Saturday, August 31, 2013

Community bankers in order to defend themselves should start by defending their more typical borrowers.

There is no reason on earth why banks should need to hold larger capital requirements when lending to those perceived as “risky”, namely the medium and small businesses, the entrepreneurs and the start-ups, that when lending to “The Infallible”, the AAAristocracy. That only discriminates against the borrowers more typical of the community banks… which besides have never ever caused a major bank crisis. Only the false “absolutely safes” have.

Community bankers need to realize that no matter how much they might like low capital requirements, in the long run these, when based on risk perceptions, will always favor the larger banks, which have more readily access to the “absolutely safe”, or can more readily access the tools needed to construe “absolutely safe” images.

January 2015, the generous bank regulators, are going to get clobbered. And no risk-weights mumbo jumbo will save them.

In January 1, 2015, according to the Basel Committee, banks are to disclose their leverage ratio, not based on risk-weighted assets, but simply on total assets, and as of course, the banks should have done all the time.

And at that moment bank regulators who have been the most generous to their banks are going to get clobbered, and no risk-weighting mumbo jumbo is going to save them.

Thursday, August 29, 2013

The condensed dark truth about the risk weighting in current Basel bank regulations

Before the current risk-weighted capital requirements for banks, the risk adjusted returns on bank equity were basically the same for all loans, and the ex ante perceived risk was cleared for in interest rates, amount of exposure, duration and other contractual terms.

But with the introduction of risk weighted capital requirements for banks, which re-cleared for the same ex ante perceived risk, in the way of less-risk much-less-capital, more-risk more-capital, the expected risk adjusted returns on bank equity are now much much higher when lending to “The Infallible” than when lending to “The Risky”.

And that results in that banks will lend, even more than usual, at even lower rates than usual, to sovereigns, housing and the AAAristocracy; and even less than usual, at even higher rates than usual, to medium and small businesses, the entrepreneurs and start-ups.

Of course there is an initial economic high when all that fresh bank credit flows to “The Infallible”, I call it economic froth, but, after that, the real economy will been going down, down, down, because, if “The Risky”, namely the medium and small businesses, the entrepreneurs and the start-ups, do not get access to credit in competitive terms, then there is nowhere else the real economy can head.

Young! Fight for your right that the society, through its banks, takes the risks you need for your future

Today I refer to the global tragedy of rising youth unemployment. I contend that to a large extent it is caused by the appalling banking regulations of the Basel Committee.

These regulations require banks to hold much more capital (equity) for assets considered "risky" than for those that are perceived as "absolutely safe". And that, no matter what you might think, makes no sense.

As a result the banks obtain much higher risk-adjusted returns on their assets, when lending to “the infallible” than when lending to "the risky”. Something which simply means favoring those already favored by the market, and discriminating those already discriminated by the market. And the consequences are dire.

That alone ensures that when one of those ex ante "infallible" is, sooner or later, ex post, found out to be risky, the bank will stand there naked, with little or no equity to cover up for huge exposures.

And worse, it shatters the chances of banks efficiently allocating credit resources in the real economy... which as you understand means low job creation.

In Washington, in October, there will be a "Youth Summit". In a world where there are so many old people much more concerned about their own welfare, than with the prospects of the young, the summit may not receive sufficient attention .

The summit invites people between 18 and 35 years to submit proposals on development cases, highlighting the challenges faced in real life development organizations. One of these is titled "A better financial product for micro entrepreneurs, young people and small businesses."

And since as "old" I cannot compete, I here try to squeeze by a proposal:

Bank Regulators: Eliminate capital requirements based on perceived risk. With these you only encourage banks to lend more and in better terms to the "absolutely safe". Accept the fact that risk-taking is the oxygen of all development.

Apart from it all your risk aversion is useless. All the major problems with banks, past, current and future, will always result from what you regulators, and the bankers, considered as “absolutely safe”; like sovereign, real estate and AAA credit ratings holders. We have never ever experienced a banking crisis that has resulted from excessive loan exposures to “the risky”, micro-entrepreneurs and small businesses.

And, regulators, if you absolutely must distort the market, in order to justify your salaries, or feed your egos, then at least let the banks hold less capital only in accordance to ratings which indicates the potential of generating employment for the youth, or the sustainability of the environment.

At least banking would in that case be fulfilling a social purpose much more important than being the financier of the AAAristocracy.

“The risky" have the right to bank credit on competitive terms, and that without being relegated to use specialized microfinance entities.

The banks cannot afford not to take the risk on “the risky". On that depends, the creation of the future jobs of our youth, the "infallible" of tomorrow, and even the existence of truly safe banks.

Note: The summit is organized by the Junior Professional Associates at the World Bank (JPA), the United Nations Foundation, Athgo a NGO in Los Angeles, and YEN , a network created by the World Bank , the United Nations and the International Organization Labour Office (ILO ).

PS. In fact there is no way that when the young finally understand the hurt that is being done to them, that they will not revolt… and then perhaps suggest to us older the reinstatement of an “Ättestupa


Tuesday, August 27, 2013

The problem with peer reviews is quite often the peers.

Peer review is the evaluation of work by one or more people of similar competence to the producers of the work (peers). It constitutes a form of self-regulation by qualified members of a profession within the relevant field. 

“The Dodd-Frank Wall Street Reform and Consumer Protection Act addressed the systemic risk oversight gap in the US regulatory framework by creating the Financial Stability Oversight Council (FSOC)… The peer review found that good progress has been made to date by the FSOC to establish systemic oversight arrangements and made some recommendations to further enhance its effectiveness. These involve:... providing a more in-depth and holistic analysis of systemic risks to financial stability;”... and; 

“The architecture for insurance supervision in the US, characterised by the multiplicity of state regulators, the absence of federal regulatory powers to promote greater regulatory uniformity and the limited rights to pre-empt state law, constrains the ability of the US to ensure regulatory uniformity in the insurance sector. Given the drawbacks of the current regulatory set-up, the US authorities should consider whether migration towards a more federal and streamlined structure may be a more effective means of achieving greater regulatory uniformity.”

My problem is that these regulators, and their peers, cannot get it into their heads to understand that the origin of the most dangerous systemic risks to the system might precisely be themselves and their uniform regulations.

For example, in the case of the Basel Committee's bank regulations: 

What a regulator could absolutely not do, if he knew what he was doing, was what they did in Basel II and are doing in Basel III, which is allowing for much lower capital requirements for assets perceived as “absolutely not risky”. In other words the regulators are 180° wrong. In other words they are making sure that the bank crises, whenever these occur, as a result of something ex ante considered to be “absolutely safe” turning out to be risky ex post, will be bigger than ever. 

Frankly are these peers willing to hold that their colleagues have been and still are 180° wrong? I don’t think so!

Saturday, August 24, 2013

Basel's "Leverage Ratio" expressed as Debt to Equity Ratios (D/E)

Below what leverage ratios (LR) of x percent, in Basel terminology, approximately mean, in terms of normal traditional debt to equity (D/E) ratios, those usually applied to all other economic organizations.

LR of 2 percent = D/E of 49/1
LR of 3 percent = D/E of 32/1
LR of 4 percent = D/E of 24/1
LR of 5 percent = D/E of 19/1
LR of 6 percent = D/E of 16/1
LR of 7 percent = D/E of 13/1
LR of 8 percent = D/E of 11/1
LR of 9 percent = D/E of 10/1
LR of 10 percent = D/E of 9/1

My recommendation: Throw away all risk-weighting and adopt a leverage ratio of from 6 to 9 percent, which should fluctuate in an economic counter-cyclical way.

Saturday, August 17, 2013

Poor Pakistan! Another developing country being held back by the Basel Committee

I read that “In order to further strengthen the capital related rules the State Bank of Pakistan (SBP) has decided to implement the Basel III reforms issued by the Basel Committee on Banking Supervision”

It is impossible for me to understand how a developing nation can adopt a bank regulatory framework which has, as its prime pillar, capital requirements which favor bank lending to The Infallible those already favored from being perceived as absolutely safe, and discriminate against The Risky, those already being discriminated against because they are perceived as risky.

If a developed and rich country, like France, wants to call it quits and not risk anything more, and accepts Basel II or III, and decide to castrate their banks, although that will not serve their real economy well, or save them from bank crises, that is their business… but, Pakistan?

In 2007 at the High-level Dialogue on Financing for Developing at the United Nations, I presented a document in titled “Are bank regulations coming from Basel good for development?" Unfortunately it received no attention, as the discussions which followed there were basically only focused on promoting, not development, but political agendas.

And little has changed since those meetings. For instance, even Professor Joseph Stiglitz, who chaired the Commission of Experts of the President of the United Nations General Assembly on Reforms of the International Monetary and Financial System, and who recently published a thick book titled "The Price of Inequality: How Today’s Divided Society Endangers Our Future" has still not understood how the risk-weighting of the capital requirements odiously favors bank lending to “The Infallible”, the haves, the old, the past, the AAAristocracy, those already favored by banks and markets, and thereby discriminates against “The Risky”, the not haves, the young, the future, those already discriminated against by banks and markets.

Developing nations, you need all your banks to exercise reasoned audacity and not to just follow the risk aversion instructions given by some overly anxious and nervous nannies, who have not even defined the purpose of the banks they regulate.

Friday, August 16, 2013

My comments to the Basel Committee on their paper titled “The Regulatory framework: balancing risk sensitivity, simplicity and comparability”

Members of the Basel Committee for Banking Supervision

In July 2013 you issued, for comments before October 11, 2014, a discussion paper titled “The Regulatory framework: balancing risk sensitivity, simplicity and comparability

In reference to it let me declare that I totally reject, and protest, your whole perceived risk based capital requirement framework. It is based on the absolutely false premise that the perceived risks are not cleared for by banks in terms of interest rates, size of exposure and other contract terms.

Your perceived risk based framework, which re-clears for the same perceived risks in the capital (equity), only guarantees that banks will overdose on perceived risk, and makes it completely impossible for banks to help the society in allocating effectively bank credit in the real economy.

Your perceived risk based framework has also been the prime cause for the current crisis, as it, by allowing banks to make higher expected risk-adjusted returns on exposures to what is perceived as absolutely safe than on exposures to what is perceived as risky, has driven the banks to create excessive exposures to what is perceived as absolutely safe, which is precisely the kind of exposures that have caused all major bank crises in history, when the ex-ante perceptions, turn out ex-post to be wrong; in this case much aggravated by the fact that the capital of the banks will also be extremely small when such unfortunate thing occurs.

Your perceived risk framework has also, in my words, castrated the banks and introduced a risk-adverseness that is making of the developed countries, submerging countries.

As a private citizen I do not have the time or the resources to repeat all my arguments over and over again and so I refer you to my blog:

And in which, for a starter, you might find especially illustrating the following post

And to follow up, you might want to read what was recently published in the Journal of Risk North Asia, Volume V, Issue II, Summer 2013

And please, before you regulate our banks one iota more, tell us what you think the purpose of our banks should be, to see if we agree.

Respectfully yours, sort of.

Per Kurowski
A former Executive of the World Bank (2002-2004)

PS. If I sound a bit disrespectful, forgive me, but I have been trying, for more than a decade now, to make you see the light. I do not ever shout in capital letters on the blogs, I am a grandfather, with a serious cv., but there has to be a way by which an ordinary citizen can get some answer, even from a Basel Committee.

PS. If I feel I have to add to these comments I will do it here…the link to this post.

Thursday, August 15, 2013

The “convenient myth” which supports current bank regulations, needs to be debunked

Many bank executives and some regulators hold that not using risk-weights when calculating capital requirements for banks can tempt banks to move towards riskier loans that earn higher returns but are more likely to result in losses.

That is complete baloney and this so convenient for some banks myth needs to be urgently debunked.

As a start we just need to understand that any “perceived risk” can be cleared for by bankers by the interest rate they apply, the size of the exposure and other contracting terms. 

And so the truth is that lower capital requirements, permitted for something perceived as “absolutely safe”, and which allows the banks to achieve a higher expected risk-adjusted return on equity on those assets, will only help to push the banks to create excessive exposures, while holding very little capital, to precisely that type of exposures which have caused all the bank crises in history, namely assets which were ex-ante perceived as safe but that ex-post turned out to be risk. And, if in doubt, just try to find one single major bank crisis that has resulted from excessive exposures to what was ex-ante, not ex-post, perceived as risky.

The different capital requirements based on perceived risk which so much favors the access to bank credit of The Infallible and thereby discriminates against The Risky, also completely distorts the allocation of bank credit in the real economy. 

What would for instance a regulator, in the US or in Europe, answer if asked: Sir, why are the capital requirements for our banks lower when they lend to a foreign sovereign, than when they lend to our national small business and entrepreneurs, those who have never ever set off a major bank crisis?

European citizens should question why their real economy has to go down, down, down

Banks all over Europe are allowed to hold much less capital when lending to a European sovereign, or to one of the world’s AAAristocracy, than when lending to medium and small businesses in their own nation.

Which means that banks all over Europe make much more expected risk-adjusted returns on their equity when lending to a European sovereign, or to one of the world’s AAAristocracy, than when lending to medium and small businesses in their own nation.

Which means of course that banks all over Europe love lending to a European sovereign, or to one of the world’s AAAristocracy, and dislike lending to medium and small businesses in their own nation.

And which means of course that the real economy in Europe, is going down, down, down,

And which means that citizens in Spain should ask their bank regulators:

Why need Spanish banks hold much more capital when lending to Spanish small businesses than when lending to France?

And while they’re at it…Why should Spaniards trust more the French government than a French small business? 

And all European citizens of all other European countries should ask their bank regulators similar questions

Sunday, August 11, 2013

Poor rich Oprah Winfrey should get herself a buyer-power-rating, issued by one of few big agencies.

Sir, I refer to James Shotter´s “Swiss image suffers after asylum row and Winfrey furore” August 10.

Poor rich Oprah Winfrey considers herself discriminated against because of how a certainly much poorer sales assistant in an upmarket Zürich boutique, dared to express the opinion that a ludicrous expensive handbag was too expensive, instead of perhaps increasing its price 50 percent as any much more able vendor would have done.

Frankly, this whole affair is so incredibly petty when I compare it to that other official discrimination which also originates in Switzerland, through the Basel Committee. That one establishes that even though “The Infallible” borrowers are already much favored in the markets, and “The Risky” much disfavored, that banks are allowed to hold much less capital when lending to the former, and thereby earn a much higher expected risk-adjusted return on its equity, than when lending to the latter.

I guess that if these bank regulators were asked, they would suggest that Oprah Winfrey equips herself with an AAA buyer power rating, issued by one of few formidable buyer-power-rating agencies.

Of course, the instinct of any normal ludicrous expensive handbags store owner, upon seeing an AAA buying-power-rating, would be to increase the listed price of the handbag, but I am sure that our Basel Committee regulators could also come up with a way of favoring these ultra rich buyers, and thereby discriminate against those who, immensely poorer, just want to feel like an Oprah Winter holding that completely unaffordable handbag in their hands for some seconds.

It is truly amazing how much we can hear about any discrimination based on color or other factor, when compared how little the officially sanctioned discrimination based on perceived risks are not even debated. Could it be because we are ashamed of having to admit to ourselves that we have changed from being risk-taking into risk-adverse nations? 

In the name of my constituency, my granddaughter, I protest though: “Damn you BaselCommittee… for having castrated our banks

The correct blog for this post is here

Thursday, August 8, 2013

Four things the next Fed chair should absolutely know, and that the candidates most probably don’t know, yet.

The Fact: Current capital requirements for banks are much much lower for exposures to the “infallible sovereigns” and the AAAristocracy, than for exposures to small and medium businesses, entrepreneurs and start-ups.

The next Fed chair, whoever it is, should know that such different capital requirements for banks, based on perceived risks already cleared for by other means, produce different expected risk-adjusted returns on bank equity, and therefore completely distorts the process of allocating bank credit in the real economy, making it unreal.

The next Fed chair, whoever it is, should know that a financial transmission mechanism, when distorted as described above, stands no chance of producing a sturdy economic growth or generate sustainable employment. And, as a result, any quantitative easing becomes just a big waste.

The next Fed chair, whoever it is, should know that lower capital requirements for banks for what is perceived as “absolutely safe” than for what is perceived as “risky”, do not make any sense from a bank safety point of view. This is so because only exposures of the first kind can grow large enough to take the system down. And also because, when something ex-ante perceived as absolutely safe, ex-post turns out to be risky, as will happen sooner or later, then regulators will find the bank there with little or no capital at all.

The next Fed chair, whoever it is, should know that since banks need to hold much less capital when lending to the “infallible sovereign” than when lending to “risky” citizens, this translates into a subsidy of government borrowings, which means that current Treasury rates are not comparable to historical rates. In other words, the usual proxy for the risk-free rate is subsidized and distorted.

Wednesday, August 7, 2013

Imagine what much good some more “daring” bank regulations could do for the real economy.

Currently capital requirements for banks are much lower for exposures to what is perceived as “absolutely safe” than for what is perceived as “risky”. It may sound logical, but it is not.

That only helps banks to earn, for no good reason, much higher risk-adjusted returns on equity when lending to what is perceived as absolutely safe, than when lending to what is perceived as risky. And that only guarantees that when something ex ante perceived as absolutely safe, ex-post turns out to be absolutely risky, that banks will stand there holding humongous failed exposures against little or no capital.

Imagine instead if the capital requirements for banks were slightly lower for what is perceived as risky than for what is perceived as absolutely safe.

That would give the banks and all their extraordinary smart number crunchers the incentives to actively go out and look for opportunities in lending to the small and medium businesses, the entrepreneurs, the start-ups. Can you imagine what that could do to the dynamism of our real economy and the creation of jobs?

Yes I hear you “But would that not increase the risk for the banking system?” No! on two counts.

First, let us not forget we are talking here about exposures to what is perceived as “risky”, meaning Mark Twain’s banker unwillingly lending out the umbrella when it rains, and not about the truly potentially dangerous exposures to what is perceived as absolutely safe, meaning Mark Twain’s banker eagerly lending out the umbrella when the sun shines.

Second, let us not forget that there is nothing better to keep a banking system safe, than a healthy and sturdy real economy, and that no banks could survive, no matter how safe, if the real economy really comes tumbling down.

Friends, do not our young unemployed youngsters deserve some more daring bank regulations?

I sure think so.