Europe, Basel Committee’s risk weighted capital requirements for banks, is the kiss of death for your real economy.

Sir, Frédéric Oudéa, president of the European Banking Federation, writes: “The Basel Committee is targeting the degree of variability in how banks define the risks that ultimately determine their capital requirements. The highly technical nature of this topic should not divert attention from the fundamental question that lies behind the review: how, in the future, will European banks be able finance the economy and hence foster growth and raise employment?”, “New Basel banking rules’ impact on European economy” November 28.

But though Oudéa correctly argues that any review of current rules, “should not… disrupt the financing of the real economy”, he then does not tackle the “fundamental question”. That’s because be completely ignores, willfully or not, that the risk weighted capital requirements for banks seriously distorts the allocation of bank credit to the real economy.

In 1997 when getting some strange vibes about what was going on in the world of bank regulations I ended an Op-Ed with: “If we insist in maintaining a firm defeatist attitude which definitely does not represent a vision of growth for the future, we will most likely end up with the most reserved and solid banking sector in the world, adequately dressed in very conservative business suits, presiding over the funeral of the economy. I would much prefer their putting on some blue jeans and trying to get the economy moving.”

The risk weighting has added a dangerous layer of regulatory risk aversion that causes banks to no longer to finance the “riskier” future, only to refinance the “safer” past or present. Since risk taking is the oxygen of any development, these regulations, if continued, represent a kiss of death for Europe… and others

Now, anyone should be rightly concerned with that getting rid of the risk weighting would create such bank capital shortages that it would put a serious squeeze on bank credit. As a solution I have suggested grandfathering current capital requirements for all the banks current assets, and then apply a fixed percentage, like for instance 8%, on all new assets. That should of course include the public debt, since a 0% risk weight for the Sovereign and 100% for We the People, is a pure and unabridged unbearable statism.

Now, if regulators absolutely must distort, so as to think they earn their salaries, I suggest they use job-creation and environmental-sustainability ratings, instead of credit ratings that are anyhow being cleared for by banks.

@PerKurowski

What is puzzling is that regulators, like Mark Carney, cannot see they might also be a source of huge systemic risk

Sir, Ed Crook, with respect to Mark Carney, the governor of BoE and the chair of FSB arguing last year that regulators need to address climate change promptly, quotes Daniel Yergin with: “It was puzzling that a central bank would choose to identify investment in this sector as a major systemic risk to the global financial system, when there are so many other more obvious and immediate risks” “Energy expert dismisses warnings of carbon bubble” October 20.

On occasions I myself have proposed slightly less capital requirements for banks based on environmental sustainability and job creation ratings, so that banks earn a little higher risk adjusted returns on lending when they are doing what many of us consider as social good. But I have always done that with much trepidation; as it clearly requires a lot of hubris to think you could intervene so without causing any unexpected negative consequences.

But the Basel Committee and FSB regulators suffer no such inhibitions. They have gladly gone ahead with imposing credit risk weighted capital requirements, all without the slightest consideration to how that could (and is) dangerously distort (for no purpose) the allocation of credit to the real economy.

In my homeland (Venezuela) we often refer to those who have been awarded power (or have given themselves powers) in order to engage in dangerous activities, as being monkeys with razorblades. That description applies perfectly well to regulators who are not eve aware of that their actions might in itself constitute the largest systemic risk for the financial system (and for the economy)

@PerKurowski ©

COP21: Bank capital requirements based on sustainability and job-creating ratings would have been a major step forward

Sir, Martin Wolf commenting on the Paris COP21 agreement on limiting the risks of climate change writes “The provision of needed finance is an aspiration, not a bankable commitment” “One small step forward for humankind” December 16.

Indeed, sadly the agreement missed something I have been proposing for quite some time.

Our banks, one of our most important agents to bring us forward, have been told by their regulators that if they hold assets perceived as safe from a credit point of view, they will be allowed to leverage their equity and the support they receive from society much more than if they hold assets perceived as risky.

Since bankers with interest rates and size of exposures already clear for credit risks, it is quite nutty to require that perceived risk to be cleared for again in the capital.

The net result of it is permitting banks to earn higher risk adjusted returns on equity when financing the safe than when financing the risky. And expected credit risk is an expected credit risk that should be managed by the banks if they want to stay open, and has not one iota to do with whether a borrower has something that is worthy to be financed.

In general terms, and since it requires hubris, I am opposed to any type of distortion of bank credit allocation to the real economy. But, if I had to distort, I would only do that in pursuit of a good purpose, like helping the sustainability of our planet and creating jobs for our youth.

I am absolutely sure that if COP21, in Paris, had come up with an agreement that instructed bank regulators to forget credit ratings and use sustainability and job creation ratings to set the capital requirements for banks instead – more sustainability and more job creation less equity and therefore higher ROE - then Wolf could have written about “A major step forward for humankind”

Of course that would have required explaining how purposeless and useless current bank regulations are, and there are many who do not want that to be understood. Regulators because they might be held accountable, bankers because that would signify having to give up a dream come true, making their big profits on what they think (or can make out to be) safe.

@PerKurowski ©

Keep bank regulators like FSB’s Mark Carney out of global warming or we’re all toast

Sir I refer to Pilita Clark’s “Carney urges ‘net zero’ company strategies” December 5.

In Basel II a corporate asset that is rated AAA to AA carries a 20% risk weight, while a similar asset rated below BB- is risk weighted 150%. That means that the capital a bank has to hold against a corporate asset rated AAA to AA is 1.6% (8%x20%), while against an asset rated below BB- it needs to hold 12% in capital… 7.5 times more.

Anyone who believes that assets rated below BB- are more dangerous to the banks than assets rated AAA to AA, even a mind-blowing 7.5 times more dangerous, has not the foggiest idea about risk-management.

The safer an asset is perceived, the larger is its potential to deliver unexpected losses, those losses that bank capital is to help cover.

And that is why Mark Carney, the chair of the Financial Stability Board, instead of appointing “Michael Bloomberg, media billionaire… to head a task force aimed at helping investors judge how companies are managing the risks that global warming poses to business”, should better see that himself and all his colleagues take a Risk Management 101 course.

Sir, as I have said many times before... if climate change/global warming regulations is to be handled by a task force in any way similar to how the Basel Committee and the Financial Stability Board handle banks… then we're all toast.

PS. If bank regulators want to help out then they should scrap the capital requirements based on credit risks that are anyhow cleared for, and make these based on sustainability (and job creation) ratings

@PerKurowski ©

Bank regulations should be a prime issue discussed during UN’s Paris conference on climate change. Will it be?

Sir, I refer to FT’s Special Report “Managing Climate Change” November 27.

If a bank is allowed to hold less capital against Good assets than against Bad assets, then the bank will be able to earn a higher risk adjusted return on equity on The Good than on The Bad. And then banks will lend more, and on better terms, to The Good than to The Bad.

Currently bank regulators have defined The Good to be those whose perceived credit risks are lower than that of the Bad. That is dumb, serves no purpose and is unjust.

Dumb because banks, by mean of interest rates and size of exposures already clear for credit risks, and so perceived credit risk gets to be considered excessively, which is something that seriously distorts the allocation of bank credit.

Purposeless because perceived credit risk has nothing to do with the usefulness for the economy and the society of a bank credit being awarded.

Unjust, because by favoring more than ordinary the access to bank credit of those perceived as safe, impede those perceived as risky to have fair access to the opportunities that bank credit provides.

If I had the opportunity in Paris I would suggest that we urgently redefine The Good bank assets. The Good should be those that help us to achieve the two things we would most love for our banks to help us out with, namely the creation of the many new jobs we need, and to make our planet more sustainable.

Could that happen? I am not sure. That requires many to understand what the credit-risk capital requirements for banks have done to our real economies, and that is not a pretty sight bank regulators likes the world to see.

Sir, would it not be nice if suddenly banks earned higher risk adjusted returns on equity doing something we like them very much to do? Of course it would. Hey, we could perhaps even see some huge bank bonuses paid in a quite very different light.

@PerKurowski ©

http://ourpiedaterre.blogspot.com

Scrap credit risk weighted capital requirements for banks and base it on sustainability and job creation instead.

Sir, I refer to David Pitt-Watson’s “‘Fossilist’ finance is proving a hindrance to the ‘clean trillion’” October 8. Again, for the umpteenth time, I make a suggestion that has steadfastly been ignored by FT. I am sorry, to be repetitive, but if that is what it will take, that is what I will be.

Intro: The pillar of current bank regulations is the credit risk weighted capital requirements. More perceived risk more capital and less perceived risk less capital. That so as to serve as an inducement to stay away from what is risky allows banks to earn much higher risk adjusted returns on “safe” assets than on “risky” assets. And that is one utterly purposeless and dangerous piece of regulation.

Purposeless, because of course the perceived credit risk has not one iota to do with if the credit is going to be used for a good societal purpose. There is not one word that defines the purpose of banks in all current regulations.

Dangerous, because it tempts banks to build up excessive exposures, against little capital, precisely with those assets that can cause major bank crises, that what is perceived as safe. What is perceived as “risky” takes care of itself with high risk premiums and low exposures.

And so Sir, it should be clear that current regulations also constitute a major hindrance to the ‘clean trillion’… just like they for instance by impeding the fair access to bank credit of “The Risky”, like SMEs and entrepreneurs also constitute a major hindrance for job creation. 

And so here again is my proposal:

First, scrap those regulations and set the same capital requirement against all assets, so as not to distort the allocation of bank credit. Initially, considering the sorry state of the economy, what is probably required is diminishing the capital requirements for what is risky, to about the level of capital banks already have against all assets.

Then, and only then, and after having clearly explained why, lower slightly the capital requirements against assets that can obtain very good ratings in terms of how they assist sustainability and how they can help create jobs for the next generation. That would allow banks to earn more, on what we all are glad they can earn more.

God make us daring!

PS. Since David Watson is an executive fellow of finance a London Business School, I want to inform him that from mid 1979 until mid 1980 I took their Corporate Finance Evening Course.

@PerKurowski ©  J

Why did not Mark Carney warn long ago entrepreneurs and SMEs, they would no longer have fair access to bank credit?

Sir, Pilita Clark reports on how Mark Carney, the current chairman of the Financial Stability Board “warns investors of ‘huge’ hit as climate action ‘strands’ fossil fuel assets” September 30.

Because nervous regulators thought bankers did not see or responded sufficiently to the credit risks that were perceived, they forced banks to hold more capital when lending to the risky, than when lending to the supposedly safe, like to Sovereigns and members of the AAArisktocracy.

And so why then did not Carney long ago warn all aspiring “risky” entrepreneurs to forget their plans, since they could not any longer count on fair access to bank credit?

And is not Carney Canadian? Should he really be talking down the value of “stranded fossil fuel assets” just like that? It sounds a bit irresponsible to me.

And if Carney is so concerned, why does he then not require banks to hold capital based on the risk of the sustainability of planet earth?

For instance, if banks when financing something that supposedly helped sustainability were allowed to hold less capital, and could thereby earn higher risk adjusted returns on equity, that would at least induce them to serve a purpose. Basing it like now solely on perceived credit risk does not. It is both useless and dangerous… dangerous because big bank crisis never result from excessive financing of what is perceived risky, but from excessive financing to what is erroneously perceived as very safe.

Disclosure: My granddaughters are Canadian.

@PerKurowski

Bank credit: In tough times there are no benefits derived from making it harder for the tough to get going.

Sir, I refer to Kadhim Shubber’s and Gavin Jackson’s report on that “Moody’s warns on lending crackdown” August 4.

Clearly the “risky” part of the economy, like SMEs, entrepreneurs and “highly indebted companies” are, as a consequence of tightening bank capital requirements, having to struggle more than others to obtain access to credit, precisely at the exact moment when we most need them to have fair access to it.

And the tightening of bank capital requirements, which lead to bank credit austerity, are usually most called for by those who oppose government spending austerity. Just read through the articles of most of your columnists over the year and you will find requests for higher capital requirements for banks going hand in hand with similar pleads of less government austerity. The most plausible explanation for that… is that it is all the result of an unconscious or conscious pro-government political agenda.

I repeat what I have argued many times over the years. Before we raise capital requirements we need to get rid of the distortionary implications of the risk weights. Let’s reduce the capital requirements like to 5 percent on all assets and then build it up over a decade to around a more reasonable 10-15 percent.

In tough times there are no benefits derived from making it harder for the tough to get going.

Also I am absolutely convinced that if banks are not distorted, bankers, pursuing maximizing the returns on bank equity, are much more able to allocate credit efficiently than government bureaucrats.

But, if bank regulators absolutely must distort, in order to show us they earn their salaries, then at least let us ask them to distort in favor of something more productive than keeping banks from failing. 

For instance let them authorize slightly lower capital requirements based on job-creation and earth sustainability ratings… so that banks earn slightly higher risk adjusted returns on equity funding what we believe should be funded, and not like now, earning much higher risk adjusted returns on equity when funding what is ex ante perceived as safe… like AAA rated securities were… like Greece was.

@PerKurowski

Europe, with your current bank regulations, the Marshall plan would not have happened, or would not have delivered.

Sir, Gillian Tett writes: “But the worse things become in Europe, the more we need crazy ideas. And not just because we need to laugh, but because jokes reveal what politicians are not discussing: the cognitive and cultural leap that must occur in Europe if the eurozone project is to fly” “An economist’s Club Med Marshall plan” July 11.

When I hold that what is really dangerous for banks, is not what is perceived as risky but what is perceived as safe, and therefore current requirements, more-perceived-risk-more-capital, less-risk-less-capital for banks, are 180 degrees wrong… many laugh but, unfortunately, the cognitive and cultural leap required to really understand its significance, seems way too big.

Can you imagine the US approving a Marshall plan to a Europe that allowed banks to have less capital, meaning to earn higher risk adjusted returns on equity, when lending to the public sector and financing houses than when lending to its private sector? And, if the US had not understood the implications of such regulations and had still approved the plan, can you imagine Europe delivering the same results?

Here is my “crazy” idea for Europe (and for the rest). Throw out the Basel Committee’s credit-risk based regulations and allow banks to hold slightly less capital based on job-creation-potential ratings (and environmental-sustainability-ratings). That way banks could earn higher risk adjusted returns on equity when doing something Europe would like them and need them to do.

@PerKurowski

OECD: Make capital requirements for banks, instead of on credit ratings, depend on job-creation-potential ratings.

Sir, Sarah O’Connor reports that “OECD warns on ‘chronic’ low pay and job insecurity” July 10.

When you have bank regulations that are solely targeted to avoid those perceived credit risk which are basically already cleared for by bankers, by means of risk premiums and size of exposure; and which care not one iota about the effective allocation of bank credit… you will not be able to generate as much jobs as you otherwise could. It is as simple as that.

If you are really desperate for jobs, then offer banks to be able to hold less capital against loans that have a high potential of job creating ratings, so that banks can obtain higher risk-adjusted returns on their equity financing what you wish they finance.

And, by the way, if you want more planet earth sustainability then equally offer banks to be able to hold less capital against loans that have high sustainability ratings.

In short it all has to do with giving banks a purpose different from just silly credit risk avoidance. “Silly”? Yes! Bank capital is to cover for unexpected losses and it is precisely what is considered as absolutely safe from a credit risk perspective that carries the greatest potential of delivering the unexpected.

OECD, has a fundamental and urgent structural reform to do, namely throwing out the credit-risk-weighted capita requirements for banks. That would do much more for the creation of jobs than its worrying and wringing hands. 

PS. And perhaps OECD needs to start thinking about worthy and decent unemployments too.

@PerKurowski

How do we reduce the uncertainty on climate change risk with a higher degree of certainty? By taking risks!

Sir, Martin Wolf writes: “Framing the challenge of climate change as a problem of insurance against disaster is intellectually fruitful. It also provides the right answer to sceptics. The question is not what we know for sure. It is rather how certain we are (or can be) that nothing bad will happen. Given the science, which is well established, it is impossible to argue that we know the risks are small. This being so, taking action is logical. It is the right way to respond to the nature and scale of possible bad outcomes. “Why climate uncertainty justifies action” June 10. 

That is absolutely the right way to analyze it… though it does not necessarily make it easier, like Wolf also describes with: “It is increasingly evident that the answer has to be technological. Humanity is unwilling, possibly simply unable, to overcome the political, economic and social obstacles to collective action. The costs to current generations seem too daunting.”

And so I would retort asking: What uncertainty is riskier with a higher degree of certainty?

That we do not do anything about climate change waiting for new solutions to pop up?

That we do not do anything about climate change but also make it more difficult for new solutions to pop up?

I ask this because making it easier for new solutions to pop up requires risk-taking… and that is precisely that which our regulators have banned the world premier financiers, the banks, to take.

Right now we have purposeless and dumb bank regulations that allow banks to earn higher risk adjusted returns on equity by means of leveraging more by avoiding credit risks.

How much better would it not be to use capital requirements for banks based on weights derived from sustainability ratings (and job creation ratings), let us call these purpose weights, and allow banks to earn more when they serve a useful societal purpose… is that not why we support them so much that we even allow them to become dangerously too big too fail?

Or let me frame it all in the way that Wolf finds intellectually fruitful. Is not risk-taking, for instance by banks, the insurance premiums we must pay when we are striving for a better future for our children looking to avert stalling and falling? The current generation has not been willing to pay these... shame on it.

@PerKurowski

New Delhi might need some quality-of-air-weighted equity requirements for banks

Sir, you know I am convinced that the pillar of current bank regulations, namely credit-risk weighted equity requirements for banks is extremely stupid, as regulators clear for risks already cleared for by the banks. And so the consequences of that can only be too much credit at too lenient terms to what is perceived as safe, and too little credit at too harsh terms to what is perceived as risky.

If instead those equity requirements cleared for instance for the potential of job creation and or the sustainability of planet earth then we would also distort, but at least we would have injected some purpose to that distortion.

And so when I read Amy Kazmin´s “New Delhi Notebook: Politicians pass the polluted buck while air quality worsens” March 7, I immediately think of recommending the Indian authorities the following:

Set up an environmental rating agency, and allow banks to hold less equity against any loans that have a good environmental rating. That way the banks can leverage more that type of loans and get a higher risk-adjusted return on their equity for a good purpose. Let us never forget that what the bank really leverages is not only its own equity but also the implicit and explicit supports the taxpayers and society in general grants them; and so it is not outrageous to ask for that support to serve a better purpose than only a quite dangerous risk aversion.

@PerKurowski

It is better to have capital requirements for banks based on clean growth and jobs than on credit risks.

Sir, Martin Wolf writes: “Clean growth is a safe bet in the climate casino”, September 24.

Indeed, and that is why I have for years argued that it would be so much better if the capital requirements for banks were based on sustainability or clean growth ratings (or potential for job creating ratings), instead of on credit risks which should be cleared for by banks with interest rates and size of exposures.

I mean, if regulators absolutely must distort the allocation of bank credit in order to show us they are working, it would be so much better if they did so with a purpose.

You might argue that credit risk weighting has the purpose of bringing stability to the banks. Forget it! Only a sturdy and growing real economy can bring real long lasting stability to banks… it is NOT the other way round.

I can partly understand bank-navel-gazing regulators not seeing that, but it is truly sad when economists like Martin Wolf do not get it.

What if instead of credit risks we used credit usefulness when weighing capital requirements for banks?

Sir, I refer to the opinions of several economists on how to jump-start wage growth… which of course has to do with the creation of jobs, “Pay Pressure” September 19.

Even though some of the economists asked by FT might have diddled a bit with bank regulations, I know at least Joseph Stiglitz has, economists in general have little knowledge of these, or, like Joseph Stiglitz, have not understood what the Basel Committee for Banking Supervision has been up to during the last decades.

The current pillar of bank regulations is the “risk weighted capital requirements”. And that, since the perceived credit risks are already cleared for in interest rates and the amounts of the loans, clears for the same risk perception a second time… something which distorts, and causes banks to lend too much to what is perceived as absolutely safe, and too little to what is perceived as risky, like SME’s and entrepreneurs.

I, also an economist, would prefer not to weigh any capital requirements for banks at all, applying the same percentage for all assets, as I believe markets distort less than economists and regulators. But, if regulators absolutely must weigh, in order to show they do something, I would implore them to instead of credit-risk ratings, use potential-of-job-creation ratings, sustainability-of-planet-earth ratings and, in the case of sovereigns, ethic-and-governability ratings.

Why are bank regulators obsessed with already used perceived credit risks and totally blind to job creation and Mother Earth?

Sir, Lucy Kellaway asks “Why we are more vocal about loo rolls that our jobs” July 21.

In the same vein I have for soon two decades asked why bank regulators are more than vocal, really obsessed, with credit ratings, and complete ignore such things that society would like to have banks financing, like the generation of new jobs or fighting climate change.

The risk-weighted capital requirements are stupid, because bankers already take into account whatever credit risk information is available when they set interest rates and decide on the size of exposures, and so there is no need to clear for the same information twice.

How much more interesting would be to allow for slightly smaller capital requirements, which means bank can leverage more and earn a higher return on their equity, based on something more useful, like potential-of-job-generating-ratings or Sustainability-of-Mother-Earth ratings.

Martin Wolf, sincerely, what is riskier, that some banks fail or that the planet fails?

Sir, Martin Wolf, as he should be, is clearly concerned with climate change, and states the report “Risky Business” to be valuable in “that it sets this out rightly as a problem in risk management”, “Climate skeptics are losing their grip”, July 9.

Absolutely, and since Wolf so often mentions he formed part of a commission reviewing bank regulations I just wonder why he there did not take the opportunity to then ask for lower bank capital requirements when financing something that could prove to be useful against climate change (sustainability ratings), instead of so purposeless and even so dangerous allowing banks to hold less bank capital against those perceived credit risks they already clear for.

But I guess that Wolf, as a baby-boomer, is more worried about the very short term health of the banks than about the planet… just as he does not seem to worry about the long term prospects of employment of our youth, since had that been the case, he would also have asked about lower capital requirements for banks depending on potential of job creation ratings. Clearly an “après nous, le Déluge…or le dryspell” reigns.

PS. Sir, since this has to do with capital requirements for banks, and Wolf has asked me in no uncertain terms not to send him more comments on it, as he knows all there is about that subject, I leave it in your hands whether to forward this letter to him or not.

Is not a failed planet earth worse than a failed bank? Do not hinder banks from financing green growth only because it is “risky”.

Martin Wolf´s “Green growth is a worthwhile goal” November 27, is a non strident account about how the world seems to be entering a very critical stage with respect to climate change, and it just can´t seem to get its act together. And this type of balance approach are much needed since climate change political activists, and rent seekers, are blocking action just as much as extreme climate change skeptics are.

I have no complete solution, but one thing I am certain of. If we are going to stand a chance, we must allow banks to be able to allocate bank credit efficiently to projects which could help us, and not be kept from doing so only because of higher capital requirements based on that these projects could be riskier from a financial perspective.

Let me just give one example. Currently when banks lend to projects like the failed solar panel producer Solyndra, they need to hold much more capital than if they lend to the government so that it in its turn lends to the Solyndras out there. And that does just not make any sense… unless you are a communist off course or in other ways a fanatic believer in the capacity of government bureaucracy.

On a personal level I have been trying to sell the concept that if bank regulators absolutely feel they must distort in order to earn their keep, they should at least align better the incentives to some social purpose. One way would be to allow banks to hold slightly less capital when lending to projects which meet certain sustainability (or job creation) standards.

I have sent out the proposal above to the UN’s Sustainable Development Solutions Network, and I hope it gets there… and is understood there. But since the fact that different capital requirements for banks for different assets distorts the allocation of bank credit in the real economy is not even something debated, I hold no major expectations that will happen.

PS. Sir, just to let you know, I am not copying Martin Wolf with this, as he has asked me not to send him any more comments related to the capital requirements for banks, as he understands it all… at least so he thinks.