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When will the history of the Basel Committee’s concoctions haunt us?

Friday, August 16, 2024 20:06

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Sir, I refer to Owen Walker’s “Haunted by history” FT Magazine, August 10. It ends with “Unfortunately Monte dei Paschi will not help to develop and sustain Siena as it has done for more than five and a half centuries.”

Unfortunately, that goes for all banks that were of importance to their localities.

In 1988 regulations known as Basel I was approved. It favored government debt and residential mortgages. That distorted but not too much. Loan officers used to follow the wishes of diverse Medici, must not have been too surprised. But then, in 2004, Basel II hit the banking world. With its risk weighted bank capital requirements so much dependent on credit ratings, the traditional loan officers, like Britain’s beloved George Banks, were thrown out. In came dangerously creative financial engineers. Their mission was now to maximize return on equity, not by good lending, but by minimizing bank capital, meaning bank equity, meaning bank shareholder’s skin in the game; in other words by maximizing leverage.

Not that all loan officers have been saints. Of course not. As in all parts of life, embezzlement and general uselessness was way too often present; but it was localized. Now it has been globalized. Monte dei Paschi’s financial engineers’ use of derivatives fabricated by Deutsche Bank or Nomura is just a minor example of it. A major one is how those securities backed by USA subprime mortgages, that when rated AAA allowed banks to leverage 62.5 times their capital, inundated European banks and caused the 2008 GFC.

How long will it take for the world to wake up to the fact that their expert bank regulators and supervisor, who lately, with all Basel III complexities multiplied in number and complexities, all missed their lectures on Bayesian conditional probabilities. As a consequence, they never understood that if they were going to use risk weighted bank capital requirements, something that for a starter was a bad hubris filled idea, then at least the weights should be conditioned to how bankers could be expected to act when perceiving risks.

Sir, David Rossi’s death, no matter how it occurred, is sad, but not remotely as much as the death of our banking system, that which made the western world prosper beyond belief.

One day our grandchildren will ask: How could our grandfathers so much favor banks refinancing their safer present, instead of financing our riskier future.

PS. Recently I asked ChatGPT which alternative, a leverage ratio or risk weighted capital/equity requirements, would most empower loan officers, and which one any creative financial engineers. Here its answer

@PerKurowski

http://teawithft.blogspot.com/2012/07/its-whats-safe-thats-risky.html

https://teawithft.blogspot.com/2016/12/the-way-ft-insists-in-treating-bank.html

Source: http://teawithft.blogspot.com/2024/08/when-will-history-of-basel-committees.html

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