Systemic risks in the financial sector keep growing. Yesterday risk weighted capital requirements and credit rating agencies. Today artificial intelligence

I refer to Izabella Kaminska’s discussion of a report published by FSB on the financial stability implications of artificial intelligence and machine learning in financial services. “When AI becomes too big to fail”, FT Alphaville, November 1 

1: “This warrants a societal discussion on the desired extent of risk sharing, how the algorithms are conceived, and which information are admissible.”

That is a discussion that should also have taken place before regulators, with their risk weighted capital requirements, created incentives for our banks, one societal prime risk-takers, to avoid all what is perceived as risky, like SMEs and entrepreneurs, and concentrate exclusively on what is perceived, decreed or concocted as safe. 

2:“Fintech and AI are being aggressively marketed as our best and only opportunity to diminish the concentrated power of the banks. The terms “new entrants”, “disruption”, “fragmentation” and “open access” form the foundations of the movement. And yet… none of these clever systems, if the FSB is to be believed, are necessarily clever enough to fend off the forces of consolidation that bring about systemic risks.”

What can I say except to repeat what I as an Executive Director of the World Bank opined when in 2003 I learned that the Basel Committee was going to put so much power in the hands of some few human fallible rating agencies… and now we are to switch into some, or one, hackable AI?

“Ages ago, when information was less available and moved at a slower pace, the market consisted of a myriad of individual agents acting on 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 the 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.” 

“A mixture of thousand solutions, many of them inadequate, may lead to a flexible world that can bend with the storms. A world obsessed with Best Practices may calcify its structure and break with any small wind.”

Why do financial regulatory authorities, while preaching the value of diversification, act in favor of concentration?

Sir I refer to Harriet Agnew’s “FT BIG READ. Professional Services: Accounting for change” August 28.

In November 1999, in an Op-Ed in Caracas Venezuela, this is what I had to say on what is discussed there:

“I recently heard that SEC was establishing higher capital requirements for stockbroker firms, arguing that . . . ‘the weak have to merge to remain. We have to get rid of the rotten apples so that we can renew the trust in the system.’ As I read it, it establishes a very dangerous relationship between weak and rotten. In fact, the financially weakest stockbroker in the system could be providing the most honest services while the big ones, just because of their size, can also bring down the whole world. It has always surprised me how the financial regulatory authorities, while preaching the value of diversification, act in favor of concentration.

The SEC should not substitute the need for capital in place of the need for ethics, nor should it allow that fraudulent behavior hides amid the anonymity of huge firms. In this respect, let us not forget that the risk of social sanctions should be one of the most fundamental tools in controlling financial activities.

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.”

@PerKurowski

Europe, you need electrical, not financial engineers (like me)

A couple of years ago when the hundred-year-old private electric utility company that served my hometown (a South American city) was taken over by an international player, it became within a short time leveraged up to its hilt in debt, and I suspect also poison pills and golden parachutes, and I knew we were heading into the wrong direction. When I now read about all the consolidations in Europe, which can only distance consumers from their day-to-day local electrical engineers and place their needs in some distant foreign trading rooms, I feel the same, although clearly, if Europe is now an all-of-the-same Europe, I could be wrong. What I do know, though, is that all those high valuations paid by financial wizards purchasing utilities will, sooner or later, need to be repaid by all those European electricity consumers who are currently living in blissful ignorance.

Sent to FT, September 8, 2005