Could the Basel Committee learn enough from puzzles and poker so as to correct their misinformation?

Sir, I refer to Tim Harford’s “What puzzles and poker can teach us about misinformation” FT Weekend December 5.

When deciding on what’s more dangerous to banks the regulators in the Basel Committee, with “expert intuition” and great emotion shouted out the “below BB-” and, for their risk weighted bank capital requirements, assigned these a 150% risk weight, and a very smallish 20% to what’s rated AAA.

But, with what type of assets can those excessive exposures that could really be dangerous to our bank systems built-up, with assets rated below BB- or with assets rated AAA?

Never ever with assets perceived as risky, always with assets perceived as safe.

Sadly, the regulators had missed their lectures on conditional probabilities.

And their “expert intuitions” are so strong that they were not able to understand the clear message sent by the 2008 AAA rated MBS. 

What does Tim Harford think regulators could learn from puzzles and poker to correct their misinformation?

PS. Trying to understand the how come of the so loony bank regulations, by reading Daniel Kahneman’s “Thinking, Fast and Slow” 2011.

@PerKurowski

Competition among banks is healthy for all, except when banks are allowed to compete on stratospheric capital leveraged heights.

Sir, Nicholas Megaw reports on some natural concerns derived from the fact that “Britain’s banks and building societies are loosening lending standards and cutting fees to maintain growth, as competition and a weakening housing market squeeze profit margins.” “UK banks loosen mortgage standards to maintain growth” August 26.

Competition among banks is always good, what were we borrowers to do without it? If as a result, some banks fail, so be it, and in fact that is quite necessary for the long-term health of the system. 

But when competition occurs where regulators allows too much leverage, because they also perceive it as very safe, then the very high exposures to the same class of assets, by many banks, can really explode and endanger the bank system.

So in conclusion, welcome the lowering of lending standards for loans to entrepreneurs that bank competition can bring about; but the capital requirements for banks when financing residential mortgages need to be increased, in order to make competition less dangerous. 

PS. Here is the somewhat extensive aide memoire on some of the mistakes in the risk weighted capital requirements for banks.

@PerKurowski

Major bank crisis, are they most likely to result from excessive exposures to what’s perceived risky than for what’s perceived safe?

Izabella Kaminska ends her fun “Festive inefficiencies would be missed in Big Tech’s perfect world” of December 20 with “Since inefficiency has a way of popping up no matter what we do, it is human experience that should be prioritised before all else.”

Sir, let me phrase some questions:

How long could it take for a bank system to suffer a major crisis because of excessive exposures to what is perceived risky?

How long could it take for a bank system to suffer a major crisis because of excessive exposures to what is perceived safe?

Do our bank regulators care at all about human experiences when they require banks to hold more capital against what is perceived as risky than for what is perceived as safe?

Sir, do you really care about what human experiences teaches us?

@PerKurowski

The German banks overextension to the shipping industry represents a great opportunity for investigative journalism.

Sir, James Shotter writes: “Before the financial crisis, lending to the shipping industry was big business for many German banks. [Now] however, those maritime exposures have assumed a nightmarish quality.” “Perfect storm looms over shipping lenders” September 21.

What a wonderful opportunity to do some real journalistic investigation. Why does not Shotter dig in and research what bank capital requirements the financing of the shipping industry generated for German banks? And then try to figure out whether German banks would have been so dangerously overexposed to it, had they been required to hold the same capital as when lending to German SMEs and entrepreneurs.

@PerKurowski

If only regulators had had one of those “what-to-do” algorithms Tim Harford mentions before regulating banks.

Sir, Tim Harford refers to Brian Christian’s and Tom Griffiths’ “Algorithms to Live By” in order to ask: “Can computer scientists –– help us to solve human problems such as having too many things to do, and not enough time in which to do them? He concludes “It’s an appealing idea to any economist”, among others because “Computers practise ‘interrupt coalescing’, or lumping little tasks together. A shopping list helps to prevent unnecessary return trips to the shop.” “An algorithm for getting through your to-do list” August 6.

How I wish the bank regulators had had access to such algorithms and to the lumping together of all their, not that small, but huge necessary tasks.

If so, they would have been remembered to define the purpose of the banks, among which is the need to allocate credit efficiently to the real economy stands out, and so they would have stayed away from their distortive risk weighted capital requirements.

If so, they would have remembered to read some books on past crises, or looked into some empirical data, and thereby have understood that bank crises are never ever caused by excessive exposures to something perceived as risky, but always from excessive exposures to something perceived as very safe when put on the balance sheet, and so they would have know their risk-weighted capital requirements were 180 degrees off target.

@PerKurowski ©

There are two entirely different kinds of risks. Investing in “risky”, and excessive investment in “safe”

Sir, Tracy Alloway reports that, as a result of “low volatility” which sets off ‘feedback loop”, “Banks warn of ‘excessive’ risk taking” August 7.

Excessive risk taking comes in two forms. Investing in something ex ante perceived as risky, and the most dangerous one, investing excessively in something, ex ante, perceived as “absolutely safe”.

It is important to make that distinction because while other investors might be running more of the first kind of risk, banks, especially because of risk-weighted capital requirements, are much more exposed to the second kind of risk.

For the society the second kind of risk is of course much more dangerous, since excessive investments in what is perceived as “absolutely safe” will take us nowhere.

Risk weighted capital requirements for banks guarantee excessive exposures against little capital

Sir, I refer to Martin Wolf’s lunch conversation with Andrew Smithers, “I don’t have any faith in forecasts” March 1.

In it Wolf quotes Smither saying “There’s a chapter in the new book on what I think economics should be about, which is not forecasts. It’s about not taking the wrong risks. You don’t know what’s going to happen but you can avoid excessive risk-taking and this, unfortunately, has not been the policy of the Federal Reserve”… and I would have to add, and neither of the Basel Committee.

Bank regulators, with their risk-weighted capital requirements, which are not even based on forecasts but on current ex ante perceptions of risks, guarantee excessive risk taking, against very little capital, to what is perceived as absolutely safe.

I am not copying Martin Wolf with this as he has expressed not wanting to hear more from me about risk-based capital requirements… he knows it all, at least so he says, but, since the above is precisely what Wolf seems unable to understand… perhaps you should copy him.

The fiduciary duty of financial journalists includes drawing attention to violations of the bank regulators fiduciary duties… capisce FT?

Sir John Kay writes “The reputation of finance has been degraded by the actions of few. But the few have been running the show” and I totally agree with him, though let me be clear, he refers to some few bankers, and I refer to some few bank regulators, “A Swansea ballboy¸ a union leader and the duty of bankers”, February 6.

If “fiduciary standards describe how people should behave when they manage the affairs of others” and if “in a sector as extensively regulated as financial services [where] the main determinant of behavior is the rule book”, is it not so that the absolutely highest fiduciary standards should then have to be expected from those who write the rule books for banks?

The whole package of Basel Committee bank regulations is in my mind in total violation of a regulators' fiduciary duties. Not only does it give banks immense incentives to create excessive and exposures to what is perceived as absolutely safe and which has always been the source of bank crises, but also, by discriminating against “The Risky” it hinders the banks to perform their most important societal duty of allocating economic resources efficiently.

And let me also remind you that one very important fiduciary duty of financial journalists is to, “without fear and without favour”, draw their readers’ attention to violations of bank regulatory fiduciary duties… capisce John Kay, and all you others in FT?

Some questions to the Masters of the Risks

Sir to anyone like Mario Draghi who in “A vision of a more resilient global economy”, November 14, seems to believe that making the credit rating agencies better at what they do would take care of their part of the problem, I would ask the following questions. 

What could be riskier, a credit about which an “expert” holds to be low-risk, which could lead banks to lower their guard, or a credit that because it has been perceived as being high-risk will probably be more carefully analyzed?

Could that not point to higher capital requirements for low risk credits and lower capital for higher risk, just the opposite of what the minimum capital requirements for banks now order? Is there not a big risk that the market instead of measuring the risks directly begins to measure the risks of a change of opinion of the risk setters? Do we then need agents to rate the credit rating agencies? And so on? 

Why do you think that solely by measuring the risk of default, without taking into account anything with respect to what could be the purpose of the credit, that this would put the world on a better track? Instead of having few credit rating agencies doing the job for the banks is it not better to give many banks full responsibility over their decisions?

Who ever told you that you had it in yourselves to be the Masters of the Risks? Who elected you?