France, why are you willing to give other countries the advantage of having better-capitalized banks?

Sir, Caroline Binham and Jim Brunsden write: France’s finance minister, Bruno Le Maire, said yesterday that France would oppose any increase in capital requirements for banks” France digs in heels over bank capital increase. “France digs in heels over bank capital increase” October 11.

I don’t get it. If I were a finance minister the last thing I would want to see are the banks of my country being less capitalized than that of others. I wonder what stories French banks must have fed him.

I am not referring to excessively capitalized banks. I just know that banks that might be leveraged 10 to 1, a capital requirement of 10% against all assets, will be more stable and more functional than a bank leveraged 20 to 1, the result of some generous risk weighted capital requirements. And I am sure that the first banks will be able to attract better shareholders willing to obtain lower but safer returns on equity, than those speculators interested in the latter option.

And the better-capitalized banks are, the more capable they are to assume that necessary risk-taking that allocates credit more efficiently to the real economy.

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

Banks described as safe in terms of risk-weighted capital requirements compliance are basically cross-your-finger-those-risk-weights-are-right safe banks. And I swear 0% for sovereigns, and 20% for what is so dangerously AAA rated, are absolutely wrong risk weights.

@PerKurowski

How could it be in the interest of any bank regulators to have CoCos with unclear and haphazard conversion terms?

Sir, I refer to Thomas Hale’s, Martin Arnold’s and Laura Noonan’s discussion on the regulatory uncertainty that exists, “Coco trade seeks to emerge from dark period” February 24.

I am amazed. If I was a bank regulator and I had signaled that one way for banks to cover for the capital regulators required were the CoCo’s, I would want these to be as clear and transparent as possible. That not only to make sure banks could raise these funds in the most competitive terms, but also to be sure I covered my own share of responsibility in the disclosure process.

Something must have gone seriously wrong if there is still such huge regulatory uncertainty. I mean I could not for a second believe that any regulator would want to withhold such information on purpose.

In April 2014 I sent you a letter that asked “Can bank regulators keep silence on the conversion to equity probabilities of cocos?" 

In it I wrote: “Do regulators have any moral or formal duty to reveal to any interested buyers of cocos if they suspect the possibilities of these having to be converted into bank equity being very high? I say this because if so, and if they keep silent on it, that would make them sort of accomplices of bankers. Would it not?... Of course banks need capital, lots of it, but tricking investors into it, does not seem like the right way for getting it.”

In May 2014 I wrote you a letter asking “Is it ok for a regulator, like EBA, to withhold information from 'experienced investors'?"

In it I asked “What would be the legal responsibility of bank regulators, towards any coco-bond investors, if they withheld important information with respect to the possibilities of those bonds being converted into bank equity?”... and also:“Britain´s regulator, the Financial Conduct Authority, has said it plans to consult on new rules to ensure cocos are only marketed to experienced investors…Would that imply that a regulator can withhold important information from “experienced investors”? If so, just in case, for the record, I have no knowledge about investments whatsoever.

And then in August 2014 I wrote you a letter that alerted: “The investors had priced market risks of CoCos, not the risks of bankers´ or regulators´ whims.”

But then again regulators might also have decided it was better to go and fly a kite J

@PerKurowski ©

Without the endorsement by regulators, banks would never have leveraged their equity 60 times to 1 with any asset.

Sir, Gary Silverman writes: “exempting the derivatives known as credit default swaps from more rigorous federal regulation…[was] one of the biggest mistake leading to the financial crisis”, “Why it is wrong to forget Lehman’s fall” September 20.

That is not so. Again, for the umpteenth time, I will explain prime cause of the financial crisis, namely the capital requirements for banks, and this by using the examples of Lehman Brothers, AIG and Greece.

The regulators in June 2004, with Basel II, decided that against AAA rated private sector assets, and against any sovereign rated as Greece was until November 2009, banks needed to hold only 1.6 percent in capital, meaning banks could leverage their equity with those assets over 60 times to 1. In comparison, when holding “risky” assets like loans to entrepreneurs and SMEs, banks were only allowed to leverage 12 times to 1. 

On April 28, 2004 the SEC decided that what was good for the Basel Committee was good enough for them, and so allowed Lehman to leverage over 60 times to 1 with AAA rated securities guaranteed with mortgages to the subprime sector… Since Europe were allowing their banks to do the same… the demand for these AAA securities became so huge that it overpowered all the quality controls in their manufacturing and packaging process… and Bang!

If AAA rated AIG guaranteed an asset, banks could also dramatically reduce the capital they needed to hold against that assets, and this overwhelmed AIG’s capacity to resist selling “very profitable” loan default guarantees… and Bang!

And Greece was of coursed offered loans in such amounts, and in such generous terms, so that its governments could not resist the temptations… and Bang!

As can be seen the above has nothing to do with deregulation, or with exempting anything from rigorous federal regulation, and all to do with imposing extremely bad and distorting regulations. On their own, and without the direct endorsement of regulators, banks would never ever have dreamt of leveraging their equity 60 times or more, with any asset… no matter how safe it looked.

If we are not going to spell out the real reasons why Lehman Brothers fell, then we better all forget Lehman’s fall.

PS. Here are 7 questions US Congressmen and Governors should ask bank regulators.

@PerKurowski

Capital requirements for banks, instead of on credit risks, should be based on the risk of loony regulators regulating.

Sir, I refer to Patrick Jenkins’ “Make advisers pay when deals go wrong” September 11. 

In it Jenkins writes: “for at least eight years, free markets have been far from genuinely free… inflated in part by the policy response to the financial crisis… market distortions… created by the tougher rules imposed on the investment banks in the aftermath of the financial crisis”. 

Evidently Jenkins does not want to contemplate the possibility that the existence of no free markets, as a consequence of distorting rules arising from Basel I and II caused the financial crisis.

And he refers to “lightly regulated banks”… Come on! Is it not high time for some intellectual honesty?

What is so light about allowing banks to leverage 60 times or more lending to sovereigns and AAArisktocracy and only 12 times lending to SMEs and entrepreneurs? What is so light about capital requirements that completely distort the allocation of credit to the real economy?

Jenkins opines: “Make advisers pay when deals go wrong” Absolutely! But what about making regulators pay when regulations go wrong? And what about making influential financial journalists pay when they completely ignored what was happening?

No Sir. Clearly the capital requirements for banks, instead of being based on credit risks, should be based on the risk of regulators being totally wrong… and it is the journalist’s responsibility to diminish that risk… so that we do not have to require banks to hold 100 percent in capital.

@PerKurowski

FT, why should bank regulators have the right to game the capital requirements with their credit risk weights?

Sir you write: “bad accounting practices can contribute to financial instability. Booms flatter their measured profitability, which encourages them to take more assets on to their balance sheets. Thus leverage begets more leverage throughout the banking system, until asset prices can rise no longer and the whole edifice comes crashing down.” “Banks should not be able to game accounting rules”, September 3.

Of course you are absolutely right we need the good accounting practices, but, frankly, don’t you think that no matter how bad the accounting, it could never have caused the kind of bank leverages that the regulators allowed for with their credit-risk weighted capital requirements. For example what about the over 60 to 1 leverages authorized in Basel II for bank exposures to AAA rated securities or to sovereigns rated like Greece was until November 2009? What about that infinite leverage authorized by Basel I in 1988 when regulators decreed the risk weights for OECD sovereign to be ZERO percent? If that is not gaming what is?

Sir, why do you insist in covering up for the fundamental mistake of the Base Committee; or when will anyone in FT dare to explain why these regulations do not dangerously distort the allocation of bank credit to the real economy?

And you also write: “Bankers complain that a tougher regime might force them to realise more losses in the short term. Tough.”… Yes, tough on banks… but, because of banks then having less capital, and the risk weighted capital requirements, it would also be tough on all those borrowers who would have even less access to bank credit… something which would also be tough for many unemployed.

@PerKurowski

Capital requirements, non-performing loans, down-ratings and fines are causing severe bank credit austerity.

Sir, Henny Sender writes: “A world awash with dollars is rapidly being replaced by a dollar-scarce world” “Pain for those most in debt looks certain to become more severe” August 26.

Yes, and that dollar scarcity will, as is, primarily generate a contraction of bank credit. Consider what is happening:

Regulators are increasing capital requirements, which put banks lending capacity under pressure.

More non-performing loans and credit down-ratings of borrowers put additional strain on the banks.

And to top it up there are the fines. The recently reported fines of $260bn for the largest 25 banks, when calculated for a leverage of 15 to 1 results in about 4 trillions less bank-credit availability.

But when Sender writes: “It is still not sure how the pain will be distributed though”, I would tend do disagree.

If bank regulations keep the risk-weighted capital requirement component, there is no doubt of who are going to suffer the most; that will be those who generate the highest needs of capital, namely “the risky”, like SMEs, entrepreneurs and the downgraded.

Since those risky already are perceived to generate much expected losses, they will generate much less “unexpected losses”, and so we should lower the capital requirements for banks when holding these assets.

Sir, if austerity has to be imposed, I much prefer that to be government spending austerity than bank credit austerity. Banks have to put up at least some capital (equity) while government bureaucrats need not to risk a dime of their own.

@PerKurowski

In terms of capital requirements for banks, when travelling towards 20 or 30 percent, how do we survive the journey?

Sir, Jonathan Ford writes Alan Greenspan exhibited both candor and clarity in an article for the Financial Times in which he called for banks to raise substantially more capital “Higher capital is a less painful way to fix banks” August 26.

First, in that article Greenspan compared the evolution of traditional bank capital levels, with the much newer risk-weighted capital requirements concocted by the Basel Committee. They cannot be compared and so in doing Greenspan clearly evidence why he should take his retirement more serious, and better do like soldiers, just fade away.

And then, in terms of what capital requirements he has in mind, Greenspan writes about “20 or even 30 per cent of assets (instead of the recent levels of 10 to 11 per cent)”. Not mentioning whether he refers to risk-weighted assets or not, something which has implications not to be frowned at. For instance, with current risk weights of 100 percent when lending to unrated SMEs and entrepreneurs, banks could be required to hold 30 per cent in capital, while allowed to hold zero capital when lending to the zero risk weighted sovereigns… Is that what we need? And how do we get from here to there, without dying during the journey? Can you imagine the initial bank credit austerity that could ensue? 

Greenspan argued: “if history is any guide, a gradual rise in regulatory capital requirements as a percentage of assets (in the context of a continued stable rate of return on equity capital) will not suppress phased-in earnings since bank net income as a percentage of assets will be competitively pressed higher, as it has been in the past, just enough to offset the costs of higher equity requirements. Loan-to-deposit interest rate spreads will widen and/or non-interest earnings will increase.”

And I would just ask Greenspan: If you were thinking of buying bank shares… and heard about “a gradual rise in regulatory capital”, would you buy those shares now, or would you prefer to postpone that decision to when the increase in regulatory capital seems closer to being completed?

@PerKurowski

$260bn in bank fines results in about 4 trillions less bank-credit availability.

Sir, Laura Noonan, with respect to the 25 largest banks, reports “Banks fine tally since crisis hits $260bn” August 24.

And I do some multiplication $260bn times let us say a 15 to 1 leverage, results in $3.9 trillions less in bank lending capacity. So many scream bloody murder about government austerity, while not caring one iota about bank-credit austerity… how come?

Can you imagine if this $260bn in fines had been paid in fresh issued non-voting bank equity to be held by governments for about a decade?

@PerKurowski

FT, I’ve blown the whistle on bank regulator’s foul play many times. But Gillian Tett does not want to hear it. Why?

Sir, I refer to Gillian Tett’s “Finance needs to blow the whistle on foul play” May 28.

I have sure blown my whistle. On my TeaWithFT blog I have, with this, 141 comments directed to Gillian Tett over the years. Surely more than half of these have to do with the lunacy of bank regulators.

With their credit-risk-weighted capital (equity) requirements for banks, that favors lending to what is perceived as safe over what is perceived as risky (as if that would be needed) they manipulate and distort the bank credit markets… clearly foul play. And all that for absolutely no good reason, since all major bank crisis have only resulted from excessive exposures to what was ex ante perceive as risky but that ex post turned out to be risky.

Sir, could you please ask Ms. Tett, as an anthropologist, to explain why journalists like her give so much more credence to those who for unexplained reasons have been named bank regulators, than to ordinary bankers who at least have to compete with other bankers… or citizens like me?

For instance from where can a professional like Ms. Tett derive the notion that a Mario Draghi, just because he was named chair of the Financial Stability Board by some unknown bureaucrats, knows more about risk managements and how banks should behave than any ordinary banker or finance professional?

If simply stating: “I am the regulator” makes someone less prone to make mistakes or to behave badly than the one being regulated, and to have that nonsense believed by journalists, then we are definitively screwed.

PS. For instance, before the approval of Basel II, I loudly blew the whistle on the dangerous systemic risks of using credit rating agencies too much in bank regulations… both as an Executive Director at the World Bank and in FT. Nobody wanted to hear it  L

Martin Wolf, besides our bankers, do we not have to trust our bank regulators too? I sure don’t.

Sir, Martin Wolf writes: “morality matters. As Prof Luigi Zingales argues, if those who go into finance are encouraged to believe they are entitled to do whatever they can get away with, trust will break down. It is very costly to police markets riddled with conflicts of interest and asymmetric information. We do not, by and large, police doctors in this way because we trust them. We need to be able to trust financiers in much the same way.” “Why finance is too much of a good thing” May 27.

But, do we not need to be able to trust our bank regulators too? I certainly don’t!

Anyone setting the weight for the capital (equity) requirements for banks when lending to government at 0%, and at 100% when lending to SMEs, must know that means that banks will lend more and at lower relative rates to the government than to SMEs. And that de facto means they believe that government bureaucrats are more productive using bank credit than SMEs.

Well, I refuse to believe that. I believe that if you believe something like that, you are either extremely dumb or a communist… in either case you’re not trustworthy. 

PS. Martin Wolf, absent conflicts of interest, and with perfect information, would there even be financial markets?

PS. All finance is great when debtors have a good plan… Force-feeding debtors is worsethan feeding geese for foie gras

@PerKurowski

Risk weights for bank credit not used productively: for bureaucrats 0%; for SMEs 100%. And FT still wonders what went wrong?

Chris Giles and Sam Fleming write: “Economists now identify the problem of low productivity as one of the great threats to improved living standards, in rich and poor countries alike… The fact that companies have become less efficient at converting labour, buildings and machines into goods and services is beginning to trouble policy makers”, "No great shakes Weak growth turns into a problem of global proportions" May 26.

Regulator set up their credit-risk-weighted capital (equity) requirements for banks, based solely on who could most safely repay a bank loan, and not one iota based on who could best use a bank loan.

And so, as ideologues, they gave the government bureaucrats a zero percent risk-weight and an SME, or an entrepreneur, a 100 percent risk weight.

And FT, you still do not get what has gone wrong?

@PerKurowski

Let us not ignore the criminally bad bank regulators who manipulated and distorted the bank credit markets.

Sir, Paul Robinson writes in his letter “The story unraveling before us is one of criminal minds working together to circumvent and deceive regulatory authorities that would leave any normal industry”

I will not discuss that but, in the same breath, it must be also be said that regulators, for whatever reasons, stupidity or ideology, criminally manipulated and distorted the bank credit markets in favor of the governments and against the citizens.

In 1988, with the Basel Accord (Basel I), regulators adopted the use of credit-risk-weighted capital (equity) requirements for banks and set the following risk weights: Lending to the government was given a Zero percent risk weight; and lending to the citizens’ SMEs and entrepreneurs was awarded a 100 percent risk weight… what more is there to say​?

@PerKurowski

If you fine a bank, request payment in shares, not in cash against their equity, which is societal masochism.

Sir, you write: “The modern dependence upon credit for growth is too great for the capital that supports it to be treated casually”, “Shareholders punished for the sins of the trader” May 22. I am glad to see that you now at long last warn about the negative should-be-expected-unexpected consequences that fines can have. I have written to you several letters on this but, as usual, as your policy, these have been ignored.

I hope you now recommend what I have been recommending for quite sometime, namely the option for the authorities to collect those fines in newly issued bank shares, and which could then be resold some years later to the markets.

To collect fines from banks, in cash, against their equity, is basically societal masochism.

http://teawithft.blogspot.com/search?q=fines

@PerKurowski

If only our bank regulators in the Basel Committee / FSB grew up to wear long pants and assumed their responsibilities.

Sir, Gillian Tett holds that: “Credit derivatives deserve a revival — if financiers grow up” May 22. I agree… but that is far from being enough.

Though Ms. Tett rightly advices that these derivatives need to be a genuine tool in risk management, and not just a technique for regulatory arbitrage… she keeps mum on the fact that the only reason for which they are used to arbitrage, is the availability of regulations that can be too easily arbitraged, or are too tempting to arbitrage, like the current credit-risk-weighted capital (equity) requirements for banks.

In short for risk-management instrument to be useful you have to remove the distortions made possible and provided by regulations… and for that to occur it is even more important that regulators grow up. 

We can all wonder how immature regulators have to be to be looking at the risks of bank’s assets and not on how banks manage those assets… and we can all wonder how immature they have to be regulating banks without even defining their purpose... and we can all wonder how infantile they can be thinking themselves able to regulate with some formulas… that no one of them can explain.

@PerKurowski

EY, when focusing on tax in developing economies, why ignore the most pernicious development tax, that on risk-taking?

Sir, I refer to EY’s inlay “Tax – Insights for business leaders: With a focus on developing economies” May 21.

Bank regulators, with their Basel Accord of 1988 decided, God knows why, that sovereigns were much safer than the citizens who make them up, and that therefore banks needed to hold much less equity when lending to sovereigns than when ending to citizens, like to SMEs and entrepreneurs.

And that, no matter how you want to bend it or hide it, means that banks, compared to a free market without these regulations, will lend more to sovereigns and less to citizens.

And that, no matter how you want to bend it or hide it, means a regulatory subsidy to sovereigns and a tax on citizens.

And this is an especially pernicious tax in a developing country that copycats those regulations, since risk-taking is the oxygen of any development.

And yet EY blatantly ignore this tax that directly taxes development. Why?

EY should perhaps talk with you Sir.

FT, you know I have sent you more than a thousand of letters on this issue, and though you have been ignoring these the last decade, in November 2004 you did publish a letter in which I wrote: “We also wonder in how many Basel propositions it will take before they start realizing the damage they are doing by favoring so much bank lending to the public sector. In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits.”

@PerKurowski

The Basel Committee causes an inefficient allocation of bank credit, something which guarantees lower productivity.

Sir, Sam Fleming writes: “the efficient use of capital and labour is key to improving living standards, at a time when advanced economies face lower potential growth because of ageing populations”, “US productivity slowdown adds to concerns among policy makers” May 7.

Indeed, but current credit risk weighted equity requirements for banks impede bank credits to clear efficiently, by means of their credit risk adjusted net margins. That is because regulators allow banks to leverage their equity (and the support they receive from society) many times more when those margins are paid by those perceived as safe, than when the margins paid by those perceived as risky.

And that means, of course, that “the safe” will get too much bank credit at too low rates, while “the risky” will get too little at too high relative interest rates.

That inefficient allocation of bank credit caused by bank regulators, guarantees productivity will be negatively affected.

That regulators, academicians, financial experts and most financial journalists, including those in FT, stubbornly ignore this is truly mind-blowing. 

On May 6, in Berlin the Financial Stability Board (FSB) held a meeting of their Regional Consultative Group for Europe. The press release states: “The meeting was preceded by an informal seminar that considered how the financial reforms have changed bank business models and more specifically, capital strategies and capital structures.”

Sir, as you well know, there are no “changed bank business models” that do not imply some changes in the allocation of bank credit. Are regulators beginning to understand the mess they created? Lets hope so. It is more than a decade late.

PS. When the FSB or the Basel Committee refers to “capital” they basically signify “bank equity”.

@PerKurowski

Why does Martin Wolf keep mum about an important regulatory inequality driver he must know of by now?

Sir, when Martin Wolf, May 2, discusses two books on inequality in a “World of difference” and makes some suggestions of his own, there is one difference he does not refer to.

Regulators, with their different equity requirements based on perceived credit risks, allow banks to earn higher risk-adjusted returns on equity when financing those who already have something, and therefore can much easier be perceived as good credit risks, than when financing those who have nothing, and therefore can much easier be perceived as risky.

That clearly diminishes the opportunities of those who have nothing to get something, and thereby de-facto constitutes an important inequality driver.

It surprises me to see that someone like Martin Wolf keeps mum on that, even though he knows, or at least should know, that never ever has lending to those who have nothing, those who are perceived as risky, created a major bank crisis. Why such silence?

Perceived credit risks are all about expected losses. And bank equity is all about a buffer against unexpected losses. To use expected losses as a proxy for the unexpected, which is what regulators currently do, is simply stupid. Could it be that FT’s chief economic commentator has too many good friends among the regulatory elite?

PS. Martin Wolf writes: “Underlying these complex trends [of increased inequality], argue the authors, are complex economic forces... financial liberalization”. Let me ask: to distort immensely with regulations the allocation of bank credit to the real economy, is that “financial liberalization”?

@PerKurowski

What distortion causes Martin Wolf’s silence about the distortions produced by the different bank equity requirements?

Sir, Martin Wolf writes: “The rising price of housing… also distorts the financial system: 70 per cent of bank loans outstanding (after netting out lending within the financial sector) are to individuals secured on property. The financial system is now totally addicted to high house prices”, “Bribes and evasions on housing and the deficit” May 1.

Why does not Martin Wolf ask one of his many banker friends how much equity regulators require his bank to hold when financing secured with property as compared to when financing a SME?

And then Wolf should call one of his finance professors friends and ask what those different equity requirements do for the risk-adjusted returns on bank equity when lending for the purchase of a somebody’s home, as compared to with the lending for the creation of a job, so that someone could pay his mortgage and the utilities of his home.

Wolf keeps mentioning “distortions”, but no matter how much I remind him, he refuses to refer to that really monstrous distortion produced by different bank equity requirements based on perceived credit risks. What journalistic distortion causes his silence?

Again, for the umpteenth time, regulators have based their bank equity requirements, those that are to cover for unexpected losses, on the perceived possibilities of any expected losses… now how loony is not that?

@PerKurowski

​

Regulators believe those perceived as “safe”, will originate less unexpected losses for banks than the “risky”. Loony!

Sir, I refer to your Special Report “Risk Management – Property” April 27.

It mentions the risks of: climate change, cyber security breaches, terrorism, earthquakes… all those risks that are difficult to currently estimate but that can produce extraordinary unexpected losses… including for banks.

But those risks are not considered at all by regulators who, when setting their equity requirements for banks, use the expected losses derived from perceived credit risks as a proxy for the unexpected… more-credit-risk-more-capital and less credit-risk-less capital

It sort of translates in that regulators would seem to believe that risks, like those listed affect more the “risky” like the SMEs, than the sovereigns and the members of the AAArisktocracy. I can’t believe you believe that too.

@PerKurowski

US Congress, keep the US Export-Import-Bank open, you’ve got much more serious credit distortions to fight.

Sir, with respect to the US closing Exim Bank you write about “the economic equivalent of unilateral disarmament in a world bristling with nuclear weapons” as if the one disarming was doing what’s immoral, “The wobbly economic leadership from America” April 25.

You write “In the past two years, Chinese development banks have lent $670bn in subsidized credit in subsidized credit to help domestic companies win bids all over the world… more than all Exim guarantees since set up in the 30s” and still you argue that Exim-Bank could serve “as a check on crony capitalism practiced by China and others? 

And you write “No private sector bank will finance 15 year emerging market projects” Of course not, why should they when they are allowed to hold less equity when lending to already emerged markets perceived as safer?

Would I close Exim-Bank? No, I have been able to use it very satisfactorily during my life, so that would be something extremely ungrateful of me. But, that said, much more important than keeping it open, is to get rid of the credit-risk differentiated equity requirements for banks, those which distort immensely the allocation of bank credit all around the world. The Basel Committee, that’s what the US Congress should really be working to close down, or at least forbidding it to discriminate between borrowers.

@PerKurowski