Regulators, shareholders and clients, do not have a vested interest in banks holding little capital; only bankers do, because of their bonuses.

Sir, Sheila Bair discussing ongoing pressures in the US to reduce bank capital levels, especially for the big banks, correctly opines: “Tough capital rules are a competitive advantage, not weakness. Studies show that well-capitalised banks do a better job of lending than more leveraged rivals. Thick capital buffers keep the banking system functioning through economic cycles. Every dollar reduction in bank capital weakens the public’s protection against big failures.” “The US must hold firm on bank capital rules”, October 2.

That is the argument that should prevail and the more it is understood that those who mostly stand to win by low bank capital requirements, are just the bankers themselves, as the less equity there is a need to compensate, the higher can the bonuses be.

To that I would perhaps add what I wrote in an Op-Ed in 2001, “Today, when the world seems to be asking much for bank mergers or consolidations, I wonder if we on the contrary should be imposing on banks special reserves depending on their size. The bigger the bank is, the worse the fall, and the greater our need to avoid being hurt.”

In 2003, in a workshop for regulators at the World Bank I repeated, “Knowing that “the larger they are, the harder they fall,” if I were regulator, I would be thinking about a progressive tax on size. “

But what is sadly almost completely left out in the debate is that, no matter how high or how low the capital requirements are, different requirements, especially when like the current risk weighted ones do are based on risks perceived and mostly already cleared for, dangerous distortions in the allocation of credit to the real economy could result.

Again, for the umpteenth time risks, even if perfectly perceived, cause the wrong actions if excessively, or insufficiently considered.

In that respect my first recommendation on any bank regulation reform would be to get rid of the risk weighted capital requirements for banks. They stand out as one of the worse piece of regulations ever.

What was the 2007-08 crisis (and Greece’s tragedy) made off? Exclusively, 100%, by assets ex ante perceived (or decreed) as safe, and against which banks needed to hold especially little capital.

@PerKurowski

More than “safer” we need to make our financial system more “functional”

Sir, as an Executive Director in the World Bank, 2002-2004, during the Basel II discussions, with respect to big banks I said: “Knowing that “the larger they are, the harder they fall” if I were regulator, I would be thinking about a progressive tax on size”. 

And, so of course I find Mark Roe’s and Michael Tröge’s proposal of “How to make the financial system safer”, March 25 quite interesting.

That said many questions come to mind.

First, if there is a tax on liabilities, who will pay for it the most, borrowers by means of higher interests, or depositors by means of lower interests?

And, since what equity holders are really out after is high returns on their equity, and these are much obtained through leverage, it would not seem like these taxes would be able to sufficiently substitute for regulations that limits bank leverage.

But the authors also state: “Until now, regulators have largely used command and control mechanisms to make banks safer: requiring them to have more capital, banning or reducing their riskiest activities, and punishing reckless behavior after the fact”. And on that I must comment.

What regulators have NOT done is requiring banks to have more capital to reduce risky activities; what they have done is allowing banks to have very little capital for what was perceived as “absolutely safe” not risky activities… and that is what really has created the big risks.

And so when the authors write that “Banks understandably do not like regulators getting involved in their strategic decisions” it shows they have not yet understood what has been going on.

On the contrary, banks have LOVED regulators for getting more and more involved with their strategic decisions… to such an extent of having even adopted the banks risk models of capital allocation.

No it is we, the not bankers, we who want safe and functional banks, we who do not want the regulators to get involved with banks’ strategic decisions. Let the banks do what they want in order to prepare for any expected risks, and expected losses, because that is truly all they can do.

The regulator’s role on the contrary is to make sure there is some bank capital to take care of the unexpected risks, of the unexpected losses, of the risks of banks not being able to do good strategic decisions, and for that it is almost a sine qua nom, that the regulators stay away as far as possible from the influence of banks.

Right now, as a result of regulators layering their risk perceptions on similar banker’s risk perceptions, we have an unsafe and utterly dysfunctional banking system incapable of allocating credit efficiently to the real economy. And so, before doing anything more creative let us just correct for that.

And also, more than bankers devising “fiendishly complicated transaction to work around the rules”, the reality might be regulators designing innumerable rules for the bankers to work around.

Please tax me too with this too big to fail tax!

Sir as an Executive Director of the World Bank during a risk management conference in 2003 I told the regulators “Knowing that the larger the banks are the harder they fall on us if I were a regulator, I would be thinking about a progressive tax on size”.

What I now see reported by Patrick Jenkins and Brooke Masters in “US impetus drives Bank regulators” as a tax of 15 basis points on assets more than $50bn, is not what I had in mind. 15bp for what seems to be the right of officially being termed too big to fail, clearly earning a triple-A rating is ludicrous, most small businesses or entrepreneurs, would gladly pay much more if given the chance.

To understand the magnitude of the tax we might use how the bank regulator seems to value the difference between an ordinary fallible business and a triple-A rated entity. When lending to the first, a bank is required to have 8 percent in equity while when investing or lending to anything related to a triple-A rating it is only required to have 1.6 percent. Supposing the cost of bank equity is 5 percent more than the cost of deposits, then the previous difference of 6.4 percent in equity amounts to a cost difference of 32 basis points; and which strangely enough the regulator feel should benefit those already benefitted by being perceived as having low risks and affect those already affected by being perceived as more risky.

How much less would a bank deemed as too big to fail be required to pay for its funds when compared to the rest of the humanly fallible banks? If we are to tax the too big to fail banks is it not supposed to hurt them instead of benefiting them?

Yes, let’s put a damper on size!

Sir John Kay is of course right in “Why ‘too big to fail’ is too much for us to take.” May 27.

In May 2003 at a Risk Management Workshop for Regulators at the World Bank, as an Executive Director, I said: “A regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, could be a much more effective regulation. The avoidance of a crisis, by any means, might strangely lead us to the one and only bank, therefore setting us up for the mother of all moral hazards—just to proceed later to the mother of all bank crises.

Knowing that the larger they are, the harder they fall, if I were regulator, I would be thinking about a progressive tax on size.”

Frightening!

Sir what many of us feared, the Union of those who can not go bankrupt with those who are to big to fail is getting closer. Henry Kaufman’s proposal contained in “Finance’s upper tier needs closer scrutiny” April 21, on a supervisory authority that takes over the role of the credit rating agencies and that starts almost micromanaging the big financial entities makes our hair stand up.

Where are we citizens going to be left in this cosy arrangement among those who could share so many mutually beneficially interests? Why do we not just place a little tax on the size of banks based on the bigger you are the harder you could fall on us concept?

Basel II just keeps digging the hole of Basel I

Sir, Charles Freeland a Former Deputy Secretary-General of the Basel Committee on Banking Supervision considers “Basel II a big improvement on outdated model” February 7, and the outdated model he refers to is Basel I which has been in place for only about ten years.

I do not think it of Basel II as an improvement but jut as a further digging ourselves into a very dangerous hole. Now, instead of going back to the freedom of the markets, besides keeping on using the outsourced bureaucrats of the credit rating agencies to measure risk (Basel I) we are with Basel II also allowing some big banks to do their own internal risk modelling, and this even when we have recently witnessed how much intrinsic risk these models create by themselves and how bad they can really be. This is all plain crazy!

I would much prefer setting an 8 percent minimum capital requirement on all the credits (including those to the public sector) and assist the market producing the information it needs to take it from there.

And, just to make certain we do not put all the eggs in the same basket, I would start thinking about a progressive tax on the size of the banks. “The bigger you are the more it will hurt if you fall on me and so the higher must the insurance premium I charge you be”

Do not dig us deeper in the hole we’re in!

Sir, Ieke van den Burg when writing “We must have strengthened oversight of bank sector” January 23, seems to propose we dig ourselves deeper in the hole where in, when asking for the creation of “holistic” public oversight. That, just as the empowerment of the credit rating agencies meant will just increase the systemic risks of global failure.

As I see it the best way to go is to follow the tradition of not putting all your eggs in the same basket and therefore creating a progressive tax on the size of the banks. The larger the bank, the more it will hurt if it fails, so the more it should pay in insurance premiums.

Marx prophesied “a progressive diminution in the number of the capitalist magnates” and the best way I know of fighting Marxism is to stop this prophecy from becoming a reality.