Compared to more than three decades ago, what is the current leverage ratio of our banks?

Sir, Martin Wolf, in FT on July 12, 2012, in “Seven ways to clean up our banking ‘cesspit’” opined: “Banks need far more equity: In setting these equity requirements, it is essential to recognize that so-called “risk-weighted” assets can and will be gamed by both banks and regulators. 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. For this reason, unweighted leverage matters. It needs to be far lower.”Soon a decade since, are bank capital requirements much higher and really sufficient?

No! Though bank capital requirements are mostly needed as a buffer against the certainty of misperceived credit risks & unexpected events, in this uncertain world, these are by far, still mostly based on the certainty of the perceived credit risks.

Consequently, when times are rosy, regulators allow banks: to lend dangerously much to what’s perceived as very safe; to hold much less capital; to do more stock buybacks and to pay more dividends & bonuses. Therefore, banks will stand there naked, when most needed. 

The leverage ratio is also important because it includes as assets, loans to governments at face value, and thereby makes it harder for excessive public bank borrowers to hide behind Basel I’s risk weights of 0% government, 100% citizens. No matter how safe the government might be, those weights de facto imply bureaucrats know better what to do with credit they’re not personally responsible for than e.g., small businesses and entrepreneurs.

November 19, 2004, in a letter you published I wrote: “Our bank supervisors in Basel are unwittingly controlling the capital flows in the world. How many Basel propositions will it take before they start realizing the damage they are doing by favoring so much bank lending to the public sector?” That this factor, in the face of huge government indebtedness, is not even discussed, as I see it can only be explained by too much inbred statism.

Before the Basel Committee Accord became operative in 1988, Basel I, banks were generally required to hold about 10 percent of capital against all assets, meaning a leverage ratio of 10.

Where do banks find themselves now? I know well it’s hard, and extremely time consuming, to make tails and heads out of current bank statements, but I’m absolutely sure most financial media, if they only dared and wanted, have the capacity to extract that information.

Should not such basic/vital data be readily available and perhaps even appear on front pages? It’s not! Why? Has media been silenced by capital minimizing/leverage maximizing dangerously creative financial engineers?

Sir, I’m not picking especially on financial journalists, the silence of the Academia, especially the tenured one, is so much worse.

@PerKurowski

Martin Wolf, again, any good economic plan needs, sine qua non, to get rid of bank credit distorting regulations.

Sir, I refer to Martin Wolf’s “Without an economic plan, patriotism is Johnson’s last refuge” FT, October 18, 2021

In Martin Wolf’s Economist Forum of October 2009, FT published an opinion I titled “Please free us from imprudent risk-aversion and give us some prudent risk-taking” (The link is gone, I wonder why)

In that article, commenting partly on the 2008 crisis, I held that getting rid of the risk weighted bank capital requirements, that which distorts the allocation of credit to the real economy, was an absolute must. 

Now, 11 years later, I must still insist in that, without doing so, there’s no economic plan that can deliver sustainable results.

The main ingredient of any safe pension system is a healthy and sturdy economy.

Sir, I refer to Martin Wolf’s “It is folly to make pensions safe by making them unaffordable” FT, June 28.

Wolf writes: “We also need true risk-sharing within and across generations, which is absent from today’s defined-contribution schemes”

But current risk weighted bank capital requirements, with lower risk weights for financing the “safer” present, e.g., loans to governments and residential mortgages, than when financing the riskier future, e.g., small businesses and entrepreneurs, is a clear example of how that intergenerational holy bond Edmund Burke wrote about has been violated.

John Kay and Mervyn King.“Radical uncertainty”? Please, give us a more stupid "radical certainty", than credit risk weighted bank capital requirements.

And way back, when observing how many Social Security System Reforms were based on the underlying assumption that they will be growing 5 to 7 percent in real terms, I also warned, time and time again, that it was not possible for the value of investment funds to grow, forever, at a higher rate than the underlying economy, unless they are just inflating it with air, or unless they are taking a chunk of the growth from someone else. In this respect the 'chickens are only coming home to roost'.

PS. Historically, through all economic cycles, there is nothing that has proven so valuable in terms of personal social security as having many well-educated loving children to take care of you, and that, in real terms, you can't beat with any social security reform.

A letter to Martin Wolf in 2015. An essential component of an Edmund Burke intergenerational holy bond, must be the willingness to take risks.

Another letter on this subject sent to Martin Wolf in in 2017

And another letter on the Covid response intergenerational conflict of monstrous proportions, also published by the Washington Post in 2020

How much lower fertility, less children, is caused by “habitual well-being”?

@PerKurowski

Will this tweet be ignored by FT?

How much hubris is needed for regulators to impose risk weighted bank capital requirements, as if they know what the risks are?

How much wishful hoping is needed when even Nobel Prize winners in Economic Sciences believe that the regulators do know?

http://subprimeregulations.blogspot.com/2019/03/my-letter-to-financial-stability-board.html

Has Thatcherism run its course, or has Thatcherism been run off its course?

Sir, Martin Wolf asks “once we accept that Thatcherism has run its course, what follows?” “Sunak takes an axe to Thatcher’s low-tax ideology” FT, March 8.

Sir, to keep it brief, let me just ask three questions:

What would Margaret Thatcher have said about risk weighted bank capital requirements that de facto imply Britain’s bureaucrats/politicians know better what to do with credit for which repayment they’re not personally responsible for, than e.g. Britain’s small businesses and entrepreneurs?

What would Margaret Thatcher have said about risk weighted bank capital requirements that de facto imply the financing of residential mortgages is more important to Britain’s economy than the financing of its small businesses and entrepreneurs?

What would Margaret Thatcher have said about risk weighted bank capital requirements that de facto imply that what’s correctly perceived as risky, is more dangerous to Britain’s bank systems than what’s perceived as safe?

Sir, can you dare your Mr. Wolf to answer those questions?

PS. My 2019 letter to the Financial Stability Board

@PerKurowski

Financial Times, is not the City your home team?

Sir in “Gain the advantage” November 16 though you accept that London will still be an important centre you are certainly not cheering up what I expected would be your home team. The arguments you give of stricter global regulations and the concerns of being at the mercy of fickle finance for tax revenues have little to do with the international importance of the City.

I am not a Londoner but if I was I would be cheering the city asking it to forget Basel with all its stupid anti-risk biases and ask my banker to look into themselves and bring out again all those merchant-bank instincts and traditions that made the City great to begin with. If there was ever a moment for professional risk-taking bankers this is it!

Free us from imprudent risk aversion and give us some prudent risk-taking.