March 17, 2017

To understand risk-weighted capital requirements for banks distort, is not geeky, just thinking outside The Group.

Sir, Gillian Tett mentions that Hyun Song Shin, and economic adviser at the Bank for International Settlements, “believes that modern economists have a crucial blind spot: they tend to ignore how the financial system really works, since they operate with idealised models of money and investor incentives.” “A blind spot masks the crisis danger signs” March 17.

Of course! As I had written to FT, in thousands of letters, the risk weighted capital requirements for banks has completely distorted the allocation of credit.

That distortion has similarity to those found in a “BIS study of German life insurance companies, which have recently accounted for 40 per cent of government bond purchases, concluded these were gobbling bonds not due to deflation forecasts, or an enhanced appetite for risk… but because “accounting rules and solvency regulation” forced insurers to match assets to liabilities.”

But then Ms. Tett goes into writing of the “kinks in how these rules work (too complex to spell out here)… The result was a bizarre, self-reinforcing feedback loop that traders describe as “negative convexity” (and George Soros, the hedge fund manager, calls “reflexivity”). This sounds geeky.”

No Ms. Tett, it’s not geeky at all! It just requires simple 101 economics to understand that if banks are allowed to leverage more with some assets than with others, that is going to produce a complete different set of expected risk adjusted return on assets than those that would be present in the absence of such regulatory distortion... and of course willingness to think outside The Group.

For instance, if the sovereign has a zero percent risk weight, and an SME a 100% one, this means banks need to hold much less capital when lending to a sovereign than when lending to a bank. Ms. Tett, honestly, is it really geeky or should it not be quite simple to then understand that the sovereign is going to be favored more than he would ordinarily been favored, and that the SME will find it more difficult than usual to access bank credit?

Sir, day by day we are getting closer to some real fundamental problems, like:

Who sold the regulators that fake idea that what is perceived as safe is more dangerous to the bank system than what is perceived as risky.

Who were the regulators who believed such crap and did not even care about defining the purpose of banks before regulating these?

Where were all the economists (and journalists) that should have raised the question that needed to be raised?

Sir, with an insistence for which I am not ashamed to be called an obsessive, I have and still do my part. Are you doing yours?