There will not be any normalization of bank credit in Europe until regulators do a 180 degrees volte-face.

Sir, Sarah Gordon writes that “While the region’s [highly credit rated] groups have gorged on cheap credit, its multitude of smaller companies have had to deal with a scarcity of funding”, “Poor corporate credit is holding back Europe’s recovery”, January 31.

Of course, how could it be otherwise, when regulators, especially in times of scarce bank capital, require banks to hold much more capital when lending to those who are perceived as having higher expected losses than to those who possess a high credit rating.

Gordon mentions that because companies are “now driven by the desire to invest. This will inevitably, result in normalization of credit at some point.” Forget it! There will be no normalization of credit until regulators realize that capital requirements for banks should have very little to do with expected losses, and a lot to do with unexpected losses, and therefore get rid of the current system of risk-weighting.

When regulators exorcised primal risk-taking from the banks, they doomed our economies to decadence.

Sir, Edmund Phelps writes that “Nations with once-dynamic economies will be helpless to recover their prosperity as long as they misunderstand what causes economic progress”, "Free innovators from the state’s deadening hand”, January 31.

Indeed before it is realized that primal risk-taking is what leads to innovations and start-ups, and which is what keeps the economy sturdy muscular. Any economic growth based on risk-aversion leads only to economic obesity. Unfortunately, bank regulators, with their loony capital requirements based on ex ante perceived expected losses exorcised such risk taking from the banks.

And Edmund Phelps also correctly states “The state is no better suited to take a big role in the technical innovation than in artistic creation”. But Phelps might not be aware of how bank regulations are stacked in favor of the state assuming such role. Currently when a bank gives a loan to a “risky” innovator, let’s for example call it a Solyndra; it is required to have much much more capital than when lending it to the “infallible sovereign”, and so that instead a bureaucrat can relend that money to an innovator, like a Solyndra.

Sir, don’t you recognize insanity when you see it?

Tobias Buck reports on how “banks from countries such as Spain and Italy borrow money cheaply from the European Central Bank to buy high-yielding sovereign debt from their own governments”, “Spain’s lenders reap profit on Madrid bonds”, January 30. And that the banks can do, because they need to hold no capital against these “infallible sovereigns”.

Frankly, Sir, don’t you recognize insanity when you see it? This is what the banks are doing in countries where the unemployment rates, especially those of the youth, want to make you cry. How on earth are the banks to help these countries to get out of what seems to be a death spiral?

And all because bank regulators do not care an iota about asking themselves what is the purpose of banks before regulating these… and therefore allow themselves to come up with loony risk-weighted capital requirements based on perceived risk of expected losses and which directly discriminates against the access to bank credit of the “risky” medium and small businesses, entrepreneurs and start-ups.

How could Europe have allowed itself to fall in the hands of regulators who do not care about the real economy? And how can FT keep quite on this?

Risk weighted capital requirements for banks means some will receive too much credit, too cheap, others too little, too expensive.

Sir, John Plender in “How to spend $2.8tn of corporate cash” FTfm January 27, writes “The financial sector is there to intermediate between those with surplus funds and those who wish to invest. It can be relied to do so”

Not so fast Mr Plender. The most important financial intermediaries, the banks, are kept from efficiently allocating credit in the real economy, as a result capital requirements based on perceived risk. In fact, since banks can lend to “the infallible” against very little capital, the lending to “the risky”, which requires much more capital, is coming to a halt.

But seemingly the regulators are blissfully unaware of that it is them who are distorting. I say this because Christopher Thompson writes “Non-financial corporate loans in have fallen… creating a headache for regulators keen to encourage lending,, especially to small and medium sized businesses, which provide the bulk of Europe´s employment” “Balance sheets hint at EU bank confidence”, also January 27.

A “headache for regulators”, Europe has indeed fallen in the hands of a real inept bunch of bank regulators. What about the pain of the unemployed?

Real banking reform will only happen when regulators understand and acknowledge what they did wrong, and correct it.

Sir, Martin Arnold writes “Regulators are forcing banks to hold much more capital and to reduce their leverage, which is making some areas of business unprofitable. This is pushing some banks to quit those areas”, “Bankers assess once-in-generation reform” January 24.

That is indeed one way to word it, but since the truth is that the profitability of these areas was artificial in that it was based on the fact that they required much less capital than other, there should hopefully be other areas which could regain competitive profitability… like lending to medium and small businesses, entrepreneurs and startups.

The real reforms of banking will, sooner or later, only come when regulators understand and acknowledge the following:

You can´t have capital requirements for banks that are “portfolio invariant”, namely those which do not consider the benefits from a diversification of assets in “the risky” category, or the dangers of excessive concentration of assets to “the infallible”.

The fact that an asset is deemed risky because it has high "expected losses", does not mean one iota that it has the potential of more “unexpected losses”, which is what capital is there for, than what is perceived as “absolutely safe”.

That the efficient allocation of bank credit to the real economy is, medium and long term, of much more significance for the real safety of banks, than what can be achieved by any distorting risk management carried out by regulators-

Unfortunately, before the above is fully realized, things could get much worse.

The distortive risk weighted capital requirements for banks will haunt Ben Bernanke and Martin Wolf

Sir, Martin Wolf writes that contemporary “banks are constrained not by reserves but by their perception of risk and rewards of additional lending”, “Model of a modern central banker” January 22.

That is indeed so, but Wolf forgot to include that banks are also constrained by capital requirements, and by how the regulators’ perceptions of risks are transmitted by means of the risk-weighting of these.

When Wolf comments “An active an enterprising financial system creates risk, often by raising leverage dramatically in good times” he is ignoring the fact that the extreme high bank leverages of now, are actually leverages that were and are authorized by the regulators… and since banking itself is much about leveraging, banks must go to where they can earn the highest-risk adjusted returns on equity… which is usually where the capital requirements are the smallest.

And that created the distortions which not only produced the crisis when allowing investment banks and European banks to leverage immensely on AAA rated securities, and “infallible sovereigns”, but it also hindered the liquidity provided by for instance quantitative easing from reaching those who could do the most with it… like the medium and small businesses, entrepreneurs and start-ups. 

Ben Bernanke has most certainly done good things as a central banker, and Martin Wolf has definitely written great pieces as a journalist, but I do believe that history will hold their silence about this source of distortion seriously against them… and this even if they plead ignorance about it.

PS. Sir, just to let you know, I am not copying Martin Wolf with this, as he has asked me not to send him any more comments related to the capital requirements for banks, as he understands it all… at least so he thinks.

Excessive exposures to what is “absolutely safe” by regulated banks could be much more dangerous than whatever lurks in the shadows.

Sir Tracy Alloway writes “Shadow banks, we are told, are unregulated institutions that lurk in the dark corners of the financial system – away from the supervised activities of run-of-the-mill commercial banks”, “Competition for banking business lurks in the shadows” January 18.

But perhaps we should keep in mind that those unregulated shadow institutions are not able to leverage remotely as much as the banks who operate in sunlight… so the question of safety is sort of relative.

And Alloway also comments “that there is perhaps an underappreciated danger: that non bank lenders will encourage riskier behavior at larger banks that find themselves compelled to try to compete with the shadows”. But that would only happen if banks are able to dress up that riskier behavior in such as way that it is perceived as “absolutely safe” so that they do not need to hold much capital.

As is, the real risky behavior of banks is building up excessive and dangerous exposures to what is perceived as “absolutely safe”… all a consequence of capital requirements which are portfolio invariant.

Alloway hopes that these “shadow lenders serve a purpose” satisfying “the needs of the real economy”. Indeed let us hope and pray it is so, because as is, the supervised banks, with the risk aversion imposed on them, are kept from doing so.

What contains “expected losses” can also contain the “unexpected profits” we need for increased productivity.

Sir, in “Two challenges for the global economy”, January 18, with respect to a decline in economic productivity, you mention: “The solution lies in structural reforms aimed at allowing the most innovative sectors to expand”. That is correct. What is not correct is to believe that you can so easily, so besserwisser, identify what are the most innovative sectors… and so the market needs to be free to collaborate doing that.

But regulators currently impose on banks risk-weighted capital requirements, which wrongly, and stupidly, assumes that what is perceived to risk more expected losses, also risks more unexpected losses. And that is monumentally wrong. Not only does history show us that the worst “unexpected losses” most often derive from what was considered to have the smallest expected losses… but it also implicitly assumes that what risks a lot of expected losses, cannot contain huge unexpected profits, and that more than pay for any losses incurred.

And that double consideration for perceived risk discriminates all what is perceived as risky from fair access to bank credit… and impedes the markets invisible hand to operate freely.

While that regulatory mistake stays in place, our chances to produce the unexpected profits needed to change the current gloomy productivity outlook are indeed slim.

How on earth can regulators be so daft so as to believe that our future lies in the hands of banks playing it safe?

How on earth can regulators be so daft so as to ignore that asking our banks to play it excessively safe is truly dangerous for the economy and for the banks?

OCC, before asking banks to raise their standards of risk management, should stop regulators' distorting parallel risk managing

Sir, Tom Braithwaite and Camilla Hall report that “The Office of the Comptroller of the Currency said it plan to raise the standards it expected for risk management at the largest banks”. “Goldman and City wreck Wall St hopes for escaping doldrums”, January 17.

Before doing that OCC should first consider the distortions the risk-weighted capital requirements for banks cause.

As OCC should know, bankers clear sufficiently well for perceived risks, by means of interest rates, size of exposures and contract terms. But current capital requirements those which the regulators order banks to hold primarily as a buffer against some “unexpected losses”, are based on the same perceptions of “expected losses”.

And so the system now considers twice the “expected losses” and none the “unexpected losses”. And as a result, the regulators have introduced a distortion that makes any high standard risk management that serves a societal purpose absolutely impossible.

And this is especially wrong when the capital requirements are portfolio invariant, because that ignores the benefits of diversification for what is perceived as “risky”, and the dangers of excessive concentration for what is perceived as “safe”.

OCC should understand that it has no problem if banks manage their risks well, only if they don’t, and so it makes absolutely no sense to base the capital requirements for banks, on the same perceptions of risk used by the banks.

OCC should understand that those who most represent “no-expected-losses” are in fact those most liable to produce the largest and most dangerous unexpected losses.

OCC, do the world a favor, throw out the risk-weights a simple straight leverage ratio and allow the bank to be banks again… not credit distributors in accordance with what the risk-weighting which produces different capital requirement tells them.

Sincerely it surprises me that, in the “home of the brave”, with a market that prides itself to be free and to give equal opportunities, OCC allows for capital requirements which allow banks to earn much higher risk-adjusted returns on equity when lending to The Infallible than when lending to The Risky.

The implied discrimination does not seem to be compatible with the Equal Credit Opportunity Act (Regulation B).

Kid! If you eat your spinach you must eat your broccoli too.

Sir I refer to Henny Sender’s “Distress appears across Asian funding markets” January 15. In it Sender describes that banks are not in great shape and are too risk adverse to lend to lower rated companies… [aggravated] by regulatory changes which require more capital for anything other than investing in sovereign debt”.

Indeed, but the main constraint to lending to “the risky” is not risk-aversion but the risk adverse capital requirements. It is like telling children who don’t like spinach that if they eat it, they have to eat broccoli too.

And let us be frank… who but communists could believe that a bank system becomes safer by lending to the “infallible sovereign” and not lending to the “risky citizen”?

Of course it is all crazy… and it all derives from the fact that regulators, instead of setting the capital requirements for banks based on “unexpected losses”, as they should, based these on the “expected losses”, those which were already being cleared for by banks by means of interest rates, size of exposure and other terms. 

Recently on a blog when asking why regulators were not asked about this mistake, someone replied“there comes a point where the hypocrisy of the situation becomes so intense that it can no longer be addressed”.

Does that apply to you FT?

FT and Martin Wolf are also part of the failing elites who threaten our future.

Sir, Martin Wolf writes “the economic, financial, intellectual and political elites…lulled by fantasies of self-stabilizing financial markets…failed to appreciate the incentives at work and, above all, the risks of a systemic breakdown”, “Failing elites threaten our future” January 15.

That is wrong! That is the Greenspan version. The truth is that regulators interfered with the financial markets by imposing risk-weighted capital requirements for banks based on perceived risk of expected losses, those risks which were already being cleared for by bankers, and not based on the risks of unexpected losses.

Wolf is absolutely right though when he writes that the “divorce between accountability and power strikes at the heart of any notion of democratic government”. A proof of that is how those responsible for the failed Basel II went on to work on Basel III, without missing a beat, without really having to explain themselves, and without changing the basic manuscript. Frankly a self-stabilizing movie industry, would never ever dream of following up a box-office flop like Basel II in that way.

But you Sir, and Martin Wolf, have for many years stubbornly ignored my arguments about the huge mistake, which considering twice same perceived risks represents. And so, when now Wolf writes “If elites continue to fail...The elites need to do better”, may I just remind you that, in my book at least, you and him are part of that elite who are dangerously silencing the mistakes of some favored elites.

PS. Sir, just to let you know, I am not copying Martin Wolf with this, as he has asked me not to send him any more comments related to the capital requirements for banks, as he understands it all… at least so he thinks.

If some tiny tapering creates much hullabaloo, can you imagine if the Fed would try to soak QEs up?

Sir, Avinash Persaud argues “central bankers need… a better understanding of what their bond-buying has achieved”, “An expensive way to speak truth to financial markets” January 14.

Absolutely! From all what we read central bankers do not understand yet that those “Cash balances… trapped in a broken system”, are a direct consequence of capital requirements for banks which do not allow for liquidity to go to where it is most needed in the real economy, namely to finance “risky” medium and small businesses, entrepreneurs and start ups.

I fully agree with Persaud in that the first QE could be explained, and even justified, based on the need “to unfreeze markets that were close to seizing up”… but, from there on, no way Jose!

If the distortion produced by the current risk-weighting of bank regulations is not eliminated, so that the invisible hand of the market can resume operations, can you imagine what would happen if the Fed would even try to soak QEs up, I mean with so much hullabaloo already resulting from some tiny tapering?

Banks’ RoRWAs is like allowing kids to grade themselves. Shareholders could, at their own risk do so. Regulators should not!

Sir, The Lex Column makes several statements about banks’ RoRWA, the return on risk-weighted bank assets, January 13.

In essence RoRWA is like allowing kids to grade themselves, and their parents, as their shareholders, believing it. And though it does not sound very wise, that is ok since parents, at their own risk, are absolutely free to do so.

But, when teachers, or bank regulators, start using the kids’ own grading system, or the banks’ own risk-weights, then something is bound to go wrong. More sooner than later the whole system will overdoses on the kids and bankers biased perceptions, as these all have a lot of vested interest in having good grades or good RoRWA.

Risk weighted capital requirements for banks should be based on unexpected losses. They are not!

Sir, a bank should be free to calculate his own capital requirements in any which way he likes, and these will be almost entirely be based on expected losses. But a regulator should set the capital requirements based on the “unexpected losses” as these are those that should really be of his concern, but they do not.

Explicitly, for reasons of simplicity, the Basel Committee sets the capital requirements for banks that are there to cover for unexpected losses based on the same risk perceptions used to estimate the expected losses. And, to top it up, these capital requirements are also, explicitly, portfolio invariant… which means that the benefits of diversification is not accounted for, nor are the dangers of any asset concentration.

What a miserable state of affair of our bank regulatory system, if the implications of simple facts like that, cannot even be discussed.

In “Banks win concessions from Basel on leverage” January 13, Sam Fleming and Gina Chon report that if relying on a non-risk weighted capital requirement, such as the leverage ratio, that would tempt banks “to take on riskier loans to earn higher returns”. But again there is no discussion about the wisdom of allowing banks, by means of risk-weights to be able to earn higher risk-adjusted returns on safer loans, and which leaves hanging in the air the question of… who is then going to finance “the risky” medium and small businesses entrepreneurs and start ups?

That one can allow a Mario Draghi to mention “The leverage ratio is an important backstop to the risk-based capital regime”, without anyone asking him, the European Central Bank President, about the distortions in the allocation of bank credit to the real economy risk-weighting produces, is clear evidence that something is rotten in the Union of Europe.

Instead of labor and capital struggling against each other, perhaps they should discuss what to do with their intermediaries

“The real disaster lies in youth unemployment” writes John Plender in “Recession has revived labour´s struggle against capital” January 11.

And there is no doubt he is right about it and there is no doubt we have no chance of solving it while we have bank regulators who insist on that “unexpected losses”, those for which they require banks to have capital, are higher for the “risky” than for the “safe”.

Because, by means of Basel´s risk-weights, this translates into the banks being able to earn much higher risk-adjusted returns on equity when they lend to the “safe”, than when they lend to the “risky”.

And that translates of course into that banks will not any longer lend to finance the “riskier” future as much as previous generations of banks did.

And Plender writes: “The real driver of income inequality over the past decade has been top pay – specifically, of chief executives and bankers” and I ask. Could the bonuses of bankers have been as high as they were if bank capital has been required to be as much as it used to be pre-risk weighting days? No way!

And so instead of labour and capital struggling against each other, perhaps they should discuss what to do with the intermediaries… whether these are executives, regulators or politicians.

I mean, do not those who receive low salaries have a lot in common with those who receive low interest rates on their savings?

Current bank fines seem to be neo-medieval indulgences, not paid by the sinners

Sir, in “The regulatory cost of being JPMorgan” you hold “Fines – however large seem an ineffective stick with which to beat miscreants”, January 11.

Absolutely! These bank fines seem to be medieval indulgences, in this case not even paid by the sinners, but by shareholders, tax savings and less credit to the real economy.

No Mr. Ralph Atkins. We know precisely that the next financial polar vortex is going to hit… where it always hits!

Sir, Ralph Atkins writes that “six years after the eruption of the financial crisis… we know remarkably little about where the next ice storm might break”, “Investors hunt for the financial polar vortex", January 10.

He is wrong. We know exactly that the next financial polar vortex is going to break out where these always do, namely in a haven that has been perceived as “absolutely safe”, but has become dangerously overpopulated.

And the damages will be worse than ever, because of the manmade fact that, when it hits, just like when the last 2007-08 hit, our banks will have little capital to cover up with, as a direct consequence of those nonsensical risk-weighted capital requirements the Basel Committee concocted.

If only an “intellectual vacuum”, but, sadly, it is worse than that Professor Michael Ignatieff.

Sir, Michael Ignatieff writes about “the waning power of ideas” and begs “Free polarized politics from its intellectual vacuum”, January 10. Although, as a self described “radical of the middle”, or “extremist of the center”, I do agree with most of what he writes, I must still confess feeling that the absence of ideas would at least be better that the presence of some really bad ideas.

And a truly bad idea currently present, are the risk-weighted capital requirements for banks, and which allow these to earn much higher risk adjusted returns on equity on exposures deemed as “absolutely safe”, than on exposures deemed as “risky”.

And that makes it of course impossible for banks to allocate credit efficiently to the real economy. And that guarantees that the chances of any major bank crisis, those usually caused by dangerously overpopulating some safe-haven, have been exponentially increased.

Technically the mistake is explained by the fact that regulators estimate the “unexpected losses”, those for which you mainly require banks to hold capital, based on the same perceptions used by the banks to estimate “expected losses”.

And here we have all the free market believers not complaining about that horrible interference with the market that risk-weighting causes … and here we have all progressives not saying a word about the odious discrimination in favor of the AAAristocracy and against the “risky” that risk-weighting causes.

And meanwhile the chances for our youth to find employment in their lifetime are evaporating, thanks to this nonsense of banishing risk-taking from our banks.

If bank liquidity will by design not be able to flow where it is needed in Europe, why more of it?

Sir, in “Europe must avoid false optimism” January 9, you recommend: “Mr Draghi should show more urgency, extending for example new liquidity to the banking sector via a fixed-rate longer-term refinancing operation”. For what purpose Sir?

You must know that given the scarcity of capital in the European banking sector, and the risk-weighting of capital requirements, that liquidity would not flow to where it is most needed, and would therefore only worsen the imbalances, like even strengthening “the lethal embrace between sovereigns and lenders”.

Professor Thomas Piketty: “Don't be so defeatist, it is so middle class.”

Sir, Robin Harding holds that “Inheritance should not be an alternative to hard work” January 6.

The setting is: “The lower the rate of growth, the smaller the percentage of society’s wealth created by those who are alive today, and thus, by definition, the larger the percentage that is passed on from previous generations… higher inheritances certainly exacerbate inequality.”

And that is derived from Thomas Piketty’s “eagerly awaited” “Capital in the Twenty First Century”. The book includes: “if the after tax return on capital is higher than the rate of growth in the economy, then all the heir and heiress need to do is save enough of the income from their inheritance… and their share of society’s wealth will rise”… ergo we must redistribute, and so we need “wealth taxes on a global scale”.

I do not agree with its general premise. An after tax rate of return on capital which is higher than the rate of growth in the economy, is something not really sustainable… unless other factors are in play. And, in this respect, I would just ask Mr. Piketty about what he believes would have happened to after tax returns on capital, without Tarps, QEs and all Fiscal Stimulus since 2007?

And also, what a horrendous vision it implies! That we should now only adapt to a shrinking economy, and give up all illusions about making it stronger and better, and just concern ourselves with that the last tree on our Easter Island we cut down is equitably shared? I can hear Downton Abbey’s Violet Crawley admonishing “Don't be so defeatist, it is so middle class.”

But of course I agree with Robin Harding in that developed (and developing) societies should “opt for the free-flowing meritocracy of the last century, not a return to the dynastic wealth of the one that preceded it.

But that, as I see it, has less to do with inheritance taxes and, at least currently, much more to do with bank regulations. You see the Basel regulators, with their risk-weighted capital requirements, do not want banks to take the risks which come with any “free-flowing meritocracy”, and instead to concentrate their exposures to the illusions of safeness of the “dynastic wealth”.

And by the way, anyone who thinks that the presence of after tax returns on capital higher than the rate of growth in the economy, would be sufficient to keep the value of an individual inheritance… has little knowledge about real life and about capitalism. Oh no! To waste an inheritance is very easy, but to keep the real value of an inheritance is, and should always be, hard work, no matter what the average interest rates are.

I wish more would concentrate more on the causes of inequality, than on the resulting inequalities. If not, and if we tax more all of the wealthy, all we will get is few oligarchs getting even more wealthy, not because of capitalism but because of crony capitalism.

Did the baby-boomers’ parents’ not take risks, or use reverse mortgages in order to extract everything for themselves?

Sir, Janan Ganesh writes “Bad luck, not policy, is the scourge of the young” January 7. What is this? I’ve seen a photo of him in FT, and so is he here just working for the baby-boomer establishment?

Of course “There is no law of the universe that says each generation most be more prosperous than the last”, but that should not diminish one iota the moral obligation of each generation from trying that to be so.

Currently grey-haired bank regulators base the capital requirement for banks which should take care of the unexpected losses, on the perceptions of expected losses. And with that they have introduced a distortion that guarantees banks will finance mostly what is perceived “safer”, like the known past, and keep out from what is perceived “risky”, like the future.

And does that mean that the young will at least inherit a safer banking sector? Of course not! The risk-weights which determine the capital requirements are portfolio invariant. That means these do not take account of the added risks of asset concentrations, or the dissipation of risks by means of asset diversification. And that means that the risk of the banking system might be increasing exponentially, even while it is being reported as safer.

Yes “Baby boomers enjoyed almost miraculously circumstances” but, to attribute that to luck and not to the daring risk-taking of previous generations is ungrateful, to say the least.

Just look at the financial products offered to baby-boomers. “Reverse mortgages” which allow parents to extract all equity possible from their houses, for their own consumption, and thereby leaving much less for their heirs. Did the baby-boomers’ parents do such things?

If the young would only look up from their virtual world, and react to what is happening in reality, then Paris of May 1968 might just seem in comparison to have been just another hip peaceful gathering of premature baby-boomers.

PS. There is not a day in which I do not thank all my antecessors for all their risk-taking, and not a day I do not fret I am not capable of taking enough risks for my successors.

God make us daring!

For markets to make the global economy safer, we must allow markets to decide, not the regulators.

Sir, I can of course understand insurers like Henry de Castries and Eric Chaney wishing and praying for some safe and liquid assets comparable to US treasuries, and with which they sincerely believe it would be easier for them to responsibly fulfill their undertakings, “How markets can make the global economy safer” January 7.

But, safe assets are not something you just pull out of a hat, and on top of that, safe assets are also something which can turn into very risky assets, with a blink of an eye.

But, if we really want to allow markets to make the global economy safer, we need to stop interfering and distorting these.

For instance when the authors write “On the positive side, financial regulations has been strengthened” they are wrong. That is only repeating what regulators say of their own work. The sad truth is that financial regulations have been even further weakened with the introduction of even more layers that make it even harder to understand what their consequences are. And the risk-weighting of the capital requirements for banks, the mother of all distortions of the allocation of bank credit in the real economy, is still very much alive and kicking.

And when the authors write “The twin sovereign and banking crisis in the eurozone have forced leader to embrace serious reforms” I really do not know what they refer to. In that respect I just know that the embrace between banks and sovereigns is, because of the fact that banks need little or no capital when holding exposure to sovereigns, getting tighter by the hour and soon, if left alone, it will just mean they strangle each other to death.

The authors end asking for “a rebalancing solution based on a pragmatic fusion of policy and markets”… but, might our real problem be an excess of pragmatic fusions?

Gideon Rachman, on our current front of bank regulations in Basel, neither Sarajevo nor Munich mentalities will do.

Sir I refer to Gideon Rachman’s “Time to think more about Sarajevo, less about Munich” January 7.

Right now our banking systems are heading towards a meltdown, caused by excessive and dangerous exposures to what is perceived as safe assets and which therefore allow banks to hold less capital… and, consequentially, our real economy is not capable of helping us out, as its more “risky” participants, are not provided with the bank credits they need for some of them to turn into the saviors of tomorrow.

Rachman quotes Margaret MacMillan in “The War the Ended Peace” lamenting that “none of the key players in 1914 were great an imaginative leaders who had the courage to stand out against the pressures building for war”; and writes that “In 1914 national leaders were so keen to appear strong and to protect their ‘credibility’, that they were unable to step back from the brink of conflict.”

In contrast, in 1938, I guess the problem was that leaders held that everything was fine and dandy.

So Rachman what shall we do? Trust the Sarajevo regulators who arrogantly hold they can fight any bank risks which come up, or trust the Munich regulators who tell us that Basel III has repaired Basel II.

As I see it, neither one will do.

If the visible banks are not rationally regulated, there is no choice for the real economy than to run for the shadows.

Sir, the risk weight function which determines the current capital requirements for banks are based on two monumental mistakes.

The first mistake is that for reasons of simplification the Basel Committee oversimplified and decided that the expected unexpected losses of those perceived as safe will be much less than the expected unexpected losses of those perceived as “risky”. And that means that the perceptions of risks will either reward or punish… twice.

The second mistake is that the risk weights are “portfolio invariant” and which means these do not take account of the added risks of asset concentration, or the dissipation of risks by means of diversification. And that means that the risk of the banking system might be increasing exponentially, even while being reported as safer.

And all this leads to banks then earning higher risk-adjusted returns on equity when lending to the “safe” than when lending to the “risky”.

And the direct result is that those perceived as “safe” will have a subsidized access to bank credit, paid by negating the same to those perceived as “risky”.

And that guarantees banks will not be able to assist in helping the economy to get out of a secular stagnation, as alerted by Lawrence Summers in “Washington must not settle for secular stagnation”, or to avoid that weak destabilizing growth to which Edward Luce refers to in “Anglo-Saxon trumpeting will strike a hollow note” January 6.

And, while these regulatory discrimination against medium and small businesses, entrepreneurs and start ups remain in force, then Italy, instead of becoming more like Germany in order to prosper, as Wolfgang Münchau proposes in “What eurocrisis watchers should look for in 2014”, would do well becoming even more Italy and run into the shadows of its economía, finanza e banca sommersa.

2025: #AI – ChatGPT – Grok: “A leverage ratio or Basel’s risk weighted bank capital requirements. expulses banking into the “shadows”?

Though Lady Luck can still work without interference, the invisible hand cannot!

Sir, Tim Harford extracts similarities to the real economy from Natasha Dow’s “Addiction by Design”, “Casino’s worrying knack for consumer manipulation” January 3. What an extraordinarily interesting and, at least for me, brand new concept.

But when Harford writes “It is hard for a free market-enthusiast like me to look unblinkingly at Las Vegas… and not feel that the invisible hand has slipped”… I must confess a slightly different vision.

For instance, when I look at a roulette table, I see that all bets, though some take you out faster than others, have exactly the same expected value, in Vegas -$0.053 for every $1… and so I conclude that there Lady Luck can work without any interference, after the commissions of the house of course.

But, when I look at banks and see how regulators have set different capital requirements based on ex ante perceived risks, which leads to assets returning different risk-adjusted returns on equity, I am absolutely convinced that the invisible hand is not given the slightest chance to operate its magic.

A philosopher’s questions to the Basel Committee on capital requirements for banks and unexpected-losses.

Sir, Alain de Botton makes "The good case for putting philosophers into company boardrooms”. January 2.

In that respect I would hold that philosophers are also urgently needed elsewhere, like in the Basel Committee for Banking Supervision. Let me explain.

In “An Explanatory Note on the Basel II Internal Rating Based (IRB) Risk Weight Functions” July 2005 we read:

“The model [is] portfolio invariant and so the capital required for any given loan does only depend on the risk of that loan and must not depend on the portfolio it is added to.”

And the explicit reason for that simplification is:

“This characteristic has been deemed vital in order to make the new IRB framework applicable to a wider range of countries and institutions. Taking into account the actual portfolio composition when determining capital for each loan - as is done in more advanced credit portfolio models - would have been a too complex task for most banks and supervisors alike.”

And this leads to:

“In the context of regulatory capital allocation, portfolio invariant allocation schemes are also called ratings-based. This notion stems from the fact that, by portfolio invariance, obligor specific attributes like probability of default, loss given default and exposure at default suffice to determine the capital charges of credit instruments. If banks apply such a model type, they use exactly the same risk parameters for expected losses (EL) and unexpected losses (UL), namely probability of default (PD), loss given default (LGD) and exposure at default (EAD).”

And so, if the Basel Committee had included a philosopher in their team, he might very well have asked the following disturbing and possibly game-changing question.

“Friends, I read here you have decided, primary for reasons of expediency, to make the capital requirements for banks, those that should cover for “unexpected losses”, dependent on the same risk perceptions used to estimate the “expected losses”.

Does that not signify that banks could overdose on perceptions about expected risks, without you regulators doing what you should do about considering the unexpected losses?”

Does that not signify you would be discriminating against “The Risky” those who are already discriminated against because of expected losses, by making them also bear the largest regulatory burden for unexpected losses?

My New Year’s wish for FT. Wake up to what the risk-weighted capital requirements for banks really signify.

Sir, if banks could measure and price risks perfectly, then there would be no need for bank capital, as all expected losses and capital cost would be covered. But, since the measuring and pricing of risk is by nature imperfect, there will always be “unexpected losses”, and so regulators need to impose capital requirements for banks.

Unfortunately, the regulators decided that the “unexpected losses” would occur mainly in assets perceived as “risky”, probably because they confuse “unexpected” with ex-ante perceived risk, or because they only concerned themselves with individual banks; while I contend instead that the kind of “unexpected” which could threaten the stability of our whole banking system, is most likely to be found in the “absolutely safe” category.

And, requiring banks to reserve more for “unexpected losses” on “risky” than on “infallible” assets, allows banks to earn much higher risk-adjusted return on equity on the latter.

And, by allowing so, the regulators introduced a distortion that makes it impossible for banks to allocate credit efficiently in the real economy.

Tom Braithwaite ends his December 31 New Year’s “Reasons [for the banks] to be cheerful, despite the threat in the shadows” with “Even as regulators tighten the screws on the banks they seem unsure as to how much they want to police their shadow risks”.

If I could have a New Year’s wish about something that FT could do in 2014, then that would be to notice more how these regulations which discriminate based on ex ante perceived risks, really “tighten the screws” on the access to bank credit for all those ex ante perceived as riskier.

And, consequentially, to notice how that increases inequality, and hinders the banks from taking those risks that could help our young to have a future… those risks that generations before us took through the banks, so that we would all have a future. 

And all for nothing, because at the end of the day, what those regulations guarantees, is that our banks are going to end up gasping for oxygen, in some dangerously overpopulated “safe-havens”.

PS. Reducing the risk of bank failures increases, exponentially, the risk of banking system failure.

God make us daring!

Since risk-weighted capital requirements are still in place, nothing is really new on the dangerous bank regulatory front

Sir, Wolfgang Münchau quite remarkably writes “Don’t fret about asset prices – this time is different” December 29. For that he refers to “all the changes in global bank regulations”. What changes? The capital requirements for banks are still risk-weighted and so these still give banks huge incentives to dress up as absolutely safe what might not be.

And given that the banks have less capital after the crisis, and must therefore go to where capital is required the least, banks are most probably building up huge dangerous exposures to what is officially ex ante considered as “absolute safe”, like in Europe to the “infallible sovereigns”.

The Basel Committee has ordered the banks to report in January 2015 the leverage ratio, that which is based on not risk-weighted assets… and that could become a really scary report.

And frankly are we not to fret what could happen to asset prizes if a retreat of the quantitative easing is declared?

No more broken hearts in every port

Sir, at age sixteen and a week, I signed up for three months on a Swedish merchant ship, where I would wash dishes and scrape rust for the next four months (delayed by strikes and storms).

Luckily that happened just “before the containerization, when it took days to unload and days to load, and you were young”. That kind of seafaring was indeed quite different from that described by Horatio Clare in “A freight adventure” Life & Arts December 28… So different I must admit I would never have even thought about the idea of signing up on a container ship.

So different that one of Sweden’s most famous poets and troubadours, Ever Taube, who among other sang about “The girl in Havana”, might never have become inspired.

I feel sad for today’s sailors, and for current sixteen years old who lack the opportunity to really sail the seas and explore ports... perhaps leaving some broken hearts, or breaking one’s own heart a bit while doing so.

My Ms Bolivia

The future of current and future pensioners is being pickpocketed by distortive bank regulations.

Sir you discuss capping pension fees in “Plug the deficit on pension regulations” December 27.

In it you hold that “workers need to save more… but they also need to invest wisely”, that “Vigilant regulation is needed to make sure that unsuspecting savers do not end up being pickpocketed”, and that “Savers should be grateful if business ideas that depend on charging unreasonable high fees never see the light of day”.

And solomonically you end holding that “Regulators cannot ensure that every provider charges a fair price. But they should give consumers the means of looking after themselves.”

How good of you! But why do you not dare to care more about how the future of current and future pensioners, like that of so many young without job, is pickpocketed by distortive bank regulations? These certainly cause much more damage than some unreasonable high fees.

“Invest wisely?” In an economy in which the capital requirements for banks are based on perceived risks already previously cleared for? In an economy where banks are therefore investing on preferential leverage terms in what is perceived as “absolutely safe”? Where are then pension funds to go? To finance railroads in Argentina perhaps?

The Basel Committee, with its Basel II, was at least 90% responsible for AAA rated AIG´s collapse.

Sir, of course “Insurers may be at the centre of the next big crisis” as Patrick Jenkins writes, December 27.

But when Jenkins describes AIG´s collapse in terms of it becoming “diversified so fast that it became impossible to manage and regulate”, he does not explain with sufficient clarity what really happened.

AIG, by having an AAA rating, was granted by bank regulators the gift of by lending its name, being able to reduce immensely the capital requirements for the banks. And that was worth so much in the market, that the banks went crazy borrowing AIG´s name and AIG lending it out… and no credit rating agency was fast enough to pick that up.

Had not Basel II been approved, something else bad could have happened to AIG, but not what happened. And I just wonder why this insistence on shielding the regulators from the truth that they were (and are) the party most responsible for the crisis, because of how they distorted all bank resource allocation, with their stupid capital requirements based on some perceived risks which are already cleared for by other means.

The members of the Basel Committee should be made to parade down our avenues wearing dunce caps. If there is one single spot where total accountability must be absolutely required, that should be in those committees that take upon them to design global rules for all.

The thought of having the same failed bank regulators given some powers to also regulate the insurers, “now a crucial part of the so called shadow banking sector” is as scary as can be.

Ms Tett. Not having a clue, “conventional blissful ignorance”, should not be confused with having an idea, “conventional wisdom”.

Sir, Gillian Tett writes “Ideas must adjust to new ‘facts’ of finance”, December 27. But as I see it therein she refers to what mostly had nothing to do with ideas, and all to do with simply not knowing. What Tett calls “conventional wisdom” is nothing but “conventional blissful ignorance”.

For instance “Before 2008 [leverage] seemed irrelevant”. Well go to all the initial reports on the 2007-08 crisis, and you will only be able to read about reasonable leverages… and that is because markets, and reporters, had no idea, most still do not have, of how much leverage could hide behind the risk-weighting of assets. Most of those compliant with “stricter Basel III capital rules” are still today, in not risk-weighted terms, leveraged over 30 to 1.

Tett also writes “Before 2008, it was almost outlandish to suggest policy makers might deliberately shape the direction of finance with policy interventions”. Really? What if not an extreme policy intervention is capital requirements based on perceived risks? That, which allows banks to earn much risk adjusted returns on their equity on assets deemed ex ante as “absolutely safe” than on assets deemed as “risky”, is for instance what drove the banks into the arms of those AAA rated securities which detonated the crisis.

And surprisingly Tett also states “Before 2008, policy makers liked to think they could mop up after excesses, if necessary, rather than intervene in advance. No longer.” What? Is not all Quantitative Easing going on based on the basic assumption that they will be able to mop it up before it all overflows into inflation?

Happy pondering Ms Tett!

There are productive and there are destructive inequalities, and we must know which are which.

Sir I refer to John Gapper’s “In search of balance: Capitalism”, December 24.

I have no problems with most of the “productive” inequalities which result from courageously moving forward – when financing the “risky” future, when increasing the cake. But I do have problems with many of the “destructive” inequalities, which occur when just trampling in the water, when extracting the last ounce of juice from any past risk taking – when refinancing the “safer” past, when only wanting to distribute the cake.

In this respect, when Pope Francis says “I exhort you to a generous solidarity and a return of economics and finance to an ethical approach that favors human beings”, I most emphatically have to state that the current capital requirements for banks based on perceived risks, risks already cleared for elsewhere, is definitely not an ethical approach to economic and finance.

And since Gapper makes a reference to Branko Milanovic of the World Bank, the author of “The Haves and the Have-Nots”, I must also comment that it is truly surprising to see how few realize how these regulations, which favor the Haves and discriminate against the Have-Nots, constitute one of the foremost drivers of “destructive” inequalities.

And that the World Bank, the world’s premier development bank, and who should be the first to know that risk-taking is the oxygen of development, keeps quiet on this whole issue, just makes me very sad for the future generations.

FT, please try to reflect on where we in the Western World would have been, had those risk-weighted capital requirements introduced over the last three decades by the Basel Accord, always applied.

QE is a drug that has been applied by the Fed in an emergency without going through any FDA type testing procedures

Sir, Barry Eichengreen considers that “The Fed’s monetary tweak is a tempest in a teapot” December 20.

But, considering the fact that the monthly reduction of $10bn in QE gets so much more attention than the $75bn that the Fed will keep on injecting in the economy, in a quite distortive way, all on the long side of the market, all for the treasury and the housing sector, then perhaps a teapot being in a tempest, could be a more adequate simile.

Eichengreen also holds that “the central bank has signaled that it is not prepared to return to normal times until a normal economy has returned”. Sorry, then we might never get there. 

A normal economy will not return until regulators stop using risk weighted capital requirements for banks. Because these allow banks to earn much higher risk-adjusted returns on equity financing the infallible sovereigns and the AAAristocracy than when financing the “risky” medium and small businesses, entrepreneurs and start-up, they do the facto guarantee the market to be abnormal.

And Eichengreen ends by referring to Hippocrates… “It has at least done no harm” What? Is that not something yet to be seen?

Europe, you have been placed in a death spiral by dangerously mistaken risk-adverse bank regulations. Get out! Fast!

Sir, Mario Monti writes that in order for monetary discipline and structural reforms in the south of Europe to pay off Europe’s policy framework [should become] more growth friendly, "Europe’s north and south must reform together” December 20.

He is more right than he knows. Europe has been place in a death spiral by risk-weighted capital requirements for banks, and which is about as unfriendly to sturdy and sustainable economic growth there is.

Allowing banks to earn much higher risk-adjusted returns on equity when financing what is “safe” than when financing what is risky, only guarantees you will milk all there is to be milked out of your past economic development, and without replacing it with the future which can only be derived by abundant and hopefully astute risk-taking.

FT, Martin Wolf, be brave, dare pickup the lessons of the crisis’s keys lying there under the lamppost.

Martin Wolf in “We still need to learn the real lessons of the crisis” December 20, refers to the search for the keys under the lamppost, only because that is “where the light falls”.

I would hold that with respect to what is currently happening, or not happening, with the economy and the banking sector, the keys have been there under the lamppost, for quite some time. The fact though is that very few seem to be willing to pick these up… and that could be because it would shine light on the sad fact that our magnificent global bank regulators, the Basel Committee and the Financial Stability Board, are just clueless.

Those keys are the risk-weighted capital requirements for banks based on perceived risks; those which allow banks to earn much more risk adjusted return on equity, when lending to the “infallible sovereign” and the AAAristocracy, than when lending to the “risky” like medium and small businesses, entrepreneurs and start-ups.

Those capital requirements being much lower for what was perceived as “absolutely safe” also guaranteed, when shit hit the fan, as always happens, and something ex ante very safe ex post turns out to be very risky, that banks would stand their naked with no capital.

In January 2003, while an Executive Director at the World Bank, FT published a letter in which I wrote: “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors to be propagated at modern speeds”.

Of course if credit ratings are already being used to determine interest rates, size of exposures, duration and other terms, to re-clear for the same ratings in the capital, condemned banks to overdose on these.

And in November 2004 FT also published another one of my letters which stated “We wonder how many Basel propositions it will take before they start realizing the damage they are doing by favoring so much lending to the public sector”

And it is still happening, banks are searching for refuge in the arms of sovereigns all the while out the in the real economy those credit needs that could hold the jobs for our youth remain unsatisfied.

No, a world where banks are told not to finance the “risky” future but only refinance the “safer” pasts is in a death spiral. And on imprudent risk aversion I wrote on the FT’s Economists’ Forum blog in October 2009.

And so Martin Wolf, be brave, and pick the keys up! Let’s get rid of those dumb innovative bank regulations the Basel Accord brought us.

PS. Sir, I leave it to you to copy or not Martin Wolf with this. He has asked me not to send him any more comments related to the capital requirements for banks, as he understands it all… at least so he thinks.

“Little people”, do not listen to Chris Giles, if they finance you at a too high rate, try to keep your consumption low

Sir, Chris Giles writes “It is also deeply patronizing for those with reasonable comfortable incomes to fret that the little people are consuming too much for their good and for that of the wider economy”, “In economics consumption is for life not just for Christmas” December 19.

That might be easy for him to say, he who probably either pays off in cash his credit cards or has the benefit of a reasonable financing rate. If Mr. Giles simply looked at what the “little people” paid in finance costs for their financed consumption, he might think differently.

One of the problems is that much of what the “little people” could spend in consumption, for their good and for that of the wider economy”, goes to pay bonuses to bankers… would Chris Giles by any chance be a banker or a shareholder of a credit company?

You, not so old journalist of @FT, say something! Help take the economy out of the respirator and to send it to rehabilitation

Sir, Mr John Riding in “Negative rates will not help investment spending” December 18, comments on Larry Summers’ “thesis of secular stagnation”.

Riding writes: “It seems to me that the impediments to stronger investment spending in the US are not monetary in origin and forcing negative real or nominal interest rates would distort asset markets further without providing meaningful stimulus to the economy”.

And he is absolutely right. What is needed to promote stronger investment spending is to get rid of those senseless risk-weighted capital requirements which allow banks to earn much higher expected risk-adjusted returns on equity on “absolutely safe” exposures, than on “risky” exposures.

That stops banks from financing the “risky” future and to concentrate instead on refinancing the “safer” past… as if what is safe today was not quite often very risky yesterday.

Sir, again, though you have clearly shown you prefer to turn a blind eye to it, you must know for sure that, in order to become and remain strong, an economy requires a lot of risk-taking, as dumb risk aversion will only make it a weakling.

And while that risk-adverse bank regulation is in place, any type of outside assistance, be it fiscal stimulus or quantitative easing, will just put the economy in a respirator, instead of having it go to rehabilitation.

Any sign of growth you might see in the interim, is pure froth… or let´s say pure fat no muscles… in other words the economy turning dangerously obese.

How curious FT does not want that to be discussed. Might it be that most of its journalists are soon to be retirees and who all fit an ultraconservative investment profile?

I sure hope that at least some of FT's younger members find it in themselves to further the cause of astute risk-taking. For that they should just perhaps reflect on the fact that any investment adviser who provided them, at their ages, with the kind of advice the Basel Committee provide the banks, would soon be prohibited to give any financial advice… and would have any professional certification revoked.

France, risk weighted capital requirements for banks, guarantees you a weak and obese economy. Any growth... just froth

Sir, Lindsay Whipp and Claire Jones report “France business activity weakens” December 17.

This is to be expected. Risk weighted capital requirements for banks which allow these to earn much higher risk-adjusted returns on equity when lending to “infallible sovereigns” and the AAAristocracy, than when lending to the “risky” medium and small businesses, entrepreneurs and start-ups can only guarantee turning our western economies into weaklings.

Distorting the banks into refinancing the safe past and not financing the more risky future is no way to create a strong and healthy economy. Any sigh of growth you might see in the interim, is pure froth… or let´s say pure fat no muscles… in other words the economy turning dangerously obese.

Even though I am aware that FT does not want to report on this, for reasons of its own, I will be remembering you about it every time I see the need for it.

If banks do well but the real economy falls, we will all fall… at the end including the banks. It is as easy as that!

Sir, it is hard for me to get a grip on what John Authers really means with heavily regulated when writing “Banking is complex, and must be heavily regulated”, “Volcker rule is doing its job despite Kafkaesque turns” December 16.

I say this because one single line of regulations, “capital requirements must be 10% of all assets”, would in my opinion be a more comprehensive regulation than the ten thousands of lines that will be derived from Basel III, Dodd-Frank Act and the Volcker rules.

Also, again, as I observed at a 2003 workshop on Basel II at the World Bank, there is still not a word about the purpose of the banks.

If the real economy does well, we will survive any bank crisis. If banks do well but the real economy goes down the drain, we will all fall… at the end, including the banks. It is as easy as that!

And in that respect I can also guarantee that my single regulatory line will distort the allocation of bank credit to the real economy, a thousand times less than the other referenced regulatory concoctions.

PS. The latest version of Basel III, December 2017, in 158 pages still contains no other stated purpose, like e.g., that of allocating credit efficiently to the real economy.

More than a new normal, stagnation has been decreed, by risk adverse regulators, as the new structural standard.

Sir, Lawrence Summers writes “The risk of financial instability provides yet another reason why pre-empting structural stagnation is so profoundly important”, “Why stagnation might prove to be the new normal” December 16. 

And I do not know what to say to that. It was precisely well intended but horribly executed efforts to avoid financial instability which basically has decreed stagnation as the new standard.

When regulators risk-weighted capital requirements for banks, they allowed banks to earn much higher expected risk adjusted returns on assets perceived as “absolutely safe”, than on assets perceived as “risky”.

And that translates into bank credit, one of the most important drivers of growth, not going any longer go to finance the “risky” future, but only to refinance the “safer” past.

And how you can avoid stagnation with that kind of misplaced risk-aversion beats me.

Does Professor Summers really believe that the economies of West would have become what they are with that kind of bank regulations?

Any economy growth based solely on “easy money”, and not based on astute risk-taking, is doomed to solely become froth on the surface.

And all for nothing as the current financial instability has, as usual, been created by excessive bank exposures to what was officially perceived as “absolutely safe”, like AAA-rated bonds, real estate in Spain, loans to Greece etc.

More than market forces government intervention forces need to be tempered

Sir, Ian Buruma writes "If the new elites in the global economy want to stave off the storm of destructive hatred, they had better to come up with some ideas of their own on how to temper the market forces", "Global forces are uniting populists against the elites", December 14.

I do not presume forming part of any elite but yet I need to question that our current problems are derived from allowing too much market forces to reign. I suggest there is plenty of evidence which points in the opposite direction.

For instance, our banks are now subject to risk weighted capital requirements, which translates directly into allowing these to earn much higher risk adjusted returns on equity on assets deemed as “safe”, than on assets deemed as risky. It beats me to know what this has to do with markets.

And then we have the whole TARP and Quantitative Easing affairs, and which in all truth might point to an urgent need to temper the intervention by governments in the markets.

Listen graduates, “plastics” is long passé… now it is “bank regulations”

Sir reading Christopher Caldwell’s “The Volcker rule is a gift to banks and excludes the rest” December 14, it is easy to see whey instead of recommending “plastics” as a future to a graduate, any person with good intentions would now easily tell him “bank regulations”.

And if we already gasp at the 828 pages of the Dodd-Frank Act, we should not forget that this is without making one single reference to the Basel Committee for Banking Supervision, and to the Basel Accord to which the US is a signatory.

If this regulatory frenzy is not digging us deeper in the hole we’re in, I do not know what is.

When banks earn more on what is “safe”, than on what is “risky”, the real economy suffers.

Sir Philip Stephens correctly writes “Europe faces a bigger threat than German caution”, December 13, and he correctly identifies that threat as “risk aversion”.

But there is an enormous difference between the consequences of natural risk aversion, like that which “comes with relatively higher standards and ageing population” and the consequences of an institutionalized pathological risk aversion… like that reflected in the risk-weighted capital requirements for banks.

If a society structures it in such a way that banks are allowed to earn much much higher risk-adjusted returns on equity when lending to what is perceived as “absolutely safe”, than when lending to “the risky”, banks will not allocated credit efficiently, and the real economy will wither away.

And the saddest part of that stupid risk-aversion is that it will anyhow bring down the banks (and perhaps the sovereigns with it) as banks will as a result, dangerously overpopulate all “safe havens”.

And what about the “pension mugging” produced by low interest rates produced by monetary policy?

Sir you write that Britain must make sure that the conversion of lifetime saving into decent retirement incomes is performed with total honesty, “Act now to prevent pension mugging” December 13.

But the number one factor which determines the amount of the annuity, at the moment of conversion, is the interest rate that insurance companies can earn long term on the “lifetime savings” received. And so now, when monetary policy is officially manipulated, so as for interest rates to be artificially low, especially the long side, the question is who is going to be responsible to the retired for the low annuities they receive?

How would you to explain to a retiree who converts into an annuity today if his neighbor, converting the same amount at a future time, receives a much higher annuity?

ECB, hard-cheese, first you need to test the credibility of the bank regulators

Sir, I refer to Sam Fleming´s and Alex Barker´s “ECB: Credibility test” December 12.

You must be perfectly aware that absolutely all bank crises in history, including the current one, have resulted from excessive lending to something that was ex ante perceived as absolutely safe, but that ex post turned out to be very risky. And no major crisis ever, has resulted from excessive bank exposures to assets that which ex ante considered risky.

And so therefore, allowing the banks to have extraordinarily little capital when exposed to something “absolutely safe”, can only guarantee that when shit hits the fan, all banks will stand there naked, with no capital to cover themselves up with.

And, to top up that mistake, that also allows banks to earn much higher risk adjusted returns on their equity when exposed to “The Infallible” than when exposed to “The Risky”, and which of course creates the distortion that makes it impossible for banks to fulfill their societal role, of allocating bank credit as efficiently as possible.

And so if there is a real credibility test that needs to be carried out first, that is the one of the bank regulators themselves since, honestly, I do not think they know what they are doing, and I consider them being about the largest producers of systemic risks in the financial system.

And with respect to the test of the banks… even more important than what´s on their books, would be to understand all the loans to medium and small businesses, entrepreneurs and start-ups that are NOT on their books, as a direct result of the capital requirements, because that is what can lead to the failure of the whole real economy… and when that failure happens, not even the safest bank stands a chance to survive.

ECB, I know it is hard for you to test your boss, Mario Draghi, the former chairman of the Financial Stability Board, but, what can I say, other than hard-cheese.

Paul Volcker and John Reed, our jobless young, more than a safer, need a more functional financial system

I cannot fully agree with Paul Volcker and John Reed about having a 6% cross the board capital requirement “standard alongside a robust system of risk weights” unless there is more clarity about what risk are to be weighted, “A safer financial system is now within our grasp”, December 12.

I say this because the problem with the current risk weighting used is that it weighs that risk of the assets which is already weighted, by means of interest rates, size of exposure, duration and other terms. And so, re-clearing for the same risk in the capital, causes banks to earn much higher risk adjusted returns on equity for assets perceived as “absolutely safe” than for assets perceived as “risky”; and this makes it therefore impossible for banks to allocate bank credit efficiently in the real economy. 

At this moment, when a generation of young people without jobs risk becoming a lost generation, the limited objective of a safer financial system needs urgently to be superseded by the much more comprehensive objective of banks becoming more functional.

Sir FT Bank regulations were not lax at all. They were, and still are, extremely dangerous.

Sir in your “A weak hand on casino banking”, December 11, you write “Lax regulation did little to discourage rash behavior”

No! You are wrong Sir. Allowing banks to leverage 60 times or more their equity with assets only because these are perceived as absolutely safe, has nothing to do with lax regulations, and all to do with dangerous regulations that encouraged rash behavior.

With the laxest regulation of them all, meaning no regulation at all, some other crisis might have happened but not the current one, a really free market would never ever have permitted such leverages.

And since you make a reference to casino banking, let me remind you that it was the regulators who, with their risk-weighted capital requirements, altered all the pay-out ratios on the different casino bets, and thereby created the distortions in the allocation of bank credit to the real economy that led to the current chaos.

And where do you get to know that “the financial system is now safer that it was four years ago”? Do you mean you think so because it is holding more infallible sovereign assets against less capital?

Mr. Kay. It is necessary to place bets that risk bankruptcy so as to have a chance to avoid bankruptcy.

Sir I refer to John Kay’s “Is it better to play it safe or to place bets that risk bankruptcy?” December 11.

In it Kay asks “Did mothers warn their daughters that marriage to brave hunters might end in widowhood, or urge them to seek husbands who would enable them to breed well-fed grandchildren?” That would in any case all be a matter of individual decisions. But, if there was a council of mothers which decided they had all to be extraordinarily nice to the sons in laws who stayed safely home and pester badly those who dared go hunting that society would definitely not prosper.

As cannot prosper an economy or a society where banks are given the incentive by their regulators to obtain much much higher risk adjusted returns on equity on assets perceived as “absolutely safe” than on assets perceived as “risky”.

And so the answer to Kay’s title question is that it is necessary to place bets that risk bankruptcy so as to have a chance to avoid bankruptcy.

How can the west have faith in its own future when its banks are hindered to finance it?

Sir, Gideon Rachman writes “The west is losing faith in its own future” December 10.

Absolutely, but how could the west not? Capital requirements for banks that are much much lower for assets perceived as absolutely safe, than on assets perceived as risky, allow banks to earn much higher risk-adjusted returns on what is “safe” than on what is “risky” and that stops banks from financing the future and makes these concentrate on refinancing, while its worth something, the safer past.

Rest assured, with its current castrated banking system, the west would never ever have become what it became.

Does FT´s capital markets editor really believe that in free markets banks could leverage equity 50 times or more?

Sir, I refer to Ralph Atkins´ review of Costas Lapavitsas´ “Profiting without producing”, “A Marxist take on economic meltdown” December 9.

In it Atkins writes “The resulting financial turmoil and global economic slump cast doubt on the ability of free markets to provide sustainable growth and employment in advanced economies”. I truly marvel at how one can call the current financial turmoil a result of “free markets” when for instance there can be no doubt that in really free markets banks could never ever have leveraged their equity 50 times or more. That was only made possible by extremely intrusive bank regulations that were based on such nonsense as risk-weighted capital requirements for banks.

It also argues that “financialisation”, which can indeed be corrosive, “has forced the retreat of labor and exacerbated income equality”. But again that is not the consequence of free markets but of regulations that so much favor the access to bank credit of “The Infallible” over that of “The Risky”.

Atkins correctly holds that “when it works, finance discipline governments and companies” but then he blithely ignores the fact that for instance, with Basel II, banks were authorized to lend to “infallible governments holding no capital at all. What a disciplining!

And as to "a Marxists take on economic meltdown", that is precisely what I would first ask the author… what is not Marxist about requiring the banks to hold substantial capital when lending to the private citizen and zero capital when lending to a central government?