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

Loony bank regulators based the capital requirements to cover for uncertainty, on the “certainty” of expected risks.

Sir, Rana Foroohar, when reviewing the former Securities and Exchange Commission regulator and Treasury department adviser Richard Bookstaber’s book “The End of Theory”, begins it with “Economists are forever running forensics on past financial crises to discover clues as to how the next one might occur.” “Uncertainty principles” April 15.

I don’t know about all my economist colleagues, but our current bank regulators, those you most should thought would do that in order to regulate, they definitely did not do that.

If they had done so, they would clearly have noted that all major bank crises result from a. unexpected events (like devaluations) b. criminal behavior (like lending to affiliates) and c. excessive exposures to something ex ante perceived safe, but that ex post turns out to be very risky.

As a consequence they would never ever have come up with something as dumb as risk weighted capital requirements for banks that were lower for what was dangerously perceived as safe, and higher for what was made innocuous, precisely because it was perceived as risky.

Indeed bank capital should be there for the unexpected, to take care of the ex post uncertainties. That is why current regulators, when basing their capital requirements for banks on the ex ante perceived risks, evidence they haven’t a clue about what they are doing.

Sir, as you have silenced some 2.500 letters of mine on this, I know you don’t want to raise this issue but do you really believe it is in your best interest to keep quite on it?

@PerKurowski

In an age of “pervasive uncertainty”, how can bank regulators trusts ex ante perceived risks so much?

Sir I refer to Oliver Ralph’s “Age of uncertainty takes its toll” March 13, in order to make just one question… that in the title.

Sir, I dare you to explain to me, or to anyone, why the capital requirements for banks should be based on the risks perceived, and not on those risk that might not be perceived?

@PerKurowski

Regulators should not focus on those risks (weather prognosis) bankers already consider, but on the uncertainties

Sir, several prominent names write: “Last week Andy Haldane… admitted that economists had failed to predict the financial crisis, and compared the situation with that of ill-informed weather forecasting in 1987 — the “Michael Fish moment”. And the experts argue: “At the heart of the crisis would appear to sit faulty accounts and unreliable audits” and as a consequence they request more reliable accounting rules. “Clearer picture of banks’ capital is required to help avert crises” January 12.

Sir, no one can argue against better accounting rules, but please, that is not what created the financial crisis.

In terms of weather forecasting what happened (and what is still happening) was that not only did the banks follow the credit forecasts to set their exposures and interest rates, but so did the regulators, when they set their risk weighted capital requirements. That meant that “weather forecasts” got to be excessively considered. The regulators role on the contrary was and is, not the management of perceived risks, but to consider the uncertainties, like weather prognosis being utterly wrong.

PS. De facto, absurdly, it meant regulators believed bankers were going to go out, especially, when the weatherman was announcing a storm. 

@PerKurowski

Risk weighted capital requirements for banks caused the animal spirits of hyenas to substitute for those of lions.

Sir. We had a crisis, which resulted directly from the distorted incentives for the allocation of credit to the real economy that the risk weighted capital requirements for banks caused. If anyone doubts that, just consider that Basel II, of 2004, allowed banks to leverage equity a mindboggling 62.5 to 1 with private sector assets, as long as these assets had an AAA to AA rating. If they did not posses a credit rating then a 12.5 to 1 leverage was the max.

True, FDIC and the Fed did not allow USA’s commercial banks to follow these Basel II rules initially, but the SEC did allow the investment banks to do so, as were European banks allowed to do. That set off the most voracious appetite ever for AAA rated assets, and the markets, understandably, set out to satisfy that demand, in any which way it could, even if by means of fraudulent behavior. Because that is what markets do!

To top it up, with Basel I of 1988, the regulators had risk-weighted Sovereigns with zero percent, and consequentially banks were allowed to build up huge exposures against little capital for sovereigns such like Greece.

And then we had Central Banks, Fed, by means of QEs, injecting the mother of all liquidity in the markets, and again, by foremost buying up sovereign debt, mostly benefitting governments, and indirectly those who already owned assets like stocks.

Sir, the can of the crisis was simply kicked down the road; and the regulations that make banks earn higher risk adjusted returns on equity when financing the “safer” past and present than when financing the “riskier” future kept in place. Our grandchildren will hold us accountable for this.

Martin Wolf nonetheless gives a very positive review of Obama’s eight years of economic policy, “How Obama rebuilt the economy” January 11. How come?

The truth is that Wolf does not get it yet! Here he writes of “a broader post-crisis loss of animal spirits” without being able to understand that those risk weighted capital requirements for banks that I referred to, pre and post crisis, what they have done is to substitute the spirits of hyenas for the spirits of lions.

@PerKurowski

It is only the bankers’ responsibility to clear for risks. The regulators should only prepare banks for uncertainty.

Gillian Tett writes that Axel Weber, the chairman of UBS, “suggests investors urgently need to think about the difference between ‘risk’ and ‘uncertainty’: the former refers to events that can be predicted with a certain probability; the latter refers to unknown future shocks.” “Emerging markets offer clues for investors in 2017: Extraordinary political events have upended western assumptions about risk and uncertainty” January 1.

Let us see if this distinction helps Ms Tett to see that with risk weighted capital requirements for banks, both bankers and regulators are clearing for risk. The result is that “risk” is excessively considered while “uncertainty” plays a secondary role. Seemingly it is too hard for regulators and anthropologists to understand the simple truth that any risk, even if perfectly perceived, causes the wrong actions if excessively considered.

To subject banks to this double counting of risk means banks will lend too much to what is ex ante perceived, decreed or concocted as “safe” like AAA rated securities and sovereigns like Greece, and too little to what is perceived “risky” like SMEs and entrepreneurs.

Only the exclusive use of a leverage ratio, which represents a capital requirement that has nothing to do with perceived risk, is what could help banks prepare for uncertainty, without distorting the allocation of bank credit to the real economy.

@PerKurowski

Tim Harford, why should the 2008 bank crisis have reminded even an "undercover" economist of that “banking matters”?

Sir, Tim Harford writes: “If 2008 was a sharp reminder that banking matters, then 2016 has reminded us that politics matters too” “Prediction in an age of uncertainty” October 29.

Obviously this has to be a statement made by a deskbound undercover economist, or by one of his current bank regulation technocrats colleagues, and not by a main-street economist. If there is little as important to an economy’s real day-today, always, that is the access to bank credit, especially in a Europe so dominated by banks.

Here Harford also writes about predictions in age on uncertainty, without seemingly having understood that the Basel Committee’s capital requirements for banks were predicated on believing in a 100% world of certainty.

Harford refers to Nicholas Bloom concluding in that “uncertainty also causes recessions because it makes consumers, employers and investors hesitate before spending money. And if we all hesitate, that is exactly what a recession looks like.”

Sir, but what is more hesitation than that what bank regulators showed, when they decided banks should not be able to leverage as much with what they perceived as risky than with what they perceived as safe… as if banks had ever done such thing.

@PerKurowski ©

Martin Wolf, the uncertainty of whether those who govern us really know what they’re doing is always upon us.

Sir, Martin Wolf writes: “Productivity is not everything, but in the long run it is almost everything… But the prospects for productivity are…the most important uncertainty affecting the economic prospects of the British people. Is it reasonable to expect a return to buoyant pre-crisis productivity growth? Will productivity continue to stagnate? Or will it end up somewhere in between?” “The age of uncertainty is upon us” March 18.

Mr. Wolf, for the umpteenth time, obsessively, I do not understand how you and so many other can so obsessively ignore that if you tell banks they can leverage their equity more with what is safe than with what is risky; so that they can earn higher expected risk adjusted returns on equity with what is perceived or deemed to be safe, than with what is risky; that then banks will foremost be refinancing the safer past while ignoring too much the credit needs of the always riskier future. And since then productivity is not been given the chances it deserves, the prospects for its improvement must be really lousy.

“The age of uncertainty is upon us”? Please when did we have an age of certainty?

Current regulators regulate banks without having defined their purpose, and base those capital requirements for banks that should cover for the unexpected, on the expected credit risk. Those facts evidence the major uncertainty we always face, namely whether those who govern us have the faintest idea of what they’re doing.

@PerKurowski ©