Here are two recommendations to Raghuram Rajan on how to get India’s banks to become functional banks

Sir, I refer to David Keohane’s and James Crabtree’s “India’s central bank struggles to ensure lenders pass on interest rate cuts” April 22.

There are references to a “broken down process of monetary transmission through which the wishes of the central bank are transmitted to the real economy”, and to “a banking system frozen by high rates of bad loans”.

The following is what I would advice Raghuram Rajan to do, if he really wanted banks to become functional financing efficiently the real economy.

First, get rid of stupid Basel bank regulations that, with their different equity requirements based on credit risks, so distort the allocation of bank credit. These introduce a regulatory risk-aversion that has no place anywhere, but much less in a developing country, since risk-taking is the oxygen of any development. In its place put for instance an 8 percent equity requirement on all bank assets, and throw out forever, the portfolio invariant credit-risk equity requirements. Of course that could create a big need for fresh bank equity, and so…

Second, in order to take away the dead weight caused by the bad loans, and to help to fill any new bank equity needs, the central banks should proceed like Chile did during its financial crisis. Namely capitalizing all the banks by purchasing their non-performing loans, against the commitment by the banks to repurchase these assets from the central bank with their retained earnings, before any substantial dividend payments to their shareholders could be made.

You would then have well capitalized banks, ready to give credit on non distorted terms to for instance “risky” SMEs and entrepreneurs, and simultaneously been made so much safer that, presumably, they would have to pay less interest rates to depositors, and in the medium or long terms less dividends to shareholders. Not bad for a couple of hours work eh?

@PerKurowski

Technocrats, pouring QEs over clogged financial transmission mechanisms, set us up for the mother of all hangovers.

Sir, Henny Sender puts her finger on what should be of utmost concern for most delegates to discuss during IMF and World Bank meetings next week, namely that “Weak growth suggests QE might not have been worth the costs” April 11.

And Sender is so right remarking on how “odd… is the absence of a vigorous debate about the costs of these experiments, whether in the US, in Japan or now in Europe.”

With their QEs, unelected technocrats are pushing our economies higher and higher up a mountain of risks, for absolutely no purpose. As I’ve written to you Sir, at least a hundred times, if the liquidity provided by these schemes, are not allocated efficiently to the real economy, then absolutely nothing good can come out of it.

But the same unelected technocrats, simultaneously, by means of credit-risk-weighted equity requirements, have clogged the financial transmission mechanism, hindering bank credit to reach where it is most needed, the SMEs and the entrepreneurs. In other words, we are being set up for the mother of all hangovers. Damn those technocrat clowns!

According to the report by Swiss Re that Sender quotes, “US savers alone have lost $470bn in interest rate income, net of lower debt costs”. That is only one of the first symptoms.

@PerKurowski

“A ship in harbor is safe, but that is not what ships are for” John Augustus Shedd, 1850-1926.

Sir, (and you other there) why is it so hard for FT and for regulators to understand that what applies to ships also applies to banks? 

The motto of the British Special Air service its “Who dares win”, and your own includes “Without fear”… and yet you find nothing wrong with regulators senselessly making banks avoid risks by allowing them dangerously immense leverages and therefore high risk-adjusted profits on what is ex ante perceived as “absolutely safe”… but which of course presents no absolute certainty about how it will turn out ex post.

The risk weighted capital requirements for banks has effectively destroyed the credit transmission mechanism to the real economy of the banks. Sir, why is that so hard to understand? 

FT, are you really proud of having your bank regulators turning your daring British banks into sissy banks?

PS. “Play the game for more than you can afford to lose… only then will you learn the game” so said also your very own Winston Churchill.

Until the financial transmission channels are repaired, BoE’s monetary injections are wasted

Sir, Chris Giles hold that “There will not be a better time than now to spend some of the BoE’s monetary policy credibility in search of a more robust recovery”, “Carney has a chance to kick-start the weak British economy” August 1.

Wrong! Anytime after the financial transmission mechanism, demolished by capital requirements for banks based on perceived risks that have already been cleared for with other means, has been repaired, is better.

Meanwhile any monetary injections would mostly flow to dangerously overpopulate the havens officially considered as safe, and too little would flow to the risky actors of the real economy who most stand a chance of knowing what to do with those injections.

Our banks are in the hands of… may I say idiots?

Any bank regulator, looking at all history of bank crises, should be able to observe that, with the exception of outright frauds, all the crises were the result of excessive exposures to something perceived ex ante as “absolutely safe” but that ex post turned out to be very risky.

And so to allow banks to hold minimum capital (equity) against what is ex ante perceived as “absolutely safe” is sort of idiotic.

Sir, Adam Posen w rites “perhaps the new Fed chief’s main challenge will be to design and institutionalise a set of tools for targeted interventions in public and private credit markets”, “After Bernanke, make the unconventional the norm”, July 16.

If so let us pray that the Fed´s new chief is someone who understands how capital requirement regulations have produced extremely miss-targeted interventions in public and private credit markets. If not, chances are, we will all just be dug even much deeper into the hole we are in.

Mr. Posen also writes about “the more complex reality of how monetary policy is transmitted to the whole economy... In the euro area, low interest rates and commitments to government bond market intervention are failing to improve credit conditions for small and medium-sized businesses across southern Europe”.

Complex? Given the fact how current bank regulations discriminate against small and medium sized businesses, on account these being perceived as “risky” something for which they have already been discriminated for, I do not find that to be a “complex reality” but rather a quite simple result that should be expected.

Current financial fragmentation is not a “north vs. south”, but an “infallible vs. risky” issue

Sir, when Michel Steen reports “Draghi faces bailout grilling” April 2, he refers to the problem of a “financial fragmentation” which has cleaved the eurozone “into two broad groups – northern countries that enjoy the official low rates and southern ones that, effectively, do not [something] known in monetary policy jargon as the impairment of its transmission mechanism”.

Forget it! This is not a south-north fragmentation. The most fundamental impairment of the financial transmission system occurred when bank regulators decided they could, for the purpose of setting capital requirements for banks, divide borrowers into “The Infallible” and “The Risky”, and all as if the banks were completely infantile and were not already taking notice of the fact that there are some borrowers riskier than others.

Is the financial transmission mechanism muddled? Yes, that is to say the least.

Sir, Gillian Tett writes that the “bigger worry is that the benefits of QE3 are so unclear, because the transmission mechanism is so muddled”, “Beware the high costs and psychology of America’s QE3.” September 21. 

And Tett reports on Richard Fisher, head of the Dallas Fed saying: “Nobody on the [Fed] committee… really knows what is holding back the economy. Nobody really knows what will work to get the economy back on course. The very people we wish to stoke consumption and final demand by creating jobs and expanding business investments are not responding to our [Fed] policy initiatives as well as theory suggests”. 

Muddled transmission mechanism indeed! How could it not be so when capital requirements for banks favor so much the lending to those perceived as “not-risky” and thereby discriminates so much against those perceived as “risky”. 

But I know for sure what is at least an absolute sine qua non to get the economy back on track, and that is getting rid of those discrimination based on perceived risks, and which almost amount to a class war waged by the “not-risky” against the “risky. 

It is the action of the “risky” which normally builds the muscles of an economy. Those “not risky” slowly, or fast, over time, most often turn into flabby fat. 

And Gillian Tett should know this after all the letters I have sent to FT, and to her, explaining the above. But, then again, as she recently wrote in “An internet free for all read by none” September 15, “People are clustering into tribes… only reading information that reaffirms their pre-existing social and political world view”, and, since I do not really belong to her mutual adoration tribe, she might not even have read my letters. 

PS. As I am putting together a Stupid Bank Regulations 101, for the benefit of those who like Martin Wolf do not get it, perhaps Gillian Tett would also like to take advantage of it.