Thursday, October 1, 2009

Free us from imprudent risk-aversion

There is no reason to believe the world would be better if financial regulators provided extra incentives to those who, perceived as having a lower default risk, are already favoured by lower interest rates, or punish further those who, perceived as more risky, are already punished by higher interest rates. In fact, the opposite is probably true.

According to the bank regulations of the Basel Committee, the global standard-setters for much of the world, if a bank lends to an unrated corporation then it must hold 8 per cent in equity, but when lending to an AAA rated client only 1.6 per cent will suffice. Given the high cost of bank equity, the difference between 8 and 1.6 per cent, a 400 per cent increase, entails substantial costs that increase the premiums on risk and confuse the market’s risk allocation mechanisms. The capital requirements for lending to governments, however, and I hope you are seated, is quite often zero per cent.

The debate over the current financial crisis ignores what really hit us. We still hear the most influential experts, Nobel Prize winners included, repeat the mantra of “excessive risk-taking”. How can they be blind? This crisis did not arise as a result of financing “risky projects”, but from financing the safest of assets, houses and mortgages, in the supposedly safest of countries, the US, and using instruments rated AAA, which are supposed to carry no risk.

This crisis resulted from some misguided and imprudent risk-aversion policies put in place by regulators employing capital requirements for banks based on risk and the empowerment of the credit rating agencies, which, with their rating signals, caused herds of capital to stampede over a subprime precipice.

If we do not want to understand and accept this, how are we supposed to move out of this crisis and into a better future, something which, as history has proved, always requires prudent and sometimes even a dose of imprudent risk-taking?

I have been writing about this issue for a long time, to little or no avail, as the financial regulatory system is founded upon an almost unbreakable paradigm created by regulators who are not interested in the larger scheme of things. Instead, they concentrate furiously on trying to live out their fantasies of a world without any bank failure — as if a world without bank failures has anything to do with a better world. Actually, the more frequent bank failures are, the smaller the risk of a systemic crisis like the current one.

If you need evidence for the above, read the 347 pages of the bank regulations known as Basel II. You will not find a single phrase that has anything to do with establishing the purpose for our banks. Regulators, when regulating, should you not start by doing just that?

In January 2003 the Financial Times 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 error to be propagated at modern speeds.” The most important part to understand, and the hardest one to accept, is that the systemic errors for the world at large would occur even if the credit rating agencies had got their ratings absolutely right.

Between 2002 and 2004, as an executive director at the World Bank, I did what I could to remind the development bank that risk is the oxygen of all development, but I was never really heard. The World Bank, forced to harmonise with Mr. Stability, the IMF, had been effectively silenced.

Today, when there are renewed puritan screams against “risks” I hope that the World Bank finally comes to grips with its role and turns into a champion of prudent risk-taking. The world needs it. Just as an intellectual exercise, think how much better off our children and grandchildren could be, had the trillions that were wasted on a useless housing boom in the US been lost instead financing projects which adapt for and mitigate climate change?

Dear baby-boomers, there is a world that needs a whole lot of risk-taking in order to stand a chance of a better future — a world which does not want to lay down and die in tranquillity just yet.

Friday, September 25, 2009

Two comments on the G20 draft

1st comment:. On financial sector compensation, the draft said the G20 fully endorsed the standards of the Financial Stability Board "aimed at aligning compensation with long-term value creation, not excessive risk taking."

And do not the poor and the developing world, where most of the “perceived risks” tend to live, also have an equal right to ask for “long-term value creation”, not excessive risk-aversion, as that which is present in the current Basel capital requirements for banks?

2nd comment: The G20 draft said it supported the introduction of a leverage ratio as an additional measure to the Basel II capital framework and that all major G20 capital centers committed to adopt that framework by 2011.

The introduction of a leverage ratio as an additional measure does not, on the margin, diminish any of the arbitrary risk averseness introduced by Basel II and that creates additional costs for the financing of all perceived as risky, and that are layered on top of the risk spreads already charged by the markets on perceived risks.

This amounts to an outright discrimination of development and an outright indirect subsidy to what has already been developed. This is simply shameful!

Friday, September 18, 2009

The 800 pound gorilla not seen in development finance

The current regulatory system of the banks agreed upon in Basel by some developed nations and applied in all of the developed world and much of the rest, orders the bank to have 8 percent in capital when lending to an ordinary client with no credit rating but only 1.6 percent when lending to an AAA rated client. 8 percent is 400 percent more than 1.6 percent.

The above amounts to an immense discrimination that pushes up the volume of funds available and down the cost when financing the “lower-risk” part of the world; and pushes down the funds available and up the cost when financing the “higher-risk” part of the world.

The rich and developed, where are they most likely to be perceived to live, in the “higher-risk” or in the “lower-risk” part of the world?

The poor and developing, where are they most likely to be perceived to live, in the “higher-risk” or in the “lower-risk” part of the world?

That is why when the rich and developed offer the poor and developing world the possibilities of a non-distorting and transparent Tobin tax of 0.005 percent on financial transactions they should answer “Thank you very much, but we much prefer you eliminate the distorting and opaque Basel tax on risk instead”

And this is no minor issue. Just in 2004 to 2008, about three trillions of dollars, more than the World bank has lent or given out in grants in total since it was created; thanks to the bias in favor of perceived low risk in the capital requirements for banks, and thanks to the AAA signs set up by the credit rating agencies, were channeled to finance what, when compared with the real needs in the world (even of the rich and developed), can only be classified as a quite useless house-value boom.

The world to move forward needs risk-taking. We cannot afford to have the future of the world to be placed in the hands of a neurotic generation of baby-boomers, who wish to create a lien on the whole world, through a reverse mortgage, so as to lie down and die in tranquility while murmuring their “Après nous le deluge”

Please stop worrying so much about bank defaults and more about the default of the world.

Saturday, August 22, 2009

Recurrent questions to my friends in the financial sector of the World Bank

When are you going to stop worrying so much about the development of the financial sector and start worrying more about the role of the financial sector in the development of the other sectors of the economy?

For how long are you going to accept those minimum capital requirement for banks based on risks of default as perceived by credit rating agencies and try to suggest some capital weights based on the purpose of the lending?

For how long are you going to accept harmonizing with the IMF frantically focusing on avoiding any bank crisis instead of focusing on getting the most development out of the whole growth and bust cycle? Are we not a "take-risks" development bank while they are a "goodnight, sleep-tight" institution?

These are no new questions. Just as an example, in March 2003, as an Executive Director of the World Bank, I said the following when discussing the “Financial Sector Assessment Program: Review, Lessons, and Issues Going Forward

“The financial sector’s role, the reason why it is granted a license to operate, is to assist society in promoting economic growth by stimulating savings, efficiently allocating financial resources satisfying credit needs and creating opportunities for wealth distribution. Similarly, the role of the assessor –in this case, WB– is to fight poverty, and development is a task where risks need to be taken.

From this perspective we have the impression that the Financial Assessment Program Report might revolve too much around issues such as risk avoidance, vulnerabilities, stress tests and compliance with international regulations, without referring sufficiently to how the sector is performing its social commitments.

As an example, only in Supplement 3, Development Issues in the FSAP, does the Bank acknowledge that; “for lower income countries with less-developed financial system, in order to be relevant to country authorities, the emphasis in the FASP must change… how residents can get a better access to a wider range of financial services”, and having to confess, on the very same page, that “no formal methodologies exist for how to address development issues in the FSAP”.

Another example is present in the survey of countries’ experiences, when in the case of country X, in response to the problems of “(i) weak credit culture with the prevalence of non-payments mechanism that undermine the development of the formal financial sector; (ii) limited access to formal, affordable financing by small and medium enterprises, a typical development trap in transition economies; and (iii) the slow pace of banking sector consolidation”, the only exemplified recommendations are; “(i) enhancement of the central bank’s ability to deal with insolvent banks, (ii) strengthening of penalty provisions and (iii) increase in minimum capital requirements”,

On a separate issue, the document Global Development Finance 2003 in relation to the minimum capital requirements of the Basel II proposals, states that they “include the likelihood of increased costs of capital to emerging market economies; and an “unleveling” of the playing fields for domestic banking in favor of international banks active in developing countries”. I believe this issue, and similar ones, should be addressed in many FSAPs, especially since WB should act as an honest broker in these matters.

Please friend, in these matters, help the Knowledge Bank evolve into the Wisdom Bank or, more humbly, the Common Sense Bank.

Thank You”

Friday, July 31, 2009

Capital requirements for banks could be based on a “credit risk - credit purpose” matrix

On July 29 2009, in Venezuela, the financial regulator, Sudeban, issued a normative by which the risk weights used to establish the capital requirements of the banks were lowered to 50%, when banks lend to agriculture, micro-credits, manufacturing, tourism and housing. As far as I know this is the first time when these default risk-weights and which resulted from the Basel Committee regulations, are also weighted by the purpose of the loan.

The way it is done Venezuela lacks a lot of transparency and it could further confuse the risk allocation mechanism of the markets (though in Venezuela that mechanism has by other means already almost been extinguished) but, clearly, a more direct connection between risk and purpose in lending is urgently needed.

In this respect the Venezuelan regulator is indeed poking a finger in the eye of the Basel regulator who does not care one iota about the purpose of the banks and only worry about default risks and, to top it up, have now little to show for all his concerns.

I can indeed visualize a system where the finance ministry issues “purpose weights” and the financial regulator “risk-weights” and then the final weight applicable to the capital requirements of the banks are a resultant of the previous two.

Does this all sound like interfering too much? Absolutely, but since this already happens when applying arbitrary “risk weights” you could also look at this as a correction of the current interference.

Tuesday, July 21, 2009

Something´s terribly wrong

When parents seem to give more importance to their children´s credit score than their school grades, like setting them up to the fact that they will have to work their whole life in just to pay interests, something's terribly wrong

Friday, July 10, 2009

Let´s then also tax those prone to sickness and subsidize those who rate healthy!

If the regulators of the insurance companies would decide to follow the regulatory paradigm concocted by the Basel Committee, then they would pick three health inspection agencies to rate the health of the insured and require the insurance companies putting up more capital when insuring someone with a low health rating and letting it of the almost off the hook if the insured is deemed to be in tip top form.

Since equity costs a lot, especially in times of crisis, the above is equivalent to placing a de-facto tax on those prone to sickness or giving a de-facto subsidy to those who rate healthy, both these on top of what the market already charges for any differences in health

With their minimum capital requirements based on a vaguely defined and extremely narrow concept of risk and as measured by their three amigos the credit rating agencies, the Basel Committee subsidizes anything that finds it easier to dress up in AAA clothing and castigates what is perceived as higher risk. It all adds up to a crime against common-sense.

With these regulations they drove in a wedge that further increases the differences between the unsustainable status-quo and the sustainable future we all must try to reach, which of course requires a lot of risk-taking.

The misguided risk-aversion these regulations was the major force behind channeling in just a couple of years more than two trillion dollars into the supposedly safest asset, houses, into the supposedly safest country, the USA and into the supposedly safest instruments, AAAs…for no particular good reason at all.

All in all these Basel financial regulations add up to a crime against humanity and against common-sense.

Wednesday, June 24, 2009

What I asked the Commission of UN experts chaired by Professor Joseph Stiglitz

My question:

Strong and rich borrowers in developed countries are more prone to be considered as having a low-risk of default and will therefore in general have to pay lower interest rates than the weak and poor clients in developing countries. That we know, c’est la vie!

But, in June 2004, ministers of the G10 countries, poured salt on the wounds when they endorsed the minimum capital requirements for banks proposed by the Basel Committee and which are solely based on vaguely defined default risks, as measured by the credit rating agencies.

The above signified, for instance, that if a bank lends to a corporation without a credit rating it has to put up 8 percent in capital (12 to 1 leverage) but, if lending to a corporation that has managed to obtain a credit rating of AAA to AA- then only 1.6 percent of equity is required; and which by the way also implies authorizing an astonishing leverage of 62.5 to 1.

With this, the regulators, in a highly discriminatory way, arbitrarily imposed on the financial markets a de-facto subsidy on anything that could dress up as a low risk, and a de-facto tax on anything that could not.

This regulation gave way to a crazy race after the triple-As; which in just a couple of years and though many insist in calling it “excessive risk taking” (even the experts here present) diverted, by means of misguiding risk-adverse capital, around 2 trillion dollars to the finance of the “safest” assets, mortgages on houses, in the “safest” country, the US and in the “safest” instruments, those rated AAA, in a very haphazard way. These funds, an amount in the range of what the World Bank and the IMF have lent since their creation, could have been put to better use all over the world, had it not been for these regulations that, astonishingly, are still in place.

The current draft of the “Report of the Commission of Experts of the President of the United Nations General Assembly on Reforms of the International Monetary and Financial System” opines something on the issue of the oligopoly of the credit rating agencies that resulted from the “additional boost with Basel II, which incorporates the CRAs’ ratings into the rules for assessing credit risk” but does not say a single word about the much more vital issue of the regulators playing God and toying around with risks they know nothing about. How come Mr Stiglitz? Does this not tell us something about how little prepared we, “experts” included, really are to confront the challenges of globalization and development?

And of course, from what we see, in the final resolution of the conference, again, not a single word will be said about this which in essence constitutes a regulatory subsidy of status quo and a tax on development, as well as a fatal and arbitrary intromission in the risk allocation mechanisms of the market. What a shame! Risk is the oxygen of life and development!

The answer: Professor Stiglitz did not personally answer this question but Mr. Yaga Venugopal Reddy, an expert on the panel, replied that in India these Basel regulations only apply to the larger banks that are internationally active and so they do not discriminate against smaller banks.

My comment to that answer: Yes the discrimination in favor of the “too large to fail banks” that the capital requirements established by the Basel Committee is also a problem, but what I was referring to in my question was to the so much worse discrimination among borrowers.

PS. I have personally and also as a former Executive Director of the World Bank been arguing about this issue for years but the profound respect that the Basel Committee has enjoyed and a misguided peer solidarity among the regulators have made it difficult for any outsider to have a voice. In 2007 at a conference of Finance for Development at the UN I was allowed to intervene in a round table and also to post a document on the issue. Unfortunately, this time, in 2009, the sole chance I had was in the NGO meeting with the panel of experts.

In May 2003, the Financial Times published the following letter I wrote

“Just a new breed of systemic error”

“Sir, except for regulations relative to money laundering, the developing countries have been told to keep the capital markets open and to give free access to all investors, no matter what their intentions are, and no matter for how long or short they intend to stay. Simultaneously the developed countries have, through the use of credit-rating agencies, imposed restrictions as to what developing countries are allowed to be visited by their banks and investors.

That two-faced Janus syndrome, “you must trust the market while we must distrust it,” has created serious problems, not the least by leveraging the rate differentials between those liked and those rejected by our financial censors. Today, whenever a country loses its investment-grade rating, many investors are prohibited from investing in its debt, effectively curtailing demand for those debt instruments, just when that country might need it the most, just when that country can afford it the least. Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds. Friends, as it is, the world is tough enough.”

A small note: In the dialogue with the Commission a NGO representative argued for more presence of women in finance since they were more “prudent”. Though I do definitely not oppose more representation of women in finance (how could I with a wife and three daughters one of whom is already in banking) I am not so sure the argument is valid… since that could have led even more capital to pursue the “safe and prudent” AAA ratings.

Psst! Why don’t we just throw out some of the dinosaurs so that we can do some good thinking inside the box instead of us always being shown having to go outside to think?

Wednesday, June 3, 2009

The financial discrimination of development

What would the world say if besides the costs of getting water to the driest areas in the world the driest area would have to pay a tax for the water being shipped there? That is exactly what is happening in the financial world with a de-facto arbitrary regulatory taxation of risk. Yet, not a single word on it appears in any pre-statements or background papers to the United Nation´s conference on the world financial and economic crisis and its impact on development, now re-scheduled June 24-26, 2009.

The Basel II: International Convergence of Capital Measurement and Capital Standards of June 2006 in its Standardised Approach requires a bank to hold the following minimum $ equity for each 100 dollars lent by a bank to a sovereign country, depending on the credit rating of that sovereign.

AAA to AA- = $0
A+ to A- = $1.6
BBB + to BBB- = $4
BB + to B = $8
Unrated = $8
Below B- = $12

And I guess you all know how expensive bank equity is, especially now.

Since clearly the lower rated sovereigns will anyhow have to pay a market rates which are considerably higher than what the better rated sovereigns need to pay, it is clear that these differences in capital requirements imply an additional arbitrary tax on capital and that subsidizes anything better able to dress up as risk-free and penalizes anything expected to be perceived as more risky.

Some could argue that this does not amount to any discriminatory protectionism since these criteria are applied across the whole globe but that argument ignores the fact of how the perceived riskiness is unequally distributed around the globe.

This financial arbitrary discrimination against risk and that is present in the minimum capital requirement for bank established by the Basel Committee and that cover all public and private bank finance makes it not only more expensive for capital to go where they could are most needed but they also falsely induce them to go where they should not.

As an example of the above suffices to see how two trillions of dollars, over a period of less than three years, was because of its AAA ratings diverted to the useless financing of a housing boom in the US, instead of for instance financing the creation of sustainable decent jobs; the elimination of many infrastructure bottlenecks that exists in developing countries; or the adaptation and mitigation efforts that climate change threat requires. Two trillion dollars is most certainly more than all the financing provided by all the development banks over all the years.

In fact the current crisis from which so much suffering will result is a direct consequence of the regulatory authorities arbitrary intervening in the risk allocation mechanism of the market… in favor of what a small and incestuous group of bank regulators from some developed countries felt like favoring. Well now those developed countries are not so developed… but this is clearly not the way we should go in order to reduce inequalities.

Friends in the development community, I ask, how long will you ignore this fundamental issue?

Tuesday, May 26, 2009

Comments on the Draft Outcome Document dated May 8, 2009 for the United Nations Conference “World Financial and Economic Crisis and its impact on Deve

Comments on the Draft Outcome Document dated May 8, 2009 for the United Nations Conference “World Financial and Economic Crisis and its impact on Development”

H.E. Mr. Miguel d'Escoto Brockmann
President of the 63rd session of the United Nations General Assembly

1. Sir, what is going on? The Basel Committee officially endorsed the capabilities of the credit rating agencies’ to identify for the whole world the whereabouts of “risk-free” investments and then, through their minimum capital requirements for the banks, they provided additional incentives for those “risk-free” AAA signs to be followed… and there, right in front of our eyes, over just a couple of years, about 2 trillion dollars were diverted to finance an almost useless and clearly risky housing and consumption boom in the USA, instead of financing the creation of sustainable decent jobs; the elimination of many infrastructure bottlenecks that exists especially in developing countries; or the adaptation and mitigation efforts that the climate change threat requests...and the Draft Outcome Document says basically nothing at all about that!

2. I am one of the very few who can evidence a track record of having in a timely fashion criticized the current financial regulatory framework that originated with the Basel Accord, both in terms of that it doomed the world to a horrendous financial crisis and in relation to the negative impact it has on development. In fact, on the latter issue, I might even be the only voice. Just as an example the following is a letter to the editor titled “Credit ratings for developing nations are just a new breed of systemic error” that I wrote and that was published in Financial Times, January 11, 2003

“Sir, Except for regulations relative to money-laundering, the developing countries have been told to keep their capital markets open and to give free access to all investors, no matter what their intentions are and no matter for how long they intend to stay. Simultaneously, the developed countries have, through the use of credit-rating agencies, imposed restrictions as to which developing countries are allowed to be visited.
This Janus syndrome – “you must trust the market while we must distrust it” – has created serious problems, not the least by leveraging the rate differentials between those liked and those rejected by our modern-day financial censors. Today, whenever a country loses its investment grade rating, many investors are prohibited from investing in its debt, effectively curtailing the demand for it just when that country might need it the most.
Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds. Friends, please consider that the world is tough enough as it is.”

3. In this respect and notwithstanding that I agree with much of what is said therein I wish hereby to record some fundamental objections to the Draft Outcome Document dated May 8, 2009 (the Draft) and which relates to the G192 Conference on World Economic Crisis and its impact on Development. Many of these comments are extensive to the Recommendations of the Commission of experts of the President of the General Assembly on Reforms of the International Monetary and Financial System (the Recommendations).


4. Paragraph 55 of the Draft states “The collapse in confidence in the financial sector is widely recognized as central in the economic crisis; restoration of confidence will be central in the recovery. But it will be hard to restore confidence without changing the incentives and constraints facing the financial crisis”

5. Of course restoration of confidence is central for economic recovery but for the recovery of confidence to happen a full understanding of what happened is a must. That a Bernard Madoff can cheat does not affect confidence in the markets because the markets are much aware that cheaters have always been around and are in fact themselves a part of the market.

6. But, if the credit rating agencies who were so recently officially bestowed with so much power in the surveillance of risks, and therefore must be the best, sort of an “Appointed Risk Surveyor to the Majesty” managed to fail so miserably, then that is of course a tremendous blow to confidence. That loss of confidence can only be cured by fully acknowledging that the mistake was in the creation of an oligopoly in risk surveillance and that this oligopoly will now be eliminated… not strengthened.

7. Paragraph 55 also states “It is imperative that the regulatory reforms be real and substantive, and go beyond the financial sector to address underlying problems in corporate governance and competition policy, and in tax structures, giving preferential treatment to capital gains, that may provide incentives for excessive leverage.”

8. The above says that not taxing the profits is at fault and so that presumably we now must tax profits? Not really so, the problem is not that the profits had tax incentives but that the profits proved to not be profits at all. The “incentives for excessive leverage” those were in fact provided by the regulators and thank God the maximum authorized financial leverages were never even reached by any bank before the crisis. This does of course not preclude that there might be many other valid reasons to tax profits, but that is a quite different matter.

9. Paragraph 55 also states “Even if there had been full disclosure of derivative positions, their complexity was so great as to make an evaluation of the balance sheet position of the financial institutions extraordinarily difficult”.

10. First the crisis was not caused by “derivative positions” and second, the “complexity” argument is irrelevant because the instruments that were so complex that they were not even understood by those who generated them, would never even have reached the balance sheet of a bank, or an investor, had they not been granted the triple-A rating which substituted for the understanding, unfortunately in a much imperfect way. There is of course a need for a better management of the exposures though central clearing houses but that is a quite different matter.

Purpose and objectives of the Financial System

11. Paragraph 57 of the Draft states: “Financial policies, including regulation, have as their objective not only ensuring the safety and soundness of financial institutions and stability of the financial system, but protection of bank depositors, consumers and investors and ensuring financial inclusion - such as access to all banking services including credit, and the provision of financial products which help individuals and families manage the risks they face and gain access to credit at reasonable terms. It is also imperative to make sure that the sector is competitive and innovative.”

12. First, the world needs to set as an explicit objective that individuals should be sufficiently gainfully employed so as not having to use debt except for the acquisition of long term capital goods or in the case of very special emergencies. Most current consumer debt does only help to advance current consumption, at interest rates higher than the risk-free rate and therefore, as a norm, only help to impoverish even more the poor consumers.

13. Second the real purpose of our financial policies should be to advance growth, the creation of decent jobs and to help society to confront special challenges such as climate change. If, in doing so, the financial sector remains stable that is of course a much welcome result, but little is gained from making stability per se the ex ante overriding objective, such as is currently the case. In fact I have even argued that a regulatory system that is much more “trigger-happy” and therefore allows financial institutions to fold much faster, would lead to more satisfactory and stable results.

14. Third, it is of course imperative that the financial sector remains competitive, but this only as long as the competition is carried out in a competitive way and not by assigning special favorable treatment to any parties. That said there is absolutely nothing that requires it to be innovative per se and much less so when the innovations, in this case regulatory innovations, can generate crisis like the current.

15. In this respect there is a need for a banking system that does not substitute bankers staring at monitors for bankers knowing their clients’ business, looking into their clients’ eyes or feeling the firmness of their clients’ handshake. It is indeed of extreme concern to see parents in developed countries giving almost more importance to some opaque credit scores than to the school grades of their children.

16. Therefore paragraph 57 should be rephrased placing as the primary objective of financial policies and regulations the development of the real economy in a sustainable and in a just way. The paragraph 28 of the Recommendations, though incomplete, reflects much of what needs to be stated.

The systemic risks of global arrangements

17. There are continuous references made to the need of “global institutional arrangements for governing the global economy” and this is all well, as longs as it comes with the absolute recognition of the systemic risks such global governance can produce. We should be aware that an objective analysis of the current financial regulations would have to conclude that the world would have been much better off without any of that global public common good we were told that the Basel Committee was, and which has now sadly revealed itself as a real global public common bad.

18. The worst regulator ever, in a small village, will produce harm of little aggregate significance. An extremely good regulator, globally connected, is a monumental menace. In this respect we need to value some of the diversity that different regulatory environments can bring and never underestimate the dangers of the rigidities that global regulations can introduce

Risk as the oxygen of development

19. According to the minimum capital requirements for banks established by the Basel Committee if a credit of $100 is given to a borrower who does not possess a credit rating, the banks need $8 in capital, but if the banks lends to a borrower that has an AAA to an AA- rating, the loans are risk-weighted at 20% and therefore the banks needs only $1.6 in equity. This is equivalent to an authorized 62.5 to 1 leverage.

20. That difference of $6.4 in required equity, especially in times when bank-equity is expensive, costs real money and acts like a de-facto tax on risk. This tax is laid as a surcharge tax on all the different risk spreads that the market already demands. Since the lack of development, just by itself normally generates in the market a perception of additional risk which has to be paid for, and since risk-taking is in so many ways the oxygen of development, it is clear that the developing countries are being especially discriminated by the current regulatory framework.

21. Now if you want to know the real extent of how the minimum capital requirements favored those able to dress up as risk free read paragraph 615 of the Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised Framework - Comprehensive Version of June 2006 which refers to investment in securities that are risk weighted at only 7% and therefore signify an authorized leverage of 179 to 1.

22. The importance that risk-taking has for development and the need to avoid imposing de-facto taxes on risk as has been done with the minimum capital requirement for banks risk-weighted structure and much less introducing artificial incentives to direct funds to real or fictitious low risk investments is completely absent in the document.

23. Paragraph 14 of the Draft argues correctly that “Financial subsidies can be just as detrimental to the efficiency of a free and fair trading system as tariffs. Indeed, they may be more inequitable, because rich countries have more resources to support subsidies” and yet, neither the Draft nor the Recommendations mention even once the current minimum capital requirements for banks and which are as previously explained a real tax or a real tariff on risks, of which the developing countries have the most… at least as perceived by the markets.

24. For a more detailed comment on this I reference a document that I was honored to see posted in October 2007 in the Finance for Development site.

Restructuring of International Institutions

25. There are many proposals related to the need of better more transparent and more democratic global institutions. They are all correct but missing from that is the following:

26. First it is not sufficient in structures like for instance the Financial Stability Forum (a name that in itself you might understand that I find much lacking) to have a representation of developing countries as this might not by itself guarantee diversity of thought. What is foremost needed is to avoid that the discussions of vital global issues are hijacked by clubs of mutual admirations and which, due to often strange ying-yang relations sometimes even include representatives from civil society.

27. Second in order to be able to introduce a more global perspective there is also need for more representatives who are not wedded to very local interests. As a former Executive Director of the World Bank I have often held that the least represented entity in the bank is planet earth itself.

Financing for Restructuring and Survival

28. Though I agree with some of the proposals made in paragraphs 21 trough 35 I just cannot comprehend how in paragraph 27 one finds room to mention minor initiatives such as PetroCaribe without even mentioning in the Recommendations or in the Draft the importance of remittances. Given that the enormous sacrifices of many migrants is what is holding many economies afloat it is truly an embarrassing omission.

29. Also and given the current role of the dollar as a kind of borrower of last resort, as a sort of last perceived safe-haven I certainly miss efforts to discuss the possibilities the US recycling some of those dollars to developing countries with perhaps some partial guarantees from other developed economies that also have a vested interest in it.

30. Paragraph 28 speaks of “efficient mechanisms for mobilizing the funds available in countries that have accumulated large reserves” and this could create the false illusion the existence of funds that have not already been deployed. In fact these reserves have one way or another already been invested and their divestment signifies by itself a major challenge.

31. Finally if there is a possibility for a Global Stimulus Fund, then now, in the midst of a crisis, this is not the best of times time to delay its workings by trying to also ascertain the voice of recipient countries.


Per Kurowski
A concerned citizen and that while being an Executive Director at the World Bank 2002-2004 had little luck in having his voice heard on this issue.