IMF Seeks Views on Surveillance: Here are mine

IMF wrote me (and all others) a letter “We would welcome views on the three key areas: surveillance, financing, and the stability of the international monetary system.”

And this is what I answered picking up on a theme that I had tried to voice while an Executive Director at the World Bank, 2002-2004, with absolutely no luck.

Friends

We have bank regulations that say that if a bank relends our deposits to a sovereign rated AAA, then it needs no capital at all, meaning unlimited leverage; if it lends to a sovereign that has been rated A+ to A, or to a private client rated AAA, then it needs only 1.6 percent capital, implying a leverage of 62.5 to 1; but when lending to small businesses and entrepreneurs, those on whom we depend so much for our jobs, those who cannot afford being rated by the raters, those who the banks are supposed to help while they make it to the capital markets, then the banks are required to have 8 percent in capital and need to limit their leverage to 12.5 to 1.

This is insane, not only because it discriminates unfairly against the natural clients of the banks;

but also because it gives immense powers to human fallible credit rating agencies, also open to capture;

but also because it subsidizes the risk aversion that already exists in the market;

but also because it turns our bankers into automats following credit ratings like if it was a financial GPS;

but also because it forces the banks to react instantaneously to the same downgrading making all take the same exit at the highway at the same time, increasing the chances of a crash;

but also because going after AAAs probably defines the mother of all pro-cyclical regulations;

but also because when something goes wrong, as it must sooner or later, even with AAAs, then the banks are left with no capital at all when we most need them to lend;

but also because it assumes the existence of real and abundant AAAs even though this must be the scarcest specie of them all;

but also because it assumes that risk lies more in what is perceived as risky than in what is perceived as not risky and which is of course pure nonsense;

but also because I cannot really think of one single bank crisis set off by something perceived as risky;

but also because the biggest profits are obtained by squeezing in under what a real AAA’s roof should look like, credit risks that are as bad as possible, placing us on a very slippery slope;

but also because I could go on and on with other similar arguments:

I knew it was insane, decades ago, and I made most of those arguments even while an Executive Director of the World Bank 2002-2004, and I read and heard much similar criticism in the pre Basel II debates.

Unfortunately, no one in the World Bank could really do much about it, because, you see, the World Bank, a development entity, has, as I see it, been tricked into having to be quite silent on financial regulations, all in the name of an misguided “harmonization” with the IMF, which is more of a disciplinary entity.

On March 18 2004 when discussing at the Board “Strengthening IMF-World Bank Collaboration on Country Programs and Conditionality” with respect to Basel II I stated “This is very clearly a case where there is a good reason for a very strong interchange of opinions between the Fund and the Bank.” Of course no such discussion occurred and in June 2004 the G10 approved Basel II.

The explanation for the silence we can find in a document attached for the September 27, 1999 meeting of the Development Committee “Progress Report: The World Bank Group’s Role in Strengthening the New International” and that states: “To strengthen collaboration in the financial sector, a joint Bank-Fund Financial Sector Liaison Committee was established in 1998. Enhanced collaboration is also reflected in the Financial Sector Assessment Programs (FSAP), jointly undertaken by the Bank and the Fund, which aim at assessing a country’s financial sector strength and vulnerabilities and at identifying reform priorities in the context of the Fund’s surveillance and the Bank’s financial sector development work.”

And, though I cannot prove it I have the impression that the discussions in the “Bank-Fund Financial Sector Liaison Committee have not been sufficiently lively and, as to the FSAP, I refer to the following that I wrote in my Voice and Noise 2006.

The Financial Sector Assessment Handbook—a postscript:

In September 2005, the World Bank and The International Monetary Fund published the Financial Sector Assessment Handbook and as I read it, it is a perfect example of what I mean by excessive harmonization, so I need to make a special comment here.

You might have already read extensively in the chapter “BASEL—Regulating for what?” about my strong belief that the world is giving too much emphasis to how to avoid crises potentially occurring in the financial sector, as opposed to how that sector is performing its role intermediating credits, generating growth, and distributing opportunities for access to capital. Yes, bank crises are setbacks, but, if in their wake they leave continuous step-by-step advances in development, we might still prefer that to a financial sector that receives a perfect bill of health but does little for the rest of the economy. In fact, such avoidance of a crisis is most probably just a temporary mirage. Developing is balancing various risks, not looking to eliminate one.

Well, in this handbook, which is more than 450 pages long, only a very few pages, perhaps fewer than ten, salute the flag of assessing and helping the banks perform their true function in development, the WB’s basic agenda. Instead, most of this handbook centers on how to supervise banks and minimize the risk of bank failures, the IMF’s basic agenda. Chapter Four contains most of the little there is about development, and “4.6.4 Development Obstacles Imposed by Unwarranted Prudential Regulation,” gives us sixteen complete lines about how entry or start-up regulation and uneven supervisory practices can hamper competitiveness and create “undue reliance on tools that are likely to disadvantage small new firms (such as excessive mandatory collateralization requirements for bank loans).”

If I have ever seen what amounts to mere flag-waving, this is it, but, on the other hand, I must admit that these flag-wavers are at least quite transparent. Under the interesting subtitle “The Demand-Side Reviews and the Effect of Finance on the Real Sector,” we can read, “development assessments are interested in the users and the extent to which the financial services they receive (including from abroad) are adequate to their needs. Development assessments must express a general view on this issue, though in many countries, especially low-income countries, detailed quantification may be beyond the scope of the assessment.

Friends, I rest my case. It is quite obvious that on this vital issue, the World Bank has been harmoniously silenced. End of quote.

Therefore, my IMF friends, all I want to suggest at this moment, for the good of the IMF, the World Bank and of course for all the rest of us, as a fundamental piece of any IMF reform, is that you… scrap all harmonization agreements and start debating with the World Bank openly the issue of what our banks are really for, because, if you haven’t noticed it, there is not a word about the purpose of banks in the 347 pages of Basel II.

Let me before ending also restate my fundamental argument by making a reference to some briefs paragraphs that I included in my Voice and Noise, 2006

We need to make more transparent our harmonization.

Some of my colleagues have expressed concerns that the paper leaves open the possibility that the World Bank Group and the International Monetary Fund may express divergent views in their assessments. But to me it would be very disappointing if diversity of opinions is not brought to the forefront of the debate, truly transparently. We and the International Monetary Fund have different development agenda, and sometimes and somehow they could be in conflict. Nothing’s wrong with that! What we cannot do is to sweep our differences under the rug in the name of some wrongly understood harmonization. What we need to do is to learn to take more of the full debates to the different capitals instead of the prefabricated and well-packaged consensus.

Otherwise instead of having Good Cop–Bad Cop strategy discussion we might end up with just a totally Blah Cop. End of quote.

IMF, I sincerely appreciate this opportunity to put forward my arguments again. I cannot swear we would have been able to avoid this crisis but I can swear that had the economists at the World Bank (and even some at the IMF) been totally free to voice their concerns about the absurdity of the regulations coming out of the Basel Committee, we would have had a much better chance of it.

Below I will append part of what I said on this issue as an ED, and if you want to see what I said about Basel regulations before and while an ED at the Bank you can find it here:

And, since then I have spoken out loudly in: "Voice and Noise on Subprime Banking Regulations", “Tea with FT” especially under the label of Subprime Banking Regulations, "Finance for Development” and of course in the not so serious but too serious "AAA-bomb".

Also searching the web you will find quite a lot in: Global Crisis Debate Vox; The Baseline Scenario; Cafe Hayek; Dani Rodrik's Weblog … and even in some of the World Bank and IMF blogs.

Now if by chance what you were really looking for is a beginner’s but all inclusive explanation of the cause of the financial crisis, written for dummies, non experts and bank regulators then I invite you to READ IT HERE

Regards

Per Kurowski

I now append here something of what I said on “harmonization” as an ED of the World Bank 2003-2004

A. The following is an extract of my formal written statement as an Executive Director delivered on March 18, 2003 when discussing: Bank/Fund Collaboration on Public Expenditure Issues. The arguments I made are equally valid for the case of financial regulations and I often made exactly that point.

“Bank/Fund Collaboration, on any topic, is of extreme importance as it can be regarded both with hope as well as with apprehension. The direct casualties on any lack of logistical coordination will of course welcome immediately more collaboration, but, others might feel that there is an impairment of the value and transparency of public debate, when entities with quite different responsibilities and horizons, almost publicly agree to publicly agree, as a way of life. …

As the paper is intended to be made public we believe that for clarity it would benefit from a different structure, for instance by separating, preferably into different papers, the following issues:

1. Coordination of activities… the avoiding to step on each other’s toes or more importantly, on governments’ official toes…. a technical paper… not restricted to the Public Expenditure issue.

2. The second paper should exclusively address the fundamental issue whether the world would benefit from a closer Bank/Fund cooperation. In this respect, and as a matter of principle, we truly believe that consensus should be welcomed, but mostly when it is the result of a heated debate. We believe that we should shy away from anything that indicates a pre-planned consensus, as this is probably the number one cause of death of all the questioning and creativity that today’s developing economics so urgently needs.

3. Finally, and only after both previous issues have been adequately clarified, would it be time to analyze the specifics of collaboration on Public Expenditure issues. In doing so we also believe it beneficial to try to identify more clearly the traditional differences in opinions between the two entities – for instance with regard to the volume and structure of public expenditure, so as to be able to much clearer focus on the probable implications.

In this respect, in our opinion it does not sound like a good idea to force an ex-ante collaboration, in topics, that by nature should be considered from different angles, most specially where any differences in opinions and proposals are supposed to be sorted out later through political processes, in the respective countries.”

Also from the discussion of the previous I extract, verbatim from the formal transcripts, the following comment:

"Collaboration should not be measured, in my view, in terms of expediency and effective management between the Fund and the Bank but in how that collaboration really means to strengthen the voice of the countries. And in that sense, a country’s voice is strengthened always by learning to manage differences in the debate, not just by ignoring them or eliminating them. So I do think that some type of perspective, all the time reminding of the country ownership, has to be a little more pointed out.”

B. The following is from the verbatim transcripts of what I said when discussing “Strengthening IMF-World Bank Collaboration on Country Programs and Conditionality—Progress Report on March 18, 2004.

http://siteresources.worldbank.org/INTPSIA/Resources/490023-1120840449856/022404.pdf

"…two brief comments, the first on the importance of making clear that even though there are still specific differences between the Bank and the Fund, more than cooperation—it sometimes even requires some antagonism and discussion to really get to the depth of the issues.

And we want to make, for instance, one big example. Last week we heard the Global Development Finance Report where it was stated that in respect to the new proposed capital accord by Basel the following—that it will involve significant compliance costs for financial institutions—that there is a fear that implementation of the Accord may further discourage bank lending to developing countries—that the proposed Accord pays insufficient attention to the benefits of diversification and may overstate the risk of lending to developing countries as a result—that it will accelerate the process of disintermediation; that there is a clear risk that implementation of the Accord will amplify procyclicality of bank lending.

It is not clear that the Accord will fully achieve its central aim of establishing a level playing field for internationally active banks. As a result the new Accord is likely to result in very undifferentiated risk-weights for developing country banks; focusing on less risky borrowers, while domestic banks is concentrating on high-quality borrowers with potential risks for the health of the domestic banking system.

And there are a couple of more risks. This is very clearly a case where there is a good reason for a very strong interchange of opinions between the Fund and the Bank. I know it is assuring but we should in all this collaboration discussion, at least remind there are still some very strong discussions needed on other issues.

Secondly, just to question the use of surveys in these type of things. On page 13, we find that, for instance, 69 percent of Bank-Fund staff believes that programs are largely or substantially aligned with the country’s own development strategy although ten percent of Funds respondents and 13 percent of Bank respondents found little or no alignment.

In a question of that sort, it is much, much more interesting—we learn much more through really getting down into a detailed analysis of those 10 and 13 percent who believe they are not aligned than just going out on a general service system whether it is aligned or not. And I do think that these types of surveys should go further into detail—there might be very useful lessons—and not let ourselves to be guided by the implicit correctness of the majority."

Me and the Basel Committee

This is the story of an unheard of Basel Committee regulation skeptic, from the private sector of a developing country, possessing only a MBA and no PhD, and who by sheer crazy luck was assigned to one of the 24 Executive Director´s chairs at the World Bank.

As an ED, he did what he could to warn about the negative effects on growth and development that he was sure the financial regulations coming out from Basel had, and about the financial crisis his intuition told him was doomed to happen. Though he thinks he was reasonably eloquent and reasonably rational arguing his opinions, he was still unheard when his term ended… and is still mostly unheard, even after the crisis happened.

You see even if you find the truth thinking out-of-the-box that does not mean an iota if that truth is not allowed to enter the within-the-network.

It is funny, or perhaps tragic is a better word, to see how much struggle there is to have a bigger voice at the World Bank´s Board, when that does not seem to matter that much.

Here below then is his file on what he has written, said and done on this subject:

BEFORE BECOMING AN ED AT THE WORLD BANK

I had been a private consultant in financial and corporate strategy issues for more than 30 years when I started to write and publish articles on a weekly basis in Venezuela. Since that very moment I can document very serious reservations about the bank regulations coming out from the Basel Committee.

June 1997. In my very first published article “Puritanism in Banking” Daily Journal I wrote the following:

It is obvious that we must ensure that banks do not overstep their bounds while exercising their primary functions—a mistake which in turn would result in costly rescue operations. We cannot, however, in lieu of perfecting this control, lose sight of the fact that the banks’ principal purpose should be to assist in the country’s economic development and that it is precisely with this purpose in mind that they are allowed to operate.

I cannot believe that any of the Venezuelan banks were awarded their charters based purely and simply on a blanket promise to return deposits. Additionally, when we talk about not returning deposits, nobody can deny that—should we add up the costs caused by the poor administration, sins, and crimes perpetrated by the local private banking sector throughout its history—this would turn out to be only a fraction of the monetary value of the comparable costs caused by the public/government sector.

It is evident that the financial health of the Venezuelan banking community requires an economic recovery and any Bank Superintendent complying with his mission should actively be supporting said recovery instead of, as sometimes seems evident, trying to receive distinctions for merit from the Basel Committee.

If we insist in maintaining a firm defeatist attitude which definitely does not represent a vision of growth for the future, we will most likely end up with the most reserved and solid banking sector in the world, adequately dressed in very conservative business suits, presiding over the funeral of the economy. I would much prefer their putting on some blue jeans and trying to get the economy moving.

November 1998. “Regulations as enemies of bank missions”, Economía Hoy:

The saddest part of the regulatory chapter is that it never really immunizes us against risk. Even in portfolio based on probabilistic expectations and compensations by means of high interest rates we know that, one way or another, risk remain… and in many cases even trying to regulate, runs the risk of giving the impression that by means of strict regulations risks have disappeared. Sometimes it is good faith... sometimes it is only pure faith. When for example the SEC (Venezuela) arrogantly presumes of performing a significant mission, we know it is pure baloney.

Frequently, in matters of financial regulations, the most honest, logical and efficient is simply to alert about the risks and allow the market, by assigning prices for them, to develop its own paths.

I do not propose, not for a moment, that the State abandons completely the regulatory functions, much the contrary, what I propose is that it assumes it correctly. History is full of examples of where the State, by meddling to avoid damages, caused infinite larger damages. In the case of banking regulations developed to be applied in developed countries, I am not sure we are doing our country a favor adopting them with so much fervor.

But what are we to do? Regulations are fashionable and there are many bureaucrats in the world trying to find their little golden niche. I just read an article about a county in Maryland, USA, where, in order to be able to work as an astrologer and provider of horoscopes, you need to be registered and obtain a license in order to “read the hand palms. The cost of such license is 150 dollars.”

November 1999. I ended “The SEC, the human factor and the Big Bang”, Economía Hoy, with:

“The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause the collapse of the OWB (the only bank in the world) or the financial dinosaur that survives at that moment. Currently market forces favors the larger the entity is, be it banks, law firms, auditing firms, brokers, etc. Perhaps one of the things that the authorities could do, in order to diversify risks, is to create a tax on size.”

February 2000. In “Kafka and global banking” a major essay on the issue I wrote:

“I think about the consolidation currently going on among banks. With every day that passes we have fewer and fewer banking institutions worldwide with which to work. This trend has been marketed as one of the seven wonders of globalization. I believe the trend introduces other risks which have been ignored. Among these:

A diminished diversification of risk: No matter what bank regulators can invent to guarantee the diversification of risks in each individual bank, there is no doubt in my mind that less institutions means less baskets in which to put one’s eggs. One often reads that during the first four years of the 1930’s decade in the U.S.A., a total of 9,000 banks went under. One can easily ask what would have happened to the U.S.A. if there had been only one big bank at that time.

The risk of regulation: In the past there were many countries and many forms of regulation. Today, norms and regulation are haughtily put into place that transcend borders and are applicable worldwide without considering that the after effects of any mistake could be explosive.

Excessive similitude: By trying to insure that all banks adopt the same rules and norms as established in Basle, we are also pushing them into coming ever closer and closer to each other in their way of conducting business. Unfortunately, however, nor are all countries the same, nor are all economies alike. This means that some countries and economies necessarily will end up with banking systems that do not adapt to their individual needs.

The cost of global assistance: When Venezuela’s banking system went down the drain, there is no doubt that the cost of the crisis was paid integrally by the country itself. In today’s world, when we see that a series of international banks are investing in our country’s institutions, I often wonder what will happen when one of these behemoths runs into serious trouble in its own country. Will we have to pay for our part of the crisis, less than our part of the crisis or more than our part of the crisis?

As bank mergers and acquisitions increase and stock exchanges worldwide call for more consolidations, I have my doubts. Should we not be imposing the creation of special reserves for especially large banks? The larger they are, the harder they fall, and so the greater the need to avoid disaster.”

July 2000. In “Our economical policies suffer from inferiority complex”, Economía Hoy, I wrote:

Financial Regulations: …our country has adopted, without blinking an eye, the regulations coming out of the Basel Committee, that are more appropriate for the banking sector of a developed country than for ours. There is nothing wrong being a developing country, the bad is only to believe that by just adopting different postures, one could reach a different degree of maturity… just like the little girl who borrows mother´s lipstick in order to feel big.

August 2000. In “Local banks and global regulations”, El Universal, I wrote:

A local bank has a serious compromise with its sphere of influence, mostly because it has nowhere else to go. Speculating on that the globalization of our local banks started when Banco de los Llanos, from Valle La Pascua (a small town in Venezuela) morphed into the Banco Principal of Caracas-- we observed that did not prove to be very useful (Banco Principal disappeared in the bank crisis of 1994). Are we now to suppose the process that takes our banks to be managed from Madrid is better?


Then going through my clipbooks it seems like I gave up writing on the issue of financial regulations… until when out of the blue I was named Executive Director at the World Bank, for the term November 1, 2002 until October 31, 2004.

It did not take long for me to come back and scale up strongly on the issue… for the good that did!

WHILE AN EXECUTIVE DIRECTOR AT THE WORLD BANK
January 11, 2003 The Financial Times published a letter I sent them which ended with:

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.

March 2003. Discussing at the Board the “Global Development Finance 2003: Striving for Stability in Development Finance” report, I included the following in my written statement:

Argentina’s external debt furnace was stoked over a long period of time by high ratings issued by the credit rating agencies who, when they awoke surprised by the resulting mountains of debt, speedily reversed themselves 180 degrees, putting new pressure on interest and reinforcing the tragedy of a self-fulfilling prophecy… In this complete Report there is no mention about the issue of the growing role of the Independent Credit Rating Agencies, and the systematic risks that might so be induced, when they are called to intervene and direct more and more the world’s capital flows.

The report argues that a local banking presence of big global banks should help to improve the efficiency of the financial intermediation system of developing countries but since it also states that most domestically owned banks in emerging economies adopt the standardized approach to credit risk and so they will be at a comparative disadvantage vis-à-vis cross border lending by international banks we would like to understand better how that could play out?

The Report does not at all analyze the very fundamental issue that the whole regulatory framework coming out of the Basel Committee… is more biased in favor of the safety of deposits when compared to the need for growth. Even though, in theory, we could agree that there should be no conflict between safety and growth, in practice there might very well be, most especially when the approach taken is by having a few fallible credit rating agencies substitute for the market.

…with respect to credit derivatives… in relation to the losses from energy trading and their related derivatives there have been reports that markets are still unsure on where the losses are finally going to surface... and be paid for. As the financial sector grows ever more sophisticated, making it less and less transparent and more difficult to understand for ordinary human beings, like us EDs, it is of extreme importance that the World Bank remains prudently skeptical and vigilant, and not be carried away by the glamour of sophistication. In this particular sense, we truly believe that the Bank has a role to play that is much more important than providing knowledge per-se and that is the role of looking at how to supply the wisdom-of last-resort.

March 2003. Discussing “Financial Sector Assessments Program: Review, Lessons and Issues going forward” the following letter to my colleagues and which I extract from by book Voice and Noise, 2006, follows very closely the transcripts of what I stated.

Dear Friends and Colleagues,

After having identified in our Review of the Financial Sector Assessment Program 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,” it is shameful to observe that the only recommendations we put forward are “(i) enhancement of the central bank’s ability to deal with insolvent banks, (ii) strengthening of penalty provisions, and (iii) increasing minimum capital requirements.” Come on!

We all know that risk aversion comes at a cost, a cost that might be acceptable for developed and industrialized countries, but that might be too high for poor and developing ones and, in this respect the Bank has the responsibility of helping developing countries to strike a right balance between risks and growth possibilities. Please, let us never forget that the other side of the Basel coin might be many unique developing opportunities (credits) forgone.

Why do I make these comments with such candor? Besides having been alerted during many years about the consequences of a Financial Puritanism that seems to be invading the world—and that does not get the real culprits either—in the specific case of my country, the combined portfolio of credits in commercial banks fell in real terms from about US$ 16,000 million in 1982, to only about US$ 4,000 by 1997. In such scenario, to then hear about Basel and its prudence regulations reminds me of the makeup of a corpse already in rigor mortis although I should perhaps note that in the case of this particular corpse, even almost six feet under, it has anyhow been able to generate surprisingly large profits, for itself.

In the area of risk management in finance, it might be an appropriate time to remember what Franklin Delano Roosevelt said in his First Inaugural Address, March 4, 1933, namely that “the only thing we have to fear is fear itself” and so in this respect we very much need the Knowledge Bank to evolve more into a Wisdom Bank or at least a more humble Common Sense Bank.

In a seminar on housing finance we heard that “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.

As a small example, let me remind you that the World Bank has for some time and to no avail argued with respect to its own accounting that were it to follow strictly the current accounting rules, its financial reports would not reflect reality. Well, if the Bank has difficulties, imagine the rest of the world.

March 2003. My written statement that relates to the same discussion above contained the following:

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 the World Bank—is to fight poverty, and development is a task where risks need to be taken.

Staff recognizes that “no formal methodologies exist for how to address development issues in the FSAP” We welcome this candid review. However, going forward, we want to ask staff how they plan to include stronger links of the FSAP program to seriously address development issues.

(Here you can see what in 2005 came out of the discussions:
http://www.imf.org/external/np/fsap/2005/022205.pdf )

April 2003. Discussing “Implementing the World Bank’s Strategic Framework 04-06” I included the following in the written statement:

The Basel Committee dictates norms for the banking industry that might be of extreme importance for the world’s economic development. In the Basel Committee’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. The World Bank seems to be the only suitable existing organization to assume such a role.

Ages ago, when information was less available and moved at a slower pace, the market consisted of a myriad of individual agents acting on a limited information basis. Nowadays, when information is just too voluminous and fast to handle, market or authorities have decided to delegate the evaluation of it into the hands of much fewer players such as credit rating agencies. This will, almost by definition, introduce systemic risks in the market and we are already able to discern some of the victims, although they are just the tip of an iceberg. Once again, who besides the World Bank has enough standing to develop itself to be a credible wisdom broker in this area?

May 2003 in a very critical article about financial regulations titled “Basel” I wrote “In a world that preaches the worth of the invisible hands of the market, with its millions of mini-regulators we find it so strange that the Basel Committee delegate, without any protest, so much responsibility in the hand of so very few and so very fallible credit rating agencies”

I ended the same article with the suggestion that all regulation coming out from the Basel Committee should be forced to include: “Warning, excessive banking regulations from the Basel Committee can be very dangerous for the development of your country”

May 2003. Because I was an Executive Director and had expressed interest in the issue I was invited to make some comments at a Risk Management Workshop for Regulators at the World Bank. Since I was never invited again I guess I probably expressed too many concerns. Please read them here.

June 2003. Discussing a sort of related issue “Enhancing the Voice of Developing and Transition Countries at the World Bank” I included the following in the written statement:

In the context of the search for a Chief Economist for the World Bank, we recently heard that it would be a quite narrow search, as it obviously would have to contain itself to “a very small and exclusive community’. Rarely have we heard the problem of Voices been so concisely illustrated, as undoubtedly many of the problems that the world encounters today, might very well be the direct result of being limited in solutions to the minds of a small and exclusive community. We urge the World Bank to develop its full research effort in such a way as to develop a wide, diversified and vibrantly open and numerous community of development economists.

What is a clear and strong voice good for, in an overly noisy environment or in a desert where no one is listening? The current functioning of the Executive Board, with its robust abundance of Directors, all supposed to be looking simultaneously at too many things, stepping over their toes and impeded by sheer time constraints to give the due consideration that all cases deserve, is a clear case of ineffectiveness and that, adequately addressed should advance the strengthening of all voices,

January 2004. I sent the following letter “About the Global Bank Insolvency Initiative” to my colleagues. I used to send these letters because I needed more voice that I could have in the normal channels.

Dear Friends,

We recently had a technical briefing about the Global Bank Insolvency Initiative. Having had a special interest in this subject for some years, I wish to make some comments.

As I have always seen it, the costs related to a bank crisis are the following three:

• The actual direct losses of the banks at the outbreak of the crisis. These are represented by all those existing loans that are irrevocably bad loans and therefore losses without a doubt.

• The losses derived from mismanaging the interventions (workout costs). These include, for example, losses derived from not allowing some of the existing bad loans the time to work themselves out of their problems. They also include all the extraordinary legal expenses generated by any bank intervention in which regulators in charge want to make sure that they themselves are not exposed to any risk at all.

• The long-term losses to the economy resulting from the “Financial Regulatory Puritanism,” that tends to follow in the wake of a bank crisis as thousands of growth opportunities are not financed because of the attitude “we need to avoid a new bank crisis at any cost.”

For the sake of the argument, I have hypothesized that each of these individual costs represents approximately a third of the total cost. Actually, having experienced a bank crisis at very close range, I am convinced that the first of the three above costs is the smallest ... but I guess that might be just too politically incorrect to pursue further at this moment.

In this respect, it is clear that any initiative that aims to reduce the workout costs of bank insolvency is always welcome and in fact the current draft contains many well-argued and interesting comments, which bodes well for its final findings and suggestions.

That said, the scope of the initiative might be somewhat limited and outdated, making it difficult to realize its full potential benefits. There is also the danger that an excessive regulatory bias will taint its findings.

Traditional financial systems, represented by many small local banks dedicated to very basic and standard commercial credits, and subject to normally quite lax local regulation and supervision, are mostly extinct. They are being replaced by a system with fewer and bigger global bank conglomerates governed by a global Basel-inspired regulatory framework (that, among other things, bypass markets in favor of credit-rating agencies) and they operate frequently by transforming the Economic realities of their portfolios through mechanisms and instruments (derivatives) that are hard to understand even for savvy financial experts.

In this respect I believe that instead of dedicating scarce resources to what in some ways could be deemed to be financial archaeology, we should confront the new market realities head on, making them an explicit objective of this global initiative. For instance, what on earth is a small country to do if an international bank that has 30% of the local bank deposits goes belly up?

We all know that the financial sector, besides having to provide security for its depositors, needs also to contribute toward economic growth and social justice, by providing efficient financial intermediation and equal opportunities of access to capital. Unfortunately, both these last two objectives seem to have been relegated to a very distant plane, as the whole debate has been captured by regulators that seem only to worry about avoiding a bank crisis. Unfortunately, it seems that the initiative, by relying exclusively on professionals related to banking supervision, does little to break out from this incestuous trap. By the way if you want to see about conflict of interest, then read the section “Legal protection of banking authorities and their staff.” It relates exactly to those wide blanket indemnities that we so much criticize elsewhere.

And so, friends, I see this Global Bank Insolvency Initiative as a splendid opportunity to broaden the debate about the world’s financial systems and create the much needed checks and balances to Basel. However, nothing will come out of it if we just delegate everything to the hands of the usual suspects. By the way, and I will say it over and over again, in terms of this debate, we, the World Bank, should constitute the de facto check and balance on the International Monetary Fund. That is a role we should not be allowed to ignore—especially in the name of harmonization.

March 2004. Discussing the "Global Development Finance 2004: Harnessing Cyclical Gains for Development” report, and in relation to several reservations and concerns therein expressed with respect to Basel II, I stated:

I read “further discouraging Bank lending to developing countries”, “accelerates the process of disintermediation”, “risk that implementation will amplify pro-cyclicality of lending”, “initial credit ratings and ratings changes are sensitive to the business cycle”. Here the World Bank is saying Basel II is a disaster. Why are we not intervening in the process? Why are we letting this go forward? If we have raised our voice on trade issues why aren’t we raising our voice on this? … We have, for instance, not reacted either on the credit rating agencies—what are their roles, what type of systemic risks can they create in the world, what types of inflexibilities do they create?

The report also lacks an in-depth analysis of the growing risk-aversion that is inundating the world, and in my mind, sometimes I accuse, correctly or not, Basel II for having put too much risk aversion on the agenda… instead of growth. More risk aversion creates the risk of not doing anything and the risk of doing nothing is as immense as the risk of going ahead

(For your information on June 24, 2004 G10 signed up on Basel II… end of discussions, game over, the Basel Committee won... for the time being)

June, 2004. Discussing “World Development Report 2005: A Better Investment Climate for Everyone” I stated:

What strikes me….is the continuous conflict between the need to accommodate to local needs on the one hand, and on the other hand, the tendency towards more harmonization and world-based institutional regulations like, for instance in the financial area though Basel regulations… global fitness creates local tensions…

September 2004. Discussing “Debt Sustainability in Low-Income Countries” ” I included the following in the written statement:

…we really cannot understand the large importance given to the creation of a consensus between the World Bank and the International Monetary Fund… in the issue of banking regulations… we might on the contrary need the Bank to outspokenly differ from the Fund.

October 2004. Discussing the “World Bank’s Liquidity Management and Borrowing Program” I included the following in my written statement:

We join in the chorus of praise of the World Banks Group’s “Financial Complex.” It is precisely because they could just become too good for our own sake, and thereby fall into the human traps of complacency and excess of confidence, that we need to put forward some comments in order to pinch.

Phrases such as “absolute risk-free arbitrage opportunities should be banned in our “Knowledge Bank”. We believe that much of the world’s financial markets are currently being dangerously overstretched through an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions.

Just as an example, we should not forget how all the risk-assessment models had to be recalibrated to take into account for Argentina.

2003-2004 Also while an Executive Director of the World Bank, I was a member of its Audit Committee. My colleagues there should be able to attest that on almost every occasion we met with the financial department, I begged them to be extremely careful with counterparty risks, arguing that when push comes to shove even the best counterparty might mean nothing. I always saw the condescending despair in their eyes… “Here Kurowski goes again” I wonder where we all would be had someone not lent a helping hands to their AAA-rated counterparties?

October 2004. And, of course in my Farewell Speech at the World Bank, I included among my memories “Fighting the Basel Committee. Banking regulations should not solely focus on how to avoid crisis and bank failures, it also needs to promote credit and access to capital to foster growth”

AFTER COMPLETING THE TERMS AS AN ED OF THE WORLD BANK

And then I was out on the streets again and, now a freer man, I ratcheted up the volume somewhat. On November 18, 2004 the Financial Times published another letter or mine titled “The mutual admiration club of firefighters in Basel” in which I had written:

Sir, if a citizen from a developed country wishes to obtain finance from his local bank to buy a pricey retirement home in his local overheated market, then Basel poses no problem. But should he want to buy a much more affordable home in a developing country and have his bank there finance him, then Basel slaps such capital-reserve requirements on the bank as to make it an impossibly onerous proposition.

This is just one way by which our bank supervisors in Basel are unwittingly controlling the capital flows in the world. We also wonder how many Basel propositions it will take before they start realizing the damage they are doing by favoring so much bank lending to the public sector. In some developing countries, access to credit for the private sector is all but gone, and the banks are up to the hilt in public credits.

Please, help us get some diversity of thinking to Basel urgently; at the moment it is just a mutual admiration club of firefighters trying to avoid bank crisis at any cost—even at the cost of growth.”

And after all what I had gone thru, an extremely interesting surrealistic experience, I had no choice than to write a book Voice and Noise, write and follow some blogs, name myself a representative of Civil Society, present a paper at the UN thanks to New-Rules for Global Finance, go to conferences to listen to mostly mediocre Monday-morning-quarterbacks who had never said anything before the crisis broke out… all just in order to be able to participate briefly in the Q&A sessions… c'est la vie!... and as said before... even if you find the truth thinking out-of-the-box this does not mean an iota if that truth is not allowed to enter the within-the-network.

And out there, in the not so real  blogging world, I have since then written a lot about our “Subprime Banking Regulations”. These writings include many new angles most of which are equally applicable to developed countries. Most of them you will find directly in:

"Voice and Noise on Subprime Banking Regulations", “Tea with FT” especially under the label of Subprime Banking Regulations, "Finance for Development” and of course the not so serious but too serious "AAA-bomb".

Also searching you will find quite a lot in: Global Crisis Debate Vox; The Baseline Scenario; Cafe Hayek; Dani Rodrik's Weblog … and even in some of the World Bank and IMF blogs.

Now if what you were really looking for is a beginners but all inclusive explanation of the cause of the financial crisis, written for dummies, non experts and bank regulators then I invite you to READ IT HERE

Cheers

Per Kurowski