ChatGPT OpenAI: Can regulatory risk aversion affect development?

Q. There’s risk aversion imbedded in risk weighted bank capital/equity requirements based on that what’s perceived as risky is more dangerous to bank systems than what’s perceived or decreed as safe. Can that hinder the development of e.g., developing nations? 

OpenAI - ChatGPT answered:

"Yes, the risk aversion embedded in risk-weighted bank capital/equity requirements can potentially hinder the development of developing nations. This is primarily because risk-weighted capital requirements tend to assign higher risk weights to assets or investments in developing nations compared to those in developed nations.

Risk-weighted capital requirements are designed to ensure that banks hold sufficient capital to absorb potential losses arising from their assets. However, the perception of higher risk associated with developing nations often leads to higher risk weights being assigned to loans and investments in these countries. As a result, banks may be required to hold more capital against their exposures to developing nations, making it more expensive for them to finance projects or provide loans in those countries.

This higher cost of capital can deter banks from extending credit to businesses and individuals in developing nations, limiting access to financing and impeding economic growth and development. It can also lead to a reduced flow of foreign direct investment (FDI) into these countries, as investors may view the higher capital requirements as an additional barrier to entry.

Furthermore, the perception of higher risk can create a negative cycle where the lack of access to affordable financing hampers investment, innovation, and entrepreneurship in developing nations. This, in turn, may slow down economic growth and limit opportunities for job creation and poverty reduction.

To address this issue, policymakers and international organizations have recognized the need to strike a balance between prudential regulation and the promotion of economic development. Efforts have been made to refine risk assessment methodologies and provide more nuanced risk weightings that reflect the specific characteristics of developing nations. Additionally, initiatives such as the World Bank's International Development Association (IDA) and various regional development banks aim to provide concessional financing and technical assistance to support development projects in these countries.

Overall, while risk-weighted capital requirements play an important role in maintaining the stability of the banking system, it is crucial to ensure that they do not inadvertently hinder the development of developing nations. Striking the right balance between risk management and supporting economic growth is a complex challenge that requires ongoing attention and cooperation between regulators, policymakers, and international organizations."

Comment: How long can the experts on development ignore this and still be considered experts?

Note: The answers are copied exactly from those given to me by OpenAI

Here my many other questions to ChatGPT – OpenAI on bank regulations

PS. Here a 2003 warning about Basel bank regulations and development

UN, World Bank, IMF, and NGO’s: Give the SDGs a fair chance. Kick out Basel Committee's bank regulations

The Sustainable Development Goals seem all very laudable, but given that bank credit is one of the most important financial resources, in order for these to stand a fair chance of being met, one would have to kick out all current bank regulators… or at least their regulatory pillar, the credit risk weighted capital requirements for banks. 

Hear me out!

Those capital requirements, where capital mostly signifies bank equity, decree more credit risk more capital – less credit risk less capital. That might sound logical, but it is not!

That means that banks are allowed to leverage more their equity (and the various sort of support they receive from taxpayers) when lending to what is perceive as safe than when lending to what is perceived as risky; which means banks can earn higher risk-adjusted returns on equity when lending to The Safe than when lending to The Risky; and which makes it impossible for banks to treat all borrowers fairly.

Specifically those bank regulations, which only single purpose is to avoid credit risk, something which has nothing to do with financing sustainability, poverty reduction or job creation, would directly impede the following SDG-Targets 

1.4: ensure that all men and women, in particular the poor and the vulnerable, have equal rights to economic resources 

1.5.a: Ensure significant mobilization of resources from a variety of sources….

2.3: equal access to… financial services… 

8.3: Promote development-oriented policies that support productive activities, decent job creation, entrepreneurship, creativity and innovation, and encourage the formalization and growth of micro-, small- and medium-sized enterprises, including through access to financial services 

8.10: Strengthen the capacity of domestic financial institutions to encourage and expand access to banking, insurance and financial services for all…

9.3: Increase the access of small-scale industrial and other enterprises, in particular in developing countries, to financial services, including affordable credit, and their integration into value chains and markets 

10.3: Ensure equal opportunity and reduce inequalities of outcome, including by eliminating discriminatory laws, policies and practices and promoting appropriate legislation, policies and action in this regard 

15.10.a: Mobilize and significantly increase financial resources from all sources to conserve and sustainably use biodiversity and ecosystems 

15.10.b: Mobilize significant resources from all sources and at all levels to finance sustainable forest management and provide adequate incentives to developing countries to advance such management, including for conservation and reforestation 

17.1: Strengthen domestic resource mobilization 

17.3: Mobilize additional financial resources for developing countries from multiple sources 

You might say that to ignore such capital requirements would put the banks at risks. Forget it! Major bank crisis do never result from excessive exposure to what is perceived as risky, these always, no exceptions, result from excessive exposures to what was erroneously perceived as safe.

Motorcycles are much riskier than cars, but much more people die when going in cars than when riding motorcycles.

If we do not want banks to take risks in order to create jobs, in order to reduce poverty and in order to help the sustainability of earth… then what the hell do we want banks for… safe mattresses would do. 

I am not much for distorting credit allocation in any way, I believe it is way too arrogant for us to pretend we know how, but, if we have to do it, I would much prefer allowing banks to hold a bit less capital when lending to something related to the SDGs, so that they make a bit more return on equity when lending to the SDGs, so that they lend a bit more to the SDGs.

Let me finalize here by quoting from John Kenneth Galbraith’s “Money: Whence it came where it went” 1975.

“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.”

The IMF keeps on ignoring one of the prime causes for manmade inequality... the risk adverse bank regulations

In June 2015 the IMF made public a paper titled “Causes and Consequences of Income Inequality: A Global Perspective”. It was prepared by Era Dabla-Norris, Kalpana Kochhar, Frantisek Ricka, Nujin Suphaphiphat, and Evridiki Tsounta (with contributions from Preya Sharma and Veronique Salins) and authorized for distribution by Siddharh Tiwari.

Once again, one of the fundamental manmade and artificial drivers of inequality is not mentioned. I refer to the credit-risk-weighted capital requirements for banks which allow banks to earn much higher risk-adjusted returns on equity, when lending to what is perceived or made to be perceived as “safe”, than to what is perceived as “risky”, like to SMEs and entrepreneurs. 

That regulation kills opportunities and impedes banks from financing the future, dedicating them mostly to refinancing the past. Of course that promotes inequality.

Also there is no mention about the bailouts directed to safeguard the value of existing assets, which also promotes inequality, as it does not do remotely as much for those who have no assets. 

In the final remarks the paper states: “The promotion of credit without sufficient regard for financial stability, however, can result in crises, as evidenced by the subprime mortgage crisis in the United States, with disproportionately adverse effects on the poor and the middle class. Moreover, it illustrates the broader point that deep social issues cannot be resolved purely with an infusion of credit. Policies thus need to strike a balance between fostering prudence stability, and inclusion, while encouraging innovation and creativity.” 

In my opinion that is a serious misstatement of financial history. Mortgages to the subprime sector never represented major problems, until Basel II regulations in June 2004 allowed banks to hold securities against only 1.6 percent in capital, meaning allowed leverage of more than 60 to 1, as long as they were rated AAA to AA. That, as should have been expected, set of a frantic demand for, and an ensuing production of, AAA-AA rated securities. In January 2003 in FT I had written: “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”

I hold that credit risk weighted capital requirements for banks seriously distort the allocation of bank credit to the real economy. The World Bank in its Global Development Finance 2003, “Striving for Stability in Development Finance” already hinted at the distortion, since under the topic of Basel II it stated:  

“risk weights would be set for a bank’s exposure to sovereigns, corporations, and other banks based on ratings from major credit-rating agencies… the new methods of assessing the minimum-capital requirement is expected to have important implications for emerging-market economies, principally because capital charges for credit risks will be explicitly linked to indicators of credit quality… the regulatory capital requirements would be significantly higher in the case of non-investment grade emerging borrowers than under Basel I", plus finally “The current proposal places project loans in a higher risk category than corporate loans”

Unfortunately it seems this type of criticism was off-limit as it has since then been silenced.

World Bank, to help raise finance for MDGs and SDGs, suggest MDG and SDG-weighted equity requirements for banks.

Right now the banks finance more than ever what is perceived as safe, because that allows them to hold less equity than when financing what is perceived as “risky”, and so there is where they earn their highest risk adjusted returns on equity.

If the World Bank wonders how to get sufficient finance to meet the MDGs and the SDGs… then think of bank equity requirements not based on credit risk weights but on Millennium Development Goals DG and Sustainable Development Goal Weights. 

That way banks would earn higher risk adjusted returns on equity when doing good.

That would help to put some purpose back into banks… because credit risk weighted equity requirements certainly do not.

The Development Committee Communiqué, April 2015. Another missed opportunity to make a real difference

The Development Committee (DC) is a ministerial-level forum of the World Bank Group and the International Monetary Fund for intergovernmental consensus-building on development issues. Its mandate is to advise the Boards of Governors of the Bank and the Fund on critical development issues and on the financial resources required to promote economic development in developing countries.

In its Communiqué after the 2015 Spring Meetings in Washington on April 18, 2015 it included the following:

“We call on the World Bank Group (WBG) and the International Monetary Fund (IMF) to support countries’ efforts to spur inclusive growth and job creation and build resilience to adverse shocks, in order to reduce poverty, and enhance shared prosperity in a sustainable manner, and protect hard-won gains in these areas.”

And I have to ask: Why on earth can they not ask the Basel Committee for Banking Supervision (BCBS), the committee that designs bank regulations to be applied for banks around the globe, the same thing?

As is, the pillar of BCBS’s bank regulations is risk-weighted capital requirements for banks, or more precisely portfolio invariant credit-risk-weighted equity requirement for banks. And this has nothing to do with “inclusive growth and job creation and build resilience to adverse shocks”.

On the contrary, since it translates into less-risk-less-equity, and since all major bank crises in history have never resulted from excessive exposures to something perceived as risky but always from excessive exposures to something erroneously perceived as safe, it only set up the banking system to even larger adverse shocks.

Also, since it of course also translates into more-risk-more-equity it means that banks will lend less and relatively more expensive to the “risky”, like SMEs, something which kills opportunities and thereby foments more inequalities. 

In short the Development Committee should have taken the opportunity to ask BCBS to substitute for the credit-risk-weights with something more purposeful for the society. For example with the potential of planet earth sustainability, job generation and poverty reduction weights.

And indeed, since risk-taking is the oxygen of any development; and it is the future generations who most need banks to take astute risks in order for them to have a better future, the World Bank should be instructed to act as the Ombudsman for the best interests of our children and grandchildren.

The World Bank should act as an Ombudsman for our children and grandchildren

The Basel Committee for Banking Supervision (BCBS) is in charge of developing bank regulations that are applied by more and more countries around the world. That has increased the coherence and reduced somewhat the regulatory competition between countries. Unfortunately, it has also introduced a serious systemic mistake. 

The pillar of the BCBS’s current bank regulations, is the risk weighted capital requirements for banks; something which for more preciseness, should be termed the Portfolio Invariant Credit-Risk-Weighted Bank Equity Requirements. In essence it indicates: more-credit-risk-more-equity / less-credit-risk-less-equity. 

Though intuitively it sounds very reasonable, it contains two fundamental flaws.

First, the risk-weights used are based on the default possibilities of the assets of a bank, and not on a real analysis of what has caused the major bank crises in the past. In this respect it should be noted that the bank assets more likely to cause a major crisis, are not those perceived as risky, but those that are erroneously perceived as safe.

Second, much worse, allowing banks to leverage their equity, and the explicit and implicit support these receive from taxpayers, differently, depending on credit risks already cleared for with interest rates and size of exposures, seriously distorts the allocation of bank credit to the real economy. In essence it causes the bank system to lend too much and at too low rates to what is perceived as safe, like for instance to sovereigns and what I have termed as the AAArisktocracy; and too little, at relatively too high interest rates, to what is perceived as risky, like for instance to SMEs and entrepreneurs.

The origin of this mistake can primarily be traced to that regulators never really defined the purpose of our banks, beyond that of each one having to be safe. With that the regulators completely ignored that banks represent one of the most important agents through which the society distributes its savings, and the risk-taking that the economy needs in order to move forward, so as not to stall and fall.

Any regulatory interference and distortion of how bank credit is allocated, is very dangerous, and so, if it is to be considered and allowed, one needs to make certain that, at the very least, it is in pursuit of some extremely worthy purpose.

In this respect it could be illustrative, instead of credit-risk-weights, to think about the potential-of-job-generation weights, or environmental-sustainability-weights. That would allow the banks to earn their highest risk-adjusted returns on equity, financing what could most matter to us.

The World Bank, as the world’s premier development bank, must know that risk-taking is the oxygen of any development. It therefore has an enormously important role in supervising bank regulations from the point of view of how banks: promote development, allow for fair and inclusive access to finance, advance poverty reduction, generate jobs and help to bring on environmental sustainability.

The challenges loom large. Current credit risk based equity requirements, by making it harder than need be for those perceived as “risky” to access bank credit, kills opportunities and thereby promotes inequality. And, with its bias against credit-risk, it guarantees that banks will not finance sufficiently the “riskier” future, but mostly keep to refinancing a “safer” past.

“A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926.

The credit-risk-aversion present in current regulations could seem adequate for someone retired with a remaining short life expectancy. It is highly inadequate though, in fact dangerous, when set in the context of the needs of future generations. And in this respect I urge the World Bank to cast itself much more in the role of being the Ombudsman for our children and grandchildren.

And let us, somewhat older, never forget that much of what we can enjoy today, is the direct result of the willingness of the generations that preceded us to save and to take risks. We have the same duty… God make us daring!

@PerKurowski

PS. Here a statement closely related to this issue that I delivered as an Executive Director of the World Bank March 10, 2003

Reserve Bank of India: This is not so smart of you. In fact it is quite dumb.

The Reserve Bank of India has decided that Basel III standards for capital (equity) and liquidity shall apply for lenders operating in the country.

That means that in India they will keep applying the regulatory pillar of more-perceived-credit-risk-more-equity and less-perceived-credit-risk-less equity.

Which means lenders in India will be able to leverage their equity, and the support they receive from taxpayers, much more with net margins collected on loans to those perceived as “safe” than on loans to those perceived as “risky”.

Which means that lenders in India will make much higher risk adjusted returns on equity when lending to those perceived as “safe” than on loans to those perceived as “risky”.

Which means that lenders in India are doomed to lend too much at too low rates to those perceived as “absolutely safe” and too little at too high rates to those perceived as “risky”, like the SMEs, entrepreneurs and start-ups. 

That, for a developing country, does not sound so smart, in fact it is quite dumb.

And all this happens probably only so that some Indian regulators can show off in front of their colleagues in the developed countries.

But, even for developed countries that Basel pillar is dumb. It is like if a young professional setting up his retirement account he tells his investment manager: “I will pay you much higher commission on earned returns from investments in what is thought safe than what I will pay for the case of investments in what seems risky”. That will lead to excessive risk aversion and probably cause him a very poor retirement income.

Have India and other developing countries completely forgotten that risk-taking is the prime oxygen of any development?

Developing countries have clearly forgotten what made them develop… and have now, with these regulations that so odiously discriminate against the fair access to bank credit of “the risky” have call it quits, and begun un-developing.

And all for nothing since never ever do major bank crises result from excessive exposure to what is perceived as risky, these do always, no exceptions, result from excessive exposures to something perceived as absolutely safe, but that ex post turned out very risky.

PS. From some things I have heard about India, and from some experiences I have had in my country, Venezuela, it would seem that equity requirements based on closeness-to-borrower ratings could make some sense. The closer the bank, and its board are to the borrower, for instance they could be siblings, the higher the equity requirement.

It behooves us all to denounce the Basel Committee's dumb and odiously discriminating bank regulatory pillar.

Currently the pillar of regulations, peddled all over the world under the trademark of Basel Committee, is equity requirements for banks based on perceived credit risk… more risk more capital… less risk less capital.

That is extremely dangerous for all, especially for developing countries. 2 reasons:

By allowing banks to leverage more their equity when lending to the safe than when lending to the risky, banks will obtain higher risk adjusted returns on equity when lending to the safe than when lending to the risky, which results in banks lending too much at too low rates to the safe and too little at relative too high rates to the risky. And who are the "risky"? All those SMEs, entrepreneurs and start-ups everyone needs and wants to have fair access to bank credit, for the economy to grow and not stall and fall.

And all which that pillar guarantees is that whenever a major bank crisis happens, those which never result from excessive exposures to the risky, but always because of excessive exposures to the “safe”, the banks will stand there naked, with little or no equity to cover themselves up with.

The regulators should have asked: “What are the risks bankers will either not perceive the risks of bank assets, or be able to manage the risks correctly?”... and that is clearly something quite different from what the perceived risks of bank assets are.

It behooves us all to denounce that dumb and odiously discriminating regulatory pillar.

I hear you: “Could expert regulators really be that stupid?” Yes, that is perfectly possible, especially when they regulate in a mutual admiration club isolated from the real economy.

For instance, when was the last time you saw a small business owner or an aspiring not yet successful entrepreneur in need or bank credit in Davos, or being heard out by the Basel Committee or G20's Financial Stability Board? 

 

I prefer one and the same equity requirements against all bank assets, because for me it is always dangerous to distort the allocation of bank credit to the real economy.

But, if regulators absolutely must distort, in order to show us they are earning their salaries, then let us please ask them to substitute with potential of job-creation-ratings, sustainability-ratings, or any other rating of what could be the purpose of a bank, for those useless credit ratings which are already considered by bankers when giving the loans, and should therefore not be considered again in the equity.

“A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926

God make us daring!

World Bank, the world urgently needs another chapter of your “World Development Report 2015: Mind, Society, and Behavior”

The World Bank argues in their “World Development Report 2015: Mind, Society, and Behavior”, that a more realistic account of decision-making and behavior will make development policy more effective. 

Indeed, and what a fabulous opportunity to ask the World Bank, in light of that report, to evaluate how expert regulators like those in the Basel Committee for Banking Supervision could have come up with something as irrational as their portfolio invariant perceived credit risk weighted capital (equity) requirements for banks… more risk more capital – less risk less capital.

Let me summarize its two main irrationalities.

Fact: All major bank crises have resulted from excessive exposures to assets that while they were being incorporated to the balance sheets of banks were considered safe, but that ex post turned out to be risky; and no bank crisis has resulted from excessive exposures to assets that while they were being incorporated to the balance sheets of the banks were considered risky, even if in fact they really turned out to be risky.

And yet: “more risk-more capital - less risk-less capital”? Should it not be the opposite?

Fact: Through interest rates, size of exposures and other terms, banks clear for perceived credit risk. To then make banks clear again for basically the same perceived risk in their capital (equity) condemns the banks to overdose on perceived credit risks. Worse yet, by allowing much lower capital against assets perceived as safe, the banks will earn much higher risk adjusted returns on equity on assets perceived as safe than on assets perceived as risky. 

And such distortion makes it completely impossible for banks to perform correctly what is its most important social function, namely to allocate bank credit efficiently to the real economy.

So how on earth could bank regulators have committed these two fundamental mistakes? And how on earth is it that so many years after the crisis exploded because of excessive bank exposures to what had very low capital requirements the causality has not been acknowledged? And how on earth is it that when clearly “risky” small businesses and entrepreneurs are squeezed out from access to bank credit because they cause the banks to need more capital this causality, again, is not acknowledged. These are questions the World Bank should help to get answers for.

In March 2003, as an Executive Director of the World Bank I stated: “Basel is getting to be a big rule book,” and, to tell you the truth, the sole chance the world has of avoiding the risk that Bank Regulators in Basel, accounting standard boards, and credit-rating agencies will introduce serious and fatal systemic risks into the world, is by having an entity like the World Bank stand up to them—instead of rather fatalistically accepting their dictates and duly harmonizing with the International Monetary Fund.”

And in April 2003, in a written statement delivered at the WB Board I wrote: "Basel dictates norms for the banking industry that might be of extreme importance for the world’s economic development. In Basle’s drive to impose more supervision and reduce vulnerabilities, there is a clear need for an external observer of stature to assure that there is an adequate equilibrium between risk-avoidance and the risk-taking needed to sustain growth. Once again, the World Bank seems to be the only suitable existing organization to assume such a role."

And I still hold all that. And so please, dear World Bank, as the world’s premier development bank don’t shy away from your responsibilities. Risk-taking is the oxygen of development and so these regulations are anathema to development. And by negating the risky a fair access to the opportunities of bank credit, these regulations are also impeding the world from being a more equitable world. 

As a starting point and having briefly read in this WDR-2015 about “automatic” and “deliberative” decisions system (and of course Daniel Kahneman) let me advance that those responsible for the risk weighting, automatically concluded that “safe is safe and risky is risky” and took it from there, without deliberating sufficiently on that in bank regulations, "safe could be risky and risky could be safe"; in other words without any consideration to differences in ex ante and ex post perceptions.

And as to the regulatory distortions in credit allocation these regulations could cause, and that were so blatantly and irresponsibly ignored, let me just point that nowhere in all the soon thousands of pages of Basel Committee and Financial Stability Board regulations, can we find a statement that indicates the “purpose of our banks”.

What do I specifically want? I want all those involved in writing the “WDR-2015” to tackle a rewriting of Chapter 10: “Improving the work of development professionals”, in terms of: “Improving the work of bank regulation professionals”. 

Since bank regulators can have a large systemic dangerous, or beneficial, influence on how our future is painted, the world would benefit enormously from that.

PS. I am not only referring to the developing world. Currently Europe is stalling and falling, as a direct consequence of these risk-adverse bank regulations, and so it is high time for someone like WB to remind them of what helped them to develop in the first place. Let us be clear, with bank regulations like Basel I, Basel II and now Basel III, Europe (or the rest of the Western world) would not have become what it is.

Is this good for developing countries? (or even for developed ones?)

Many developing countries, because their government bureaucrats do not want to seem less sophisticated than their counterparts in the developing countries, have adopted the Basel Committee for Banking Supervision as expressed in Basel II and soon Basel III.

The pillar of those Basel regulations is something called credit-risk weighted capital (equity) requirements for banks, more risk more bank equity – less risk less bank equity.

And that allows banks to earn much higher risk-adjusted returns on equity on what is perceived ex ante as “absolutely safe” than on what is perceived as “risky”.

Questions: Do you think developing countries can develop by giving the banks incentives to populate safe-havens, possibly causing a dangerous overcrowding of these, and keeping away from exploring the risky bays? Is not risk-taking the oxygen of development? Do you think that developed countries can stop taking risks and not stall and fall?

“A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926

Dear development organization

Current bank regulations, which are being imposed globally, have as their principal pillar that of capital requirements based on perceived risk; the more the risk the higher the capital, the lower the risk the lower the capital. That, although at first it sounds logical is something extremely dangerous for the economies, because the perceived risks are already cleared for, by banks and markets, through interest rates, amounts of exposures and other contractual terms. 

The result of those regulations which double-count perceived risks, is that banks are able to earn much higher risk adjusted returns on equity when investing in or lending to “The Infallible”, than when investing in or lending to “The Risky”, like small businesses, entrepreneurs and most infrastructure and development projects. 

That of course makes it much more difficult for “The Risky” to access bank credit, or forcing them to accept much higher interest rates, much smaller loans and much harsher terms than would have been the case without these regulations. 

In this respect I wonder if your organization, so much involved in the development efforts of the world, and that must be aware of the fact that risk-taking is the oxygen of any development, has any interest in supporting my efforts to eliminate these regulatory subsidies to “The Infallible”, and the consequential taxes on The Risky”. 

Our banks are currently drowning in dangerous excessive exposures to what is officially considered as “The Infallible”, while credit needs for so many productive projects of “The Risky” are completely ignored.

Yours sincerely 

Per Kurowski 

A former Executive Director at the World Bank (2002-2004) 

perkurowski@mail.com 

http://subprimeregulations.blogspot.com/

Development economists, you have now been shamed

Now most development economists have been shamed by none other than Vikram Pandit, the chief executive of the Citigroup and who, in the Financial Times of October 26, is reported as saying “Under Basel, the ‘sweet spot’ business model for banks in the developed world will be to take retail deposits from mom and pop – small but stable customers – and lend only to big business and the wealthy. I do not believe this is the banking system we want”

Of course this is not the arbitrary regulatory discrimination we need, and I have been arguing against it since 1997 with for example a document I presented at the UN in October 2007 titled “Are the Basel bank regulations good for development?”. Unfortunately much of the development debate of developing countries has been hijacked by baby-boomer development economists from developed countries and who cannot get it in their head that development requires a lot of risk-taking… and that therefore concentrating too much on avoiding bank failures will hinder the growth and the development of the economy.

As an example it suffices to read the Recommendations by the Commission of Experts of the President of the General Assembly on reforms of the international monetary and financial system chaired by Joseph Stiglitz. Nowhere in it do we find a word about the utterly misguided and odiously discriminatory capital requirements for banks imposed by the Basel Committee and which signify that a bank needs to have 5 TIMES more capital when lending to small businesses and entrepreneurs (100%-risk-weight) than when lending to triple-A rated borrowers (20%-risk-weight); and this even though the first are already paying much higher interest which goes to bank capital; and this even though no financial crisis has ever resulted from excessive lending to those perceived as “risky” as they have all resulted from excessive lending to those ex-ante perceived as not risky.

The Commission of Experts speak of increasing risk-premia but fail to notice that one of the reasons for that is the arbitrary regulatory risk-adverseness. It also speaks out against under-regulated and dysfunctional markets that fail to allocate capital to high productivity uses, without noticing that perhaps the major cause of markets being dysfunctional is often bad regulations, such as those issued by the Basel Committee.

Perhaps it is high-time economists from developing countries start to develop their own development paradigms; some of which might even help developed countries to keep from submerging.

And meanwhile, all you traditional development economists, put on your cones of shame.

A final question should Vikram Pandit now move on to the World Bank?

God make us daring!

A verse of Psalm 288 Text: F Kaan 1968 B G Hallqvist 1970 reads:

“God, from your house, our refuge, you call us
out to a world where many risks await us.
As one with your world, you want us to live.
God make us daring!”

“God make us daring!” That is indeed a prayer that the members of the Basel Committee do not even begin to understand the need for.

The world needs risk-taking in order to move forward

The willingness to take risks is one of the most powerful sources of energy. If we do not channel risk-taking into the construction of society, it will inevitably flow into the destruction of society.

The current regulatory paradigm imposed by the Basel Committee on Banking Supervision on the banks, and to which most of the world has agreed to, does not promote our bankers to be intelligent risk-takers in their fundamental role of satisfying the financial needs of all those other risk-takers like small businesses and entrepreneurs.

On the contrary, what these regulations do is to stimulate plain dumb risk-adverseness among the bankers by increasing the returns to banks on what is perceived by some credit rating agencies as being, ex-ante, of very low risk… and which is also precisely the terrain where excessive lending or investments that lead to a systemic crisis always bloom.

Unless the bank regulators are determined to regulate for submerging countries they must come to understand much better the whole concept of risk.

IMF and World Bank, please help stop the Basel Committee from bullying the “risky”.

Access to bank credit is hard and expensive enough for those small businesses, entrepreneurs with no access to good credit ratings to additionally be subjected to what could be considered as bullying by the Basel Committee on Banking Supervision… or just plain odious discrimination.

Though lending to this “risky” group has never ever originated any bank or financial crisis, since those only happen because of excessive investments or lending to what is perceived as not risky, the strong regulator bullies decided to impose on the banks 5 TIMES more capital requirements when lending to the weak and “risky” (100% regulatory-risk-weight) than when lending to the triple-A rated (20% regulatory-risk-weight).

And this even though this group of clients, by being charged higher interest rates on account of their market-risk-weights, already contribute much more to the capital of  banks than any triple-A rated client.

And this even though this group of clients, with little alternative access to financing, is supposed to stand first in line as bank clients; and this even when this group is first in line to supply the world with the economic growth and the jobs it always needs.

In many places bullying is a punishable act that can lead to jail sentences. Though the Basel Committee might deserve it, especially since by bullying the weak it pushed the banks over the triple-A cliff, it would be hard to jail it. As the “risky” has so much less lobbying power than the “not-risky” could the IMF and World Bank at least help to stop the Basel Committee from bullying the “risky”? Please!

Not-rated or rated risky of the world, unite!

Below are three occasions where I recently pleaded IMF and the World Bank for the above. Will I also need to get down on my knees?

The Civil Society Town-Hall Meeting

In the video you can find my question in minute 47.28, Dominique Strauss-Kahn’s answer in minute 1.01.08, and Robert Zoellick’s answer in minute 1.16.32

http://www.imf.org/external/mmedia/view.aspx?vid=628246206001

Structural Reforms: Effective Strategies for Growth and Jobs

Here my first and second question can be seen from minute 1.14.25 on.

http://www.imf.org/external/am/mmedia/view.aspx?vid=629575645001

Accelerating Financial Inclusion–Delivering Innovative Solutions

My question (not the best sound quality, but it is a similar question) can be found in minute 1.04.03 on

http://www.imf.org/external/am/mmedia/view.aspx?vid=629531170001

Per Kurowski

A former Executive Director at the World Bank (2002-2004)

http://subprimeregulations.blogspot.com/

Today I had a great day!

For someone who since 1997 has been opposing the regulatory paradigm used by the Basel Committee for Banking Supervision, even as an Executive Director of the World Bank 2002-2004, today was a great day.

As a member of Civil Society, whatever that now means, at a City Society Town-hall Meeting during the 2010 Annual Meetings, I had the opportunity to pose the following question to Dominique Strauss-Kahn, the Managing Director of the International Monetary Fund, and to Robert B. Zoellick, the President of the World Bank:

“Right now, when a bank lends money to a small business or an entrepreneur it needs to put up 5 TIMES more capital than when lending to a triple-A rated clients. When is the World Bank and the IMF speak out against such odious discrimination that affects development and job creation, for no good particular reason since bank and financial crisis have never occurred because of excessive investments or lending to clients perceived as risky?”

Dominique Strauss-Kahn answered in no uncertain terms that “capital requirement discrimination has no reason to be” and Robert B. Zoellick agreed and pointed to what he has done in order to diminish the regulatory discrimination against trade finance.

The question that now floats around there out in the open, is what the Basel Committee on Banking Supervision, the supreme global regulatory authority, has to say about that, because bank capital requirement discriminations based on perceived risks is precisely the heart and soul of their regulatory paradigm.

Real development does not occur in a safe attraction park

Developed countries’ bank regulators came up with the notion that if they required banks to have more capital when they invested or lent to someone perceive as more risky by the credit rating agencies and less capital when they invested or lent to someone perceived as less risky, then their banks would never default again and everyone would live forever happy.

Of course in order to believe in that illusion they had to ignore the historic truth that no financial or bank crisis has ever occurred from excessive lending or investment in what is perceived as risky, the markets and bankers are much too coward for that, they have all resulted from excessive lending or investment in what is perceived as not risky.

But we developing countries and emerging countries, we know better that without intelligent risk-taking, primarily by our bankers, there will be no development… and that the thought of risk-free development could only happen in a Disney sponsored super safe developer’s attraction park, not in the real world.

I beg and I beg and I beg again for the World Bank to lift the banner of risk-taking in the name of development and in the name of the developing and emerging countries.

If the developed world feel they have reached a plateau were they just want to try to defend what they have and are so desperate in avoiding risks, well that is their problem. They will be un-developing and submerging… but the rest of us cannot afford to do so... under any circumstances.

Enanitos Verdes phrase it so right when they sing about their need and their right of “having to run the risk of getting up, in order to keep on falling”

A letter to finance and development ministers of developing and developed countries.

Do you finance and development ministers believe that it is the purpose of your commercial banks to help nurture those small businesses and entrepreneurs that create new jobs while they become large enough to have credit ratings and access to capital markets?

Do you finance and development ministers believe that bank regulations are not there in order to increase the returns of banks in areas that are perceived as having low credit default risks and therefore already much favored by the markets?

Do you finance and development ministers believe that the banks should work as bridges directing capitals to generate growth and jobs and not just serve as tolls to assure profits to the financial sector?

Do you finance and development ministers believe that a 450 pages long “Financial Sector Assessment handbook”, published in 2005 by the World Bank and the International Monetary Fund, should contain more than 10 pages and the suggestion of only “express a general view” on the issue whether the financial services are adequately serving the needs of the real economy?

Do you finance and development ministers believe that there are other risks in the world much more important for the future wellbeing of your country than the risks of banks defaulting?

Do you finance and development ministers believe that the debt-sustainability framework should be about more than just sending the message that debts are good as long as they are sustainable?

Do you finance and development ministers believe that after a crisis like the current one exploded, regulators would be busy revising their regulatory paradigm instead of digging us even deeper in the hole we’re in?

If you do believe so you would perhaps want to contact someone like me.

Otherwise keep on doing what the Basel Committee and the Financial Stability Board and the International Monetary Fund and the big global banks want you to do.

Of course, much better than just contacting someone like me would be if you could contact the World Bank directly on the issue of banking and development. Unfortunately, ever since the Bank-Fund Financial Sector Liaison Committee was set up in 1998, the experts in the World Bank, in the name of harmonization, have been very much silenced by those in the Fund who, come what may, can only dream about of financial stability.

Best regards

Per Kurowski

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

The Basel Committee makes small businesses and entrepreneurs pay much more for their bank credit

When compared to a regulatory system with equal bank capital requirements for all type of assets, the Basel system that imposes different requirements based on some arbitrary risk-weights related to credit ratings, implies that a small business needs to pay about 2 percent (200 basis points) more in interest rates in order to stay competitive when accessing bank credit.

Suppose a bank feels that the normal risk premium should be .5 percent for an AAA rated company and 4 percent for a small business. If the bank was required to have 8 percent for both assets and could therefore leverage itself 12.5 to 1, then the expected before credit loss margin on bank equity for the AAAs would be 6.25% and for the small business 50%, a difference of 43.75%.

But, since the bank is allowed by Basel to hold only 1.6 percent against AAA rated assets, which implies permitting a leverage of 62.5 to 1, the previous margin 6.25% margin for AAA assets becomes a whopping 31.25%, which now implies a difference in the margins on equity of only 18.75% when compared to that generated by the small businesses.

In order to restore the initial required competitive margin difference of 43.75, now only 18.75% the small businesses will have to generate for the banks an additional gross margin of 25 percent, which, divided by the 12.5 to 1 leverage allowed for their class of assets, comes out to be the additional 2 percent in interest rate referred to.

Of course a complete analysis would require considering many other dynamic factors, but those would only help to fog the basic truth that our regulators are discriminating against those the banks are most supposed to serve.

What will it take for the regulator to understand that this is no minor problem, especially when so much of any job recovery lies in the hands of small businesses and entrepreneurs?

What will it take for the regulator to understand and admit that the regulatory discrimination in favor of the AAAs caused the current financial crisis?

We do not need a "Financial Stability Board" we need a "Financial Systems Working for the World Board."

You can put the responsible for the financial stabilization from all the countries of the world on this Board and you will not achieve diversity nor will it serve any real good purpose since finance is much more than a pure wimpy quest for stability.

Allowing these one-kind-of mind regulators to do whatever they please in their mutual admiration club will only result in that hubris that had them thinking they could control for risk; designing capital requirements for banks that required a 12.5 to one leverage when lending to small businesses and entrepreneurs, those on whom we depend so much on for jobs, but cannot afford being rated by the raters; but allowed a 62.5 to one leverage, five times higher, when banks were stocking on public debts like Greece’s, just because some human fallible credit rating agencies rated Greece as good.

Do you believe for instance this should be the Charter for an institution designed to make the Financial System to work for us?

Article 1. Objectives of the Financial Stability Board

The Financial Stability Board (FSB) is established to coordinate at the international level the work of national financial authorities and international standard setting bodies (SSBs) in order to develop and promote the implementation of effective regulatory, supervisory and other financial sector policies. In collaboration with the international financial institutions, the FSB will address vulnerabilities affecting financial systems in the interest of global financial stability.

Article 2. Mandate and tasks of the FSB

(1) As part of its mandate, the FSB will:

(a) assess vulnerabilities affecting the global financial system and identify and review on a timely and ongoing basis the regulatory, supervisory and related actions needed to address them, and their outcomes;
(b) promote coordination and information exchange among authorities responsible for financial stability;
(c) monitor and advise on market developments and their implications for regulatory policy;
(d) advise on and monitor best practice in meeting regulatory standards;
(e) undertake joint strategic reviews of the policy development work of the international standard setting bodies to ensure their work is timely, coordinated, focused on priorities and addressing gaps;
(f) set guidelines for and support the establishment of supervisory colleges;
(g) support contingency planning for cross-border crisis management, particularly with respect to systemically important firms;
(h) collaborate with the International Monetary Fund (IMF) to conduct Early Warning Exercises; and
(i) undertake any other tasks agreed by its Members in the course of its activities and within the framework of this Charter.

(2) The FSB will promote and help coordinate the alignment of the activities of the SSBs to address any overlaps or gaps and clarify demarcations in light of changes in national and regional regulatory structures relating to prudential and systemic risk, market integrity and investor and consumer protection, infrastructure, as well as accounting and auditing.

Warning!: After some years of giving the big banks growth hormones to help them turn into “Too-Big-To-Fail-Banks” any day these stabilizers will inform us who these definite TBTF are, and then we are really stuck with them, forever, or at least while they eat each other up and we are finally left with “The Only Bank of the World”

Perhaps Joseph Stiglitz should return his Nobel Prize

Stiglitz correctly holds that whenever there is imperfect information or asymmetric information, in essence always, the reason the invisible hand seems to be invisible it is because it is not there. One of the problems for this is of course that the markets are not efficient information transmitters… because if they were “no one would have any incentive to gather information”.

Is this why he never spoke out when the regulators appointed the credit rating agencies as official information gatherers for the purpose of establishing the capital requirements of banks?

If so how intellectually stupid to think that giving so much power to some very few opinion givers would solve the lack of asymmetric information in the market and not just dangerously increase the size of the asymmetric information gaps? He should perhaps return his Nobel Prize!

Stigliz is now also telling us we should ask “what is the financial system supposed to do?” Why did he himself not ask that before? Did he not know that our current primary bank regulators, those holed up in the Basel Committee, do not utter a word on the purpose of our banks in the Basel II regulations approved by G10 in June 2004?

The regulators in Basel, with amazing hubris thinking they could control for risk, designed capital requirements for banks that while allowing for what sounds like a reasonable 12.5 to one leverage when lending to small businesses and entrepreneurs, those on whom we depend so much on for jobs, but cannot afford being rated by the raters; they permitted the banks to leverage 62.5 to one, five times more, when stocking on public debts like Greece’s, just because some human fallible credit rating agencies rated Greece as good? Did Stiglitz not know about this either? For someone who likes to talk so much about development, he should have.

PS.1. Stiglitz states “The financial sector paid good money to make sure the regulators weren’t doing what they were supposed to do!” If I was a member of the Basel Committee, which of course I am not, I would ask Mr. Stiglitz to clarify what he seems to be implying.

PS.2. In minute 55:50 you hear Stiglitz saying: “What rate of return do we need to get on our investments in order for the tax revenues that we get from the short run growth and from the long run growth lead to an actual reduction in the national debt in the long run?; and the answer is a very low return, only about 5 to 6 percent return on public investments will lead to a long lower long term national debt; and the evidence is that the returns from investments for instance in public technologies are much-much higher…. so we should encourage expenditure that yield returns.”

And when I hear that I shiver, because I know that he knows, this argument will support expenditure that will not yield returns… but which is ok with his agenda. Somewhere in there, Stiglitz refers to “when we hear those politicians talk” What a laugh!

In order for the world to recover its footing it cannot be afraid of risks.

Figure 2.1 of the Global Economic Prospects 2010, Crisis Finance, and Growth, page 49, is titled “Since the early 2000s, credit expansion has grown more than twice as fast as nominal GDP”. In it we see that Global Banking Assets followed closely World nominal GDP until it accelerates in 1997 and truly explodes around 2004. At the end the index of 100 at June 1990 had grown to about 580 for Global Banking Assets while only to around 250 for the World nominal GDP.

The figure contains most of the mostly untold truth of what led us to this crisis, namely the incredible relaxation of the capital requirements that resulted from Basel I and especially Basel II (1994) when the regulators decided that the credit rating agencies were capable of identifying what was risky and what was not.

The capital requirements for banks were brought down from a traditional range of 8-12 percent for any type of assets to an unbelievable low 1.6 percent when related to operations with private sector AAA ratings or even zero percent for the case of the sovereign AAAs. These lowering of capital requirements released a tremendous lending power of the banks, and which created havoc in the capital allocation mechanism of the markets and caused a stampede into safe-havens that, as a consequence, became overcrowded and extremely dangerous AAA havens.

It is an untold story as comes clear from the following paragraph that appears on the same side of the report and that pertains to one of “the competing and not necessarily contradictory explanations” for the crisis. It reads: “An excessive loosening of regulatory oversight. The reduction of regulatory barriers to speculation and excessive reliance on self regulation of the banking sector in industrial countries generated and failed to curb excessive risk taking by financial institutions.”

And I ask how can one speak about excessive reliance on self regulation of the banking sector, when the risk analysis that determines the adequacy of bank capital is outsourced to some few human fallible credit rating agencies?

Yes, ex-post it might seem as excessive risk-taking, but ex-ante it was most clearly a result of an excessive trust in the credit rating agencies capabilities of identifying what is not risky, as if risks are perfectly identifiable and quantifiable.

What is now much weighing down the road to recovery is the need to rebuild those real bank equity ratios that were consumed by the supposedly risk free AAAs and which, from figure 2.1, seems to be extraordinarily large amounts.

But, we also need to correct the most basic fault of the current paradigm of our financial regulations, namely that the regulators, on top of those benefits that coward capitals already assigns to what is perceived having low risk, felt they had to lay another layer of benefits in terms of low capital requirements for banks. What has the risk of bank defaults and the risk of credit defaults have to do with the general risks of human growth and development? Very little I would say.

Accepting that risk is the oxygen of any development and correcting the current regulatory bias against risk-taking, could only help development, whenever, wherever and in whatever form it occurs.

The World Bank, as the world´s premier development bank has as its prime responsibility to help the world at large to achieve a better understanding of what risk really signifies so that it is able to enter into a more rational relationship with risk.

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.

Published in the FT.com/Economistforum

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!

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.

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”

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.

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

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.

The UN Conference Crisis & Development June 2009 - My Dissapointments

UN Conference Crisis & Development June 2009 Disappointments
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