July 09, 2017

Parc / Darpa, please ask the intelligent machines to explain to us, in simple terms, how human bank regulators think

Sir, Richard Waters writes about the difficulties to ascertain exactly how artificial intelligence, when sifting through immense amounts of data, reaches it conclusions. “Valley researchers press AI systems to explain their thinking in simple terms” July 9. 

Of course, if you are to follow the recommendations of someone, it is usually a very good thing to know how he (it) thinks.

But that is also relevant to humans. For instance I would love to understand why, if there has never even been a major bank crisis that has resulted from excessive exposures to something perceived as risky when placed on banks’ balance sheets, regulators came up with their risk weighted capital requirements for banks… more perceived risk more capital, less perceived risk less capital.

That causes banks to build up large exposures against little capital to what is perceived decreed or concocted as safe, like AAA rated securities and sovereigns like Greece; and to stay away almost entirely from “the risky”, like SMEs and entrepreneurs. 

I suspect it was because first they never gathered empirical data about previous banks crisis that made a relevant distinction between the ex-ante and the ex-post perceptions of risk.

And then because they might have only cared about avoiding the crisis and not one iota about how banks perform the allocation of bank credit between the crisis.

I have asked regulators over and over again about this but have not yet been able to extract even a crooked answer, much less a straight one… they just keep mum on it.

Perhaps Darpa could do us the favor to ask their intelligent machines, to explain to us, or at least to me, in simple terms, how human bank regulators think.

For instance why did they with their Basel II allow banks to leverage their capital over 62 times if AAA ratings were present, and only about 8 times with what was below BB- rated? Should they not have known that bankers love what’s “safe” and do not want to touch even with a ten feet pole something as risky as a below BB-?