January 06, 2016

IBM, Watson could have a role in regulations that accept the need of the real economy for banks to take credit risks

Sir, I refer to Richard Waters report on the difficulties IBM faces in expanding the application of its Jeopardy champion Watson, “FT Big Read: Artificial Intelligence: Can Watson save IBM” January 6.

In it quotes Lynda Chin mentioning the challenge that “On Jeopardy! there’s a right answer to the question, but, in the medical world, [in the real world] there are often just well-informed opinions… [So how to know] how much trust to put in the answers the system produces. Its probabilistic approach makes it very human-like… [Watson] Having been trained by experts, it tends to make the kind of judgments that a human would, with the biases that implies.”

Indeed how much trust is just another way of stating how much risk is one willing to take.

For instance if one wants driverless cars to provide absolutely security, then traffic will probably become very slow, or even come to a standstill. And one of the difficulties these cars will encounter will be based on defining the acceptable amount of risk taking.

Likewise, if one wants our banks to be absolutely secure, then one would be better off with hiding money under mattresses in bank vaults… but the real economy would be languishing because of the lack of credit.

So there might be a big role for Watson in bank regulations. First of all it could help me convince the Basel Committee of that their credit risk weighted capital requirements are based on a very faulty human bias against risk; something which at the end of the day only endangers banks, since it causes excessive exposures to what is perceived as safe, precisely that which has caused all major bank crisis.

And, if fed with continuous information on bank credit and the state of the real economy, Watson could also be used to automatically send out countercyclical adjustments. Too much growth in credit… increase capital requirements somewhat… too little growth in credit reduce capital requirements somewhat. The most important thing needed for that would be to make Watson immune to lobbying pressures of all sorts.

What I would not allow Watson to do though is to display that kind of human arrogance of thinking itself capable of setting different capital requirements for different assets, so as to distort the allocation of bank credit as it thinks fit to distort.

To do that, I would still want a human to be behind that kind of risk taking… of course a human who understand what he is doing and is willing to be held very much accountable, if taking the next generations down the wrong path.

@PerKurowski ©