October 22, 2013

Some disagreements with Professor Persaud´s excellent comments on bank bail-ins and contingent convertible notes, Cocos.

Sir, Avinash Persaud deserves much praise for the clarity of his “Bank bail-ins are no better than fool´s gold” October 22. I do hope the regulators take notice and try sincerely to understand it, though I have many reasons to doubt they will. In the mutual admiration club of the Basel Committee and the Financial Stability Board, they only listen to the members.

That said there are though three issues on which I differ much with Professor Persaud.

The first is when he states “Financial crises are the result of market failure”. This is not always so. The current crisis was produced by regulatory failures present in the loony capital requirements for banks based on, ex ante, perceived risk. These made banks go, excessively, with very little capital, into areas deemed as “absolutely safe” and which we all know, or should know, are precisely those areas capable of creating big financial crises, when, as always happens, some of the perceptions turn out to be wrong, ex post.

The second is when he writes about “the failed philosophy at the heart of the 2004 Basel II global banking rules, which made the market pricing of risk the frontline defence against financial crises.” Where on earth does he get that from? The frontline of Basel II, its only pillar, were the capital requirements I just mentioned… and its implied frontline defence was allowing banks to earn much much higher risk-adjusted returns on their equity on assets deemed as “infallible” than on assets deemed as “risky”. And that is why banks now are not financing the future but only refinancing the past.

The third is when, with respect to Basel II, he mentions “a throwback” and which seems to imply he believes that Basel III is fundamentally different. That is not the case. Where it really matters, on the margins of banks' credit allocation decisions, regulatory risk-weighting is still in full force… and so the distortions of the real economy will keep on occurring… and keep on producing larger and larger crises… to be paid by all, especially by the young.