How long will it take for bank regulators to ask AI regulators for a little favour?

Sir, Michael Skapinker writes: “Why did no one speak up “inside Sil­icon Val­ley Bank before it col­lapsed? People thought speak­ing up would leave them vulnerable to vic­tim­isa­tion.” “Listen and you might learn something” FT July 17.

Thought, or knew? 

What should a risk manager know about the risk of informing the board that according to revised models that included the interest rate risk (duration), SVB’ risk weighted capital/equity requirements would increase substantially? 

Would a bank supervisor like to go on record informing his superiors, the regulators, that because of IRR, the 0% risk weighting of long-term US Treasury bonds made no sense?

Sir, instead of exposing humans to victimisation, it seems precisely the moment that we could make great use of artificial intelligence. 

E.g., I asked ChatGPT – OpenAI: “Should regulators and supervisors be aware of risks with US Treasury long-term bonds? 

It answered: “Yes, they should be aware of the duration risk and interest rate risk associated with long-term Treasury bonds held by banks”

But of course, AI could be vulnerable to victimisation too.

I asked Open AI:” Can those who become an Artificial Intelligence regulator, make you or any other AI participants agree with all they want you to agree with?” 

It answered: “Regulators aim to address ethical considerations, potential risks, and ensure responsible AI practices… AI systems don't possess independent consciousness or the ability to willingly agree or disagree with regulations. Their behavior is determined by their programming and the data they have been trained on.”

Sir, you know much to well, that for more than two decades I’ve been vociferating, as much as I can, my criticism against the risk weighted bank capital requirements. Clearly when someone does want to hear, he does not hear. For instance, as Upton Sinclair Jr. explained it: “It is difficult to get a man to understand something, when his salary depends on his not understanding it.”

Therefore, when I heard about OpenAI, I asked it a series of questions. From the answers you must agree I found an ally. I just wonder how long it will take for bank regulators to shut it up. “We can’t have someone questioning the risk weights of 0% government – 100% citizens. Can we?”

How long will it take to FT to really listen to some of its faithful subscribers?

PS. US Treasury long-term bonds still carry a 0% risk weight.

https://subprimeregulations.blogspot.com/2023/04/chatgpt-openai-should-bank.html

https://perkurowski.blogspot.com/2023/07/ai-chatgpt-open-ai-artificial.html

https://subprimeregulations.blogspot.com/2023/06/my-questions-to-chatgpt-openai-about.html

@PerKurowski

They inject loads of liquidity, keep interests ultra-low and distort bank credit… and then they call the system results, systemic risks

Sir, Colby Smith reports “the booming $1.3tn market for leveraged loans — or those extended to highly indebted companies that are then packaged up and sold to investors as bonds — has faced a tide of criticism from central bankers and financial watchdogs. Former US Fed chair Janet Yellen warned of the “systemic risk” rising from the loans.” “Systemic risk fears intensify over leveraged loan boom” October 30.

Smith quotes Douglas Peebles, the chief investment officer for fixed income at AllianceBernstein with “Investors are deathly afraid of rising interest rates so the floating rate component paired with the fact that these loans have seniority over unsecured bonds set up an easy elevator pitch to buyers that may not be fully aware of the risks”

Why are investors deathly afraid of rising interest rates? Clearly because the rates being so low for so long, paired with huge liquidity injections has built up a mountain of fix rate bonds that few dare touch; except those who by means of lower capital requirements are given strong incentives to go there, like banks and insurance companies.

In this respect “the booming $1.3tn market for leveraged loans” is not a systemic risk but a system result. That regulation that increases the exposure of banks and insurance companies to long term fixed rate bonds, and thereby increases the interest rate risk, that is a real systemic risk. The problem though is that central bankers and regulators will never want to understand they are the greatest generators of systemic risks… as Upton Sinclair said “It is difficult to get a man to understand something, when his salary depends on his not understanding it.”

@PerKurowski

Bank regulators suffer “pre-dread-risk”, an exaggerated sense of fear and insecurity anticipating catastrophic events.

Sir, you know, and John Plender knows that over the years, with more than a thousand letters, I have warned that current capital requirements doom banks to dangerously overpopulate “safe havens” and equally dangerously under-explore the “riskier” but surely more productive bays where SMEs and entrepreneurs reside. And the regulators, as the safest of all safe havens, designated the infallible sovereigns… their paymasters.

In November 2004 FT published a letter where I said: “We 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.”

And now John Plender writes about “a shortage of so-called safe assets… a stampede into sovereign bonds with negligible or negative yields — Even a modest move in the direction of historic interest rate norms could pose a threat to solvency [of] banks whose balance sheets are stuffed with sovereign debt” “Why bullish markets did nothing for bearish boards”, August 6.

An in the discussion Plender mentions that “OECD economists [have] identified flawed incentive structures as part of the reason for divergent perceptions of risk… equity-related incentives and performance-related pay…earnings per share and total shareholder return, [which] are manipulable by management.”

And Plender also brings forward “economists at the Basel-based Bank for International Settlements believe that low interest rates beget yet lower rates because they cause bubbles, followed by central bank bailouts. Their worry is that we risk trapping ourselves in a cycle of financial imbalances and busts.”

But Plender, in true FT tradition, does not say one single word about the perverse manipulation of credit markets carried out by bank regulators.

Plender mentions Andrew Haldane putting “particular emphasis on the phenomenon of “dread risk”, a term used by psychologists to describe an exaggerated sense of fear and insecurity in the wake of catastrophic events.

But, does not requiring banks to have 500% more capital when they lend to “the risky” than when they lend to “the safe”, evidence the mother of all exaggerated sense of fear and insecurity… in this case anticipating catastrophic events… a sort of pre-dread risk?

Because, that is exactly what regulators showed when, with Basel II, they required bank to hold 8 percent in capital when lending to a “risky” SME or entrepreneur, but only 1.6 against AAA rated assets… and allowed zero capital when lending to infallible sovereigns.

PS. The OECD’s Business and Finance Outlook 2015 also similarly ignores the effects of the risk-averse bank capital requirements. When referring to the “reduced bank lending [which have] affected SMEs in particular” it shamelessly limits itself to stating “credit sources tend to dry up more rapidly for small companies than for large companies during economic downturns”. 

@PerKurowski

Greece, Europe, to keep your banking sector afloat, and in good spirits, look to Chile.

Sir, Wolfgang Münchau writes: “So to default “inside the eurozone” one only needs to devise another way to keep the [Greek] banking system afloat. If someone could concoct a brilliant answer, there would be no need for Grexit.” “A Greek default is necessary but Grexit is not” April 20.

I am sorry. I do not think the problem of banks is limited to the Greek ones. All European banks must surely have problems with excessive long-term exposures at low rates to what is perceived as “safe”, and to which they are seriously undercapitalized because of the risk-weighting… and any little tick up in interest rates could wipe out all their equity.

In my mind what Greece (and the rest of Europe) most need now is an ambitious recapitalization of banks plan that brings their equity up to around 8 percent for all assets… inclusively against sovereign debt. None of that risk-weighted assets nonsense that only confuses.

Chile might be the role model for how to proceed. Banks there were recapitalized by the Central Bank issuing local credit, in order to buy all the nonperforming loans of the banks. And the banks in their turn agreed to repurchase all non-performing loans, plus to pay some interests, out of retained profits... before resuming any dividend payments.

In fact that is what ECB should be doing with its QEs. To have ECB competing with pension funds and widows and orphans for whatever little “safe” assets there are left does not make much sense.

@PerKurowski

We must indeed fret the possibility of some fundamental lack of character at the Federal Reserve

Sir, Henny Sender makes a well argued call in “The Federal Reserve must not linger too long on QE exit” July 5; concluding with opining that “The Fed wants to have its cake and eat it too”, and asking “Might it be that the Fed has everything in reverse?" It is truly scary stuff! 

On August 23, 2006, you published a letter I sent titled “Long-term benefits of a hard landing”. Therein I wrote:

“Sir, While you correctly argue (“Hard edge of a soft landing for housing”, August 19,) that “even if gradual, a global housing slowdown would be painful” you do not really dare to put forward the hard truth that the gradualism of it all could create the most accumulated pain.

Why not try to go for a big immediate adjustment and get it over with? Yes, a collapse would ensue and we have to help the sufferer, but the morning after perhaps we could all breathe more easily and perhaps all those who, in the current housing boom could not afford to jump on the bandwagon, would then be able to do so, and take us on a new ride, towards a new housing boom in a couple of decades.

This is what the circle of life is all about and all the recent dabbling in topics such as debt sustainability just ignores the value of pruning or even, when urgently needed, of a timely amputation.”

And now Sir, soon eight years later, we can only observe how the Federal Reserve, even when facing clear evidence all what their liquidity injections and low rates have achieved is increasing or maintaining value of existent assets, and little or nothing has it done for the creation of any new real economy… are unwilling to cut the losses short, and keep placing more and more bets on the table… with our money!

Sincerely, no matter how we look at the Greenspan-Bernanke and incipient Yellen era at the Fed, we have reasons to fret the existence of some fundamental lack of character.

PS. Of course, when it comes to banks, the regulators have already evidenced plenty lack of character with their phobia against “the risky”. And so now they also have our banks placing ever larger bets on what is “safe”, blithely ignoring that in roulette, as in so many other aspects of life, you can equally lose by playing it too safe.

What does Martin Wolf know we don’t? It would seem very important to know

Sir, Martin Wolf holds that the Fed, and especially Bernanke, must be much more careful because “Careless talk may cost the economy” June 26. He is correct, but perhaps we should remember that careless actions might cost the economy even more, but, then again Wolf seems to know something that I, and may I say we don’t.

For instance, banks can lose fortunes by investing in fixed rate long term bonds when interest rates go up (just look at the chart he provides us with) but, in Martin Wolf’s opinion, “This is purely market-risk, not credit risk. That can be managed by a mix of lower leverage and, if necessary, regulatory forbearance.” And at least I just don’t get it.

Also Wolf holds that “It is unlikely that markets would cease to fund systemically significant financial institutions that have only mark–to market losses on safe haven government bonds”… and which must also mean he believes that the market would go on financing those banks at the previous low rates. And again, I don’t get this either.

And, just in case the market would not want to cooperate with the banks, Wolf argues that “the authorities will need to have plans to address such an eventuality”. What plans? To help banks unload all this I don’t could be worthless paper on some others? Or a Quantitative Easing II, the Fed buying those bonds from banks at way above market value? And so again, I am sorry, but I just don’t get this either.

But when Wolf writes “the likely result of a credible exit [of the US quantitative easing program] will be a shift towards assets in the recovering high-income economies”, that I do understand, even though that would normally go under the name of inflation, and that would most likely also be the result of a not-credible exit or even just a “tapering” down.

Since Martin Wolf seems to know so much more at least I would much appreciate if he were to provide us with further clarifications.

By the way, should not someone who can influence opinions as much as Martin Wolf, need to make a disclosure of his own investment portfolio? Perhaps that information could also help to enlighten us all.

Monothematic regulators are really not interested in interest rate risk

Sir, Gillian Tett asks on March 11 “Have we really learnt lessons of 1994´s sharp rate spikes?” The answer must be NO, foremost because regulators seem not the least interested in that topic.

Current banks regulations are 100 percent based on perceived risk of defaults… and so all other risks… like the interest rate risk Gillian Tett points out, or the risk that our financial system does not perform adequately its capital allocation function that I worry about… or the thousand of unknown risks that I lie around any next corner, are all ignored by these monothematic regulators.