May 26, 2016

Regulators have been coopted by banks of “East”, forgetting the needs of those that banks of the “West” best serve.

Sir, Martin Wolf opines, “In the real world, central banks must remain our doctors of choice”, “The risks of central banks’ radical treatments”, May 26.

In it Wolf quotes Mario Draghi, president of the ECB, with: low interest rates “are not the problem. They are the symptom of an underlying problem, which is insufficient investment demand, across the world, to absorb all the savings available in the economy.”

But Draghi, the former chair of the Financial Stability Board, is the current chair of the Group of Governors and Heads of Supervision of the Basel Committee for Banking Supervision, and so he is more than a central banker, he is a bank regulator too… and as such he is definitely not my doctor of choice.

With Basel regulations banks have de-facto been told: “If you stay away from lending to the risky (like SMEs and entrepreneurs) then we will reward you with lower capital requirements for what is perceived, decreed or concocted as safe; which means that then you will be able to leverage your equity the most with assets of the “safe” type; which means that then you will earn the highest risk adjusted returns on your equity when doing business with sovereigns and the AAArisktocracy, and financing residential housing.” Does that not sound like a banker’s wet dream come true”

And to put that regulatory favoring of the safe into context, let me quote one who Wolf would not classify as a rightwing populist, John Kenneth Galbraith. In his book “Money: “whence it came, where it went” (1975), Galbraith writes:

“For the new parts of the country [USA’s West]… there was the right to create banks at will and therewith the notes and deposits that resulted from their loans…[if] the bank failed…someone was left holding the worthless notes… but some borrowers from this bank were now in business...[jobs created] 

It was an arrangement which reputable bankers and merchants in the East viewed with extreme distaste… Men of economic wisdom, then as later expressing the views of the reputable business community, spoke of the anarchy of unstable banking… The men of wisdom missed the point. The anarchy served the frontier far better than a more orderly system that kept a tight hand on credit would have done…. what is called sound economics is very often what mirrors the needs of the respectfully affluent.

The function of credit in a simple society is, in fact, remarkably egalitarian. It allows the man with energy and no money to participate in the economy more or less on a par with the man who has capital of his own. And the more casual the conditions under which credit is granted and hence the more impecunious those accommodated, the more egalitarian credit is… Bad banks, unlike good, loaned to the poor risk, which is another name for the poor man.”

And so, to me, that clearly implies that the regulators of the Basel Committee are regulating in favor of, or under instructions from, the banks of “East” and the sovereigns, the respectfully affluent they meet in Davos; while completely ignoring the risk-taking needs of the new economy of the “West”, and for which any additional bias against perceived credit risk, condemns it to even more misery and doom.

In the West live the unemployed, the younger generations, the developing economies and all those clamoring for an opportunity to have a go at their dreams. 

The prime purpose of banks is to channelize efficiently excessive savings to the economy and, if you cut off the options, just because you do not like banks to take risks, those excessive savings must find other outlets or do nothing… all with expected unexpected consequences.

To top it up, regulators did not do their basic homework. Had they done so they would have understood that for the bank systems in general, what is perceived ex ante as risky, poses no danger at all. All big bank crises always result from excessive exposures to something wrongly perceived ex ante as safe.

PS. The following risk weights, for the purpose of determining the capital requirements for banks, evidence clearly he dangerous ideology and ignorance of the member of the Basel Committee.

Sovereigns 0% Citizens 100% can only be risk weights thought up by convinced raving mad statists. 
AAA rated 20% Below BB- rated 150% can only be risk weights thought up by those who have no idea of life on Main Street.

Per Kurowski

@PerKurowski ©