Let’s pray AI does not lose its humility of accepting it needs HI

Sir, I refer loosely/closely to “Humans must remain at the heart of the AI story” by Marc Benioff, FT July 11, 2025.

About bank regulations, an obsession of mine, I dialogued with the recently introduced to society Grok 4, SuperGrok. 

In reference to whether a hypothetical “Super-Duper-Grok” could outperform the decentralized, messy wisdom of millions in the market, without amplifying systemic risks it stated:

“The market, as an aggregate of millions of individual decisions, is a remarkable mechanism for pricing risk and allocating capital. It’s not perfect—prone to bubbles, panics, and mispricings, its strength lies in its diversity of perspectives, incentives, and local knowledge. Interest rates act as signals, reflecting collective judgments about risk and reward. 

Now, imagine a “Super-Duper-Grok”—an AI with vastly superior data processing, predictive modeling, and decision-making capabilities. Could it outdo the market? In theory, it might:

But here’s the catch: centralizing risk management in a single AI, no matter how advanced, introduces new vulnerabilities:

Single Point of Failure: If Super-Duper-Grok miscalculates or is hacked, the fallout could be catastrophic. 

Model Risk: Even a super-AI relies on assumptions and data inputs. If those are biased or incomplete (e.g., missing “unknown unknowns”), it could misjudge risks. 

Loss of Human Judgment: Markets incorporate intuition, skepticism, and ethical considerations—qualities an AI might lack. An AI, however sophisticated, might over-optimize for measurable metrics, ignoring intangibles like cultural values or long-term societal resilience.”

Sir, if only those besserwisser bank regulators in the Basel Committee had possessed such humility. Then they would not have decreed those risk weighted bank capital requirements which so dangerously and weakening distort the allocation of credit.

Sir, it would seem that without stupid human intelligence to feed it, artificial intelligence could also become stupid. Thanks God, it seems that we will still be needed. Let's make sure we fulfill our part.

PS. I dare you to read the full dialogue I had with Grok4 SuperGrok 

 

12 years since, and yet the true cause of the 2008 crisis shall seemingly not be told

Sir, John Flint a former Before chief executive of HSBC writes: “Before 2008, regulators’ approach to conduct risk in banking was what they called “principles based” — deliberately light touch. It relied too much on banks’ abilities to govern themselves and it failed.” “Warning lights are flashing for Big Tech as they did for banks” November 30.

“principles based”? Yes, but tragically with risk weighted bank capital requirements based on a very wrong principle, namely that what’s perceived as risky is more dangerous to our bank system than what’s perceived as safe.

“It relied too much on banks’ abilities to govern themselves and it failed.”? No, it relied way too much on some very few human fallible credit rating agencies, a systemic risk.

“deliberately light touch”? If as Basel II allowed​, ​ banks could leverage a mindboggling 62.5 times their capital with assets rated AAA to AA, I would not call that a “light touch”, I would call it putting Minsky Moments on steroids.

“This time it is the technology sector rather than the financial that is leaving us all exposed.”

Sir, current bank capital requirements, 12 years since the 2008 crisis, are still mostly based on the expected credit risks banks clear for on their own; not on misperceived credit risks, 2008’ AAA rated MBS, or unexpected dangers, like COVID-19. Therefore, banks will again stand there with their pants down. A good job Sir?

@PerKurowski

Here a formal statement in 2003 as an Executive Director of the World Bank 

Here my brief explanation of the 2008 crisis

And here the 2019 letter I sent to the Financial Stability Board

What a pity Martin Weitzman did not chair the Basel Committee for Banking Supervision. If he had we would surely not have suffered the 2008 crisis.

Sir, Tim Harford when referring to an economic paper by Martin Weitzman on climate change classifies it as a “this changes everything” paper, leading him to conclude “extreme scenarios matter. What we don’t know about climate change is more important, and more dangerous, than what we do”, “How this economist rocked my world” September 14.

So I must ask why is it possible to understand that and yet so hard to understand the mistakes of bank regulations based on that what’s perceived as risky being much more dangerous to our bank systems, than what might be lurking behind that which is perceived as safe?

“The truly eye-opening contribution” — for Tim Harford — “was Weitzman’s explanation that the worst-case scenarios should rightly loom large in rational calculations.”

In January 2003 you published a letter in which I said, “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds. Friends, please consider that the world is tough enough as it is”. 

Sir was it not clear I was warning about big crises resulting from some human fallible credit rating agencies assigning a very safe rating to something very risky? Like that in 2008 caused by the AAA to AA rated securities backed with mortgages to the subprime sector? European banks and US investment banks, loaded up with because with those credit ratings they were allowed according to Basel II, to leverage their capital a mind-blowing 62.5 times.

Ten years later, when it comes to bank regulations, Martin Weitzman’s wisdom about “worst case scenarios”, is still blithely ignored.

PS. In April 2003, as an Executive Director of the World Bank, in a formal statement I wrote "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"

PS. My 2019 letter to the Financial Stability Board

PS. My 2019 letter to the IMF

@PerKurowski

The case against insane globalism also remains strong.

The purpose of the Basel Committee for Banking Supervision BCBS, established in 1974 is to encourage convergence toward common approaches and standards. That sure reads as it could qualify as that global cooperation Martin Wolf asks for in his “The case for sane globalism remains strong” July 16.

But what if it is not sane?

BCBS has basically imposed on the world the use of credit risk weighted capital requirements for banks.

Since perceived credit risks are already considered by bankers when deciding on the interest rate and the size of exposures they are willing to hold, basing the capital requirements on the same perceived credit risks, means doubling up on perceived credit risks. 

And Sir, as I have argued for years, any risk, even if perfectly perceived, causes the wrong actions, if excessively considered. 

I dislike the concept of any kind of weighted different capital requirements, because that distorts the allocation of credit with many unexpected consequences. But if we wanted to have perceived credit risk to decide bank capital, it would of course have to be based on the conditional probability of what bankers are expected to do when they perceive credit risks, and these might be wrongly perceived.

Would we in such a case assign a 20% risk weight to what is rated AAA and a whopping 150% to what is rated below BB- as in Basel II’ standards? Of course not!

And if we did not think that government bureaucrats know better what to do with bank credit they are not personally liable for, than entrepreneurs, would we then assign the “safe” sovereign a 0% risk weight and the “risky” not rated entrepreneur a risk weight of 100%, which would clearly send way too much credit to sovereigns and way too little to entrepreneurs? Of course not!

And if we thought having a job as important or even more so than owning a house, would we then allow banks to leverage so much more with residential mortgages than with loans to small and medium enterprises, meaning banks can obtain easier and higher risk adjusted returns on their equity by financing “safe” houses than by financing “risky” job creation? Of course not!

Sir, in 2003, when as an Executive Director of the World Bank I commented on its Strategic Framework I wrote: "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."

Does this mean that I do not agree with Martin Wolf when he argues in favor of multilateral co-operation? Of course not! But it sure argues for being much more careful when going global with plan and rules.

By the way in those same 2003 comments at the World Bank I also wrote: “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 it did not take the world long before drowning in 2007 and 2008 in the AAA rated securities backed with mortgages to the subprime sector in the U.S.

But have those who concocted those ill suited risk weighted bank capital requirements ever admitted a serious mea culpa? No, they have blamed banks and credit rating agencies.

And in EU the authorities assigned a 0% risk weight to all Eurozone sovereigns even though they all take up debt that is not denominated in their local printable currency. And no one said anything?

Sir, in the whole world, I see plenty of huge dangers and lost opportunities that can all be traced back directly to BCBS risk weighted bank capital requirements. 

So, besides having to be very careful when going global, we also have to be very vigilant on what the global rulers propose. Of course, for that our first line of defense are the journalists daringly questioning what they do not understand or like.

Has FT helped provide sufficient questioning about what the Basel Committee has and is up to? I let you Sir answer that question.

http://subprimeregulations.blogspot.com/2003/03/my-comments-on-world-banks-strategic.html

@PerKurowski

Does not common sense dictate that in good times we want our banks to be weary about what they perceive as safe? Does not what’s seen as risky take care of itself?

Joe Rennison writes: “Investors and rating agencies have warned that companies might struggle to refinance huge debt burdens, resulting in downgrades from triple B into high yield or “junk” territory.” “BIS sounds alarm on risk of corporate debt fire sale” March 6.

What does that mean? Namely the risk that ex ante perceptions of risk might, ex post, turn out really wrong.

Also, “Bond fund managers could then have to sell the bonds as many are bound by investment mandates barring them from holding large amounts of debt rated below investment grade. ‘Rating-based investment mandates can lead to fire sales,’ warned Sirio Aramonte and Egemen Eren, economists, in the BIS quarterly review released yesterday.”

And what does that mean? Clearly procyclicality in full swing! Just like the insane procyclicality caused by the risk weighted capital requirements for banks.

Sir, does not common sense tell you that in good times we want our banks to be weary about what they perceive as safe, as what they perceive as risky takes care of itself? And in bad times, do we not want our banks not to be too weary of the risky, and burdened with having to raise extra capital when it could be the hardest for them?

Sir, so what are regulators doing allowing banks to hold less capital against what they in good times might wrongly perceive as safe, and imposing higher capital on what they would anyhow want to stay away from, especially in bad times?

Sir, for literally the 2,781 time, why does not the Financial Times want to dig deeper into unavailing what must be the greatest regulatory mistake ever? 

Are you scared of then not being invited to BIS’s Basel Committee’s and central banks’ conferences? “Without fear and without favour” Frankly!

@PerKurowski

Bank regulators insist on feeding the systemic risk of credit ratings, even after it became tragically evident.

Sir, Kate Allen writes “Funds that allocate capital based on instruments’ investment grades and index weighting may look as if they are playing it safe but they are, in fact, taking a gamble, creating towers of risk, any floor of which could prove unstable… do not look to the canaries in the financial markets’ coal mines to sound an early warning. By the time the downgrades come, it will be too late” “Tail Risk” February 28.

Indeed by the “time issuers’ credit ratings were downgraded, [banks] were already staring the worst-case scenario in the face.

Basel II’s standardized risk weights for the risk weighted bank capital requirements:

AAA to AA rated = 20%; allowed leverage 62.5 times to 1.

Below BB- rated = 150%; allowed leverage 8.3 times to 1

Absolute lunacy! With the same risk weight banks would anyway build up much more exposure to what they ex ante perceived as very safe, than against what they perceived as very risky.

As is, that regulation dooms our bank systems to especially large crisis, resulting from especially large exposures, to what is perceived as especially safe, against especially little capital. 

Allen observes: “An investment structure that is revealed to have done a bad job only when disaster arrives, as in the financial crisis”. Unfortunately no. Bank regulators blamed the credit rating agencies, and not themselves for betting too much on these, and so that so faulty regulations that should have been eliminated with a big “Sorry!” is still very well active. 

PS. In FT January 2003: “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds. Friends, please consider that the world is tough enough as it is.”

PS. At World Bank: April 2003: "Market or authorities have decided to delegate the evaluation of risk into the hands of much fewer players such as the credit rating agencies. This will, almost by definition, introduce systemic risks in the market"

@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

I trust banks and markets much more when regulators keep their hands off.

Sir, I refer to John Authers’ “In nothing we trust” Spectrum, October 6.

Let me give you brief one page version of my story:

1998, in an Op-Ed (in Venezuela I wrote) “In many cases even trying to regulate banks runs the risk of giving the impression that by means of strict regulations, the risks have disappeared…History is full of examples of where the State, by meddling to avoid damages, caused infinite larger damages”

1999 in another Op-Ed “What scares me the most, is what could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause its collapse”

January 2003, in a letter published by FT I wrote: “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds”

April 2003, as an Executive Director of the World Bank, in a formal statement, I repeated that warning: "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"

June 2004, the Basel Committee on Banking Supervision issued Basel II. By means of their standardized risk weights, they allowed banks to leverage a mind-blowing 62.5 times their capital if only an asset carried an AAA to AA rating issued by a human fallible credit rating agencies.

October 2004, in one of my last formal written statements as an ED at the Board of the World Bank I held: “We believe that much of the world’s financial markets are currently being dangerously overstretched, through an exaggerated reliance on intrinsically weak financial models, based on very short series of statistical evidence and very doubtful volatility assumptions”

After reading an incomprehensible explanation provided in June 2005 by the Basel Committee I have, in hundreds of conferences tried to get the regulators to answer the very straightforward question of: “Why do you want banks to hold much more capital against what, by being perceived as risky, becomes less risky to our bank systems, than against what perceived as safe poses so many more dangers?” I have yet to receive answer.

So we have regulators who still, after a crisis caused exclusively by assets perceived as safe and that therefore banks could be held against less capital, allow especially large bank exposures, to what’s perceived as especially safe, against especially little capital. 

Sir, that dooms our bank system to especially severe crises. Why on earth should I or you trust them?

Sir, in hundreds, if not thousands of letters to you over the last decade, I have also tried to enlist FT in helping me ask that question (one that seemingly shall not be made) and to insist on receiving a comprehensible answer. I’ve had no luck with that either, so, respectfully, why should I trust your motto “Without fear and without favour”?

PS. Here is an aide memoire on the mistakes in the risk weighted capital requirements for banks.

PS. And this letter does not refer to the horrendous introduction of full fledged statism that happened when with Basel I in 1988 the regulators assigned a risk weight of 0% to the sovereign and one of 100% to the unrated citizen.

@PerKurowski

A world obsessed with Best Practices may calcify its structure and break with any small wind.

Sir, Nicholas Dorn in his letter “Drive for global banking conformity increases systemic risk” of September 18, refers to your leader article, “Waning co-operation will make the next financial crisis worse”, and MEP Molly Scott Cato’s letter “Global finance can work if rulemakers co-operate”, September 14. Dorn writes:

“Converging international financial regulation encourages similar business models and greater homogeneity of finance, raising systemic risk”.

“No one knows where the next crisis is going to come from. The more useful question is how the propagation of crises through the system can be minimised”

“The plain implication is the need for greater variation in finance, so that such risks as do arise cannot so easily ripple through the global ensemble. What is desperately needed, therefore, is not bland global conformity but more variation between important regulatory regimes.”

I could not agree more. In April 2003, as an Executive Director of the World Bank, I made the following formal statements at the Board, which relate directly to those fundamental points Dorn raises.

"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.”

“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.”

What else can I say? Well perhaps that that statement also included:

“Basel dictates norms for the banking industry that might be of extreme importance for the world’s economic development. In Basel’s drive to impose more supervision and reduce vulnerabilities, there is a clear need for an external observer of stature to assure that there is an adequate equilibrium between risk-avoidance and the risk-taking needed to sustain growth”

Sadly Sir, as I have written to you umpteenth times, a different purpose for banks than just being a safe place where to stash away cash (and implicit to help fund the sovereign) is nowhere to be found in all the voluminous official writings about bank regulation.

Was I able to get my message thru? No! I guess the attraction of that with risk weighted capital requirements the regulators would be able to make our banks safer, was such that not even FT was (is) able to resist the songs of Basel Committee’s sirens. 

@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

Indeed, reforming the credit rating market is an urgent necessity. Indeed, shame on the regulators

Sir, Arturo Cifuentes concludes, “Reforming the credit rating market is an urgent necessity. Shame on the regulators” “Few lessons have been heeded 10 years after Lehman collapse” August 23.

Yes shame on the regulators! But also for some other reasons than those Cifuentes mentions.

Just for a starter, the credit rating agencies would never ever have caused so much damage had their opinions not been leveraged immensely by the risk weighted capital requirements for banks. Imagine, Basel II, 2004, allowed banks to leverage 62.5 times if only a human fallible credit rating agency assigned an asset an AAA rating. 

It should have been crystal clear that with that the regulators were introducing a huge systemic risk in the banking sector. That I mentioned for instance in a letter published by FT in January 2003; and I loudly explained and protested it while an Executive Director in the World Bank during those Basel II preparation days.

In Europe, the EU authorities even overrode the credit rating agencies opinions and assigned Greece a 0% risk weight, which of course doomed it to its current tragic condition. 

Then, let us mention the mother of all regulatory mistakes; for their risk weighted bank capital requirements, initiated in 1988 with Basel I, the regulators used the perceived risk of assets instead of the risks of those assets conditioned on how their risks are perceived? How loony, how sad, what a distortion, what a recipe for disaster was not that? And still, 30 years later, they do not even acknowledge their mistake.

By the way, when Cifuentes denounces that Solvency II, with its myopic risk view, will discourage insurance companies, the natural holders of illiquid assets, to hold these investments, and it will therefore increase the systemic risk by making their portfolios less diversified, I could not agree more.

Sir, you know that for over more than a decade I have written to Financial Times 2.787 letters objecting to the “subprime banking regulations”, this one not included. Galileo could indeed be accused for being obsessed with his theories, but, could those doing their utmost to silence his objections, the inquisitors, not be accused of the same?

PS. Cifuentes mentions “Olivier Blanchard’s 2016 admission that incorporating the financial sector in macro models would be a good idea”, I might have had something to do with that.

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

@PerKurowski

EU bank regulators have clearly proven themselves to be a source of systemic risk

Sir, Jan Toporowski writes that the “White House…represents a much more serious systemic threat to European banks. European governments and the ECB need to rethink how European banks are funded and regulated.”, “Threat to European banks of US political agenda”, August 14.

That could be but, foremost, it is the EU that needs to rethink how European banks are regulated. The 0% risk weight that for the purpose of bank capital requirements was assigned to Greece was, without any doubt, what caused that country’s excessive public debt tragedy. And did any EU authority offer to help Greece in order to compensate for that mistake? No! Not even the slightest “We’re sorry”. They do not even acknowledge their mistake… they just keep on blaming Greece.

@PerKurowski

The Stock Exchange should report, in real time, the current average holding period for each security.

Sir, Megan Greene writes: “The average holding period for a security on the New York Stock Exchange has fallen from two months in 2008 to just under 20 seconds today, according to analysis from Cumberland Advisors” “Passive investing is storing up trouble” August 3.

I had no idea we were into holding periods measured in seconds. Some years ago U.S. Sen. Mark Warner mentioned "The average time someone used to hold a share of stock back in the ’60s was eight years.”

Seeing this, it’s clear the stock market should begin to report the individual holding period for each security. Any ordinary investor, who makes his own slow analysis to come up with a decision whether to buy or sell, I assume would not really want to be competing against computers working in milliseconds… distant from fundamentals.

And Megan writes about the systemic risk present in “Passive investments… Often set up to mimic an index, ETFs have to buy more of equities rising in price, sending those stock prices even higher…creates a piling-on effect as funds buy more of these increasingly expensive stocks and less of the cheaper ones in their indices — the polar opposite of the adage “buy low, sell high” … [with] no regard for underlying fundamentals”.

In that Megan is not very far away from that systemic risk I so often write to you about, namely that of higher capital requirements for banks against what is perceived safe than against what is perceived risky. First, those capital requirements take no consideration of the purpose of the credit; and second they are the polar opposite of what they should be, since what is perceived as safe is in fact much more dangerous to our bank systems than what is ex ante perceived as risky.

@PerKurowski

When huge mistakes that hurt all of us are made, but no one is even publicly ashamed for these, what does that hold for our future?

Sir, John Authers writes about “The power unwittingly vested in ratings agencies. Regulations steered fund managers into credits with a certain minimum quality. Banks knew the capital they had to hold as a buffer depended on the rating the agency gave credits they held. The result was fund managers left judgment on credit quality to the agencies, while trying to bamboozle agencies into granting higher ratings than many securities deserved.” “Consultants’ claims and the evasion of responsibility” July 20.

“Unwittingly”? Meaning …without being aware; unintentionally? 

No! John Authers should allow the regulators to get away with that!

One needed not to be an expert on bank regulations to know that assigning so much power into the credit rating agencies was (is) simply wrong.

A letter I wrote to the Financial Times that was published in January 2003, stated: “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds. Friends, please consider that the world is tough enough as it is.”

And as an Executive Director of the World Bank, in a workshop for regulators who in May 2003 were discussing Basel II, I opined: “I simply cannot understand how a world that preaches the value of the invisible hand of millions of market agents can then go out and delegate so much regulatory power to a limited number of human and very fallible credit-rating agencies. This sure must be setting us up for the mother of all systemic errors.”

And in a formal statement at the Executive Board of the World Bank in March 2003 I prayed: “The sole chance the world has of avoiding the risk that Bank Regulators in Basel, accounting standard boards, and credit-rating agencies will introduce serious and fatal systemic risks into the world, is by having an entity like the World Bank stand up to them”.

So unwittingly it was not! And, really, if it was, then the more reasons to get rid of all those regulators fast.

Authers writes: “The problem is that when nobody takes responsibility, bad decisions can flourish”. Indeed, it is seriously critical for all of us that those who make serious mistakes are held accountable for it. 

So let me ask Sir: How many regulators have been fired or at least been publicly ashamed for this issue of the excessive importance to credit ratings, or for that matter for the much larger and serious issue of the utterly faulty risk weighted capital requirements for banks? Not a single one?

Could that partly be because you Sir, and too many of your colleagues, for whatever reasons of your own, have treated these regulators with the softest of the soft kid gloves?

Sir, as far as I know, you have not even been able to ask the regulators why they think that what is perceived as risky is more dangerous to our bank system than what is perceived safe.

Could it be because “Without fear and without favors” does not want or dare to hear the answer, or ask friends that question?

@PerKurowski

The Basel Committee’s bank regulators being replaced by an algorithm could be the best that could happen.

Sir, I refer to Gillian Tett’s “Self-driving finance could turn into a runaway train”, December 8.

Well human-driven banks are now not doing so well either. 

Any algorithm currently making credit decisions for a bank would do so based on maximizing risk-adjusted returns on equity, based on perceived risks of assets and on regulatory bank capital requirements regulations.

Where would it get the risk perceptions? Currently credit ratings… Who knows if in the future algorithms would also take over the credit rating functions… if these have not already done so?

Where would it get the capital requirements? Currently it get those from the Basel Committee’s standardized risk weights, or if the algorithm works for a sophisticated bank, from its own risk models.

So, if the algorithm does its job well, and works for a sophisticated banks, it would seem that in order to obtain the highest risk adjusted return on equity, its priority has to be creating the risk model that minimizes the capital requirement.

And if it works for a bank that uses the standardized risk weights, then it is clear it would not waste its time with what carries a 100% risk weight, like an entrepreneur, but concentrate entirely on those with much lower risk weights, sovereign 0%, AAA rated 20%, residential mortgages 35%.

So, with the risk weighted capital requirements it is clear that whether the banker is a human or an algorithm, we can forget about savvy loan officers… they will all be equity minimizers.

Of course, an entrepreneur can always offer to pay sufficiently high interest rates to overcome the regulatory handicap. But, would doing so not make him even more risky? With current regulatory risk aversion we should cry for the future real economy of our children.

Sir, in 2003, at the World Bank’s Executive Board (before Nassim Nicholas Taleb had appeared on the scene to discuss fragility) I stated: "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."

So, I guess you can you imagine how much I fret us humans falling into the hands of a final conquering algorithm.

Or having to suffer the consequences of the systemic risks resulting from banks using fewer and fewer human bankers… with probably higher bonuses to the remainders.

By the way since the replaced bankers used to pay taxes, will we at least be able to tax those algorithms?

But, come to think of it, if an algorithm substituted for bank regulators that could be great news. I mean any half-decent algorithm would be able to figure out that what is really risky for our bank system is not what is perceived as risky but what is perceived as safe.

And any half-decent algorithm would also require an answer to the question of “What is the purpose of banks?” And I suppose no regulator would dare tell it, “Only to make the maximum risk adjusted returns on equity” 

@PerKurowski

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.”

Financial Conduct Authority dare go after the Great Financial Distorters, your hubristic bank regulating colleagues

Sir, Madison Marriage, Peter Smith and Caroline Binham, reporting on the Financial Conduct Authority’s FCA work on investment managers write that: “tougher measures come as regulators and policymakers are turning their attention from banks to other parts of the financial system that could pose future risks.” “UK financial regulator lifts bar to create one of the toughest investment regimes” June 29.

Yes, but the part of the financial system that poses the most important current and future risks, are the regulators who with their risk-weighted capital requirements for banks, horribly distort the vital allocation of bank credit to the real economy.

Come on FCA, don’t waste time on the small guys, dare go after the big ones, even if they are your colleagues.

PS. FCA, suppose ALL Investment Managers behaved exactly they are supposed to do: Would that create less inequality? Would that represent more or less of a systemic risk?

PS. FCA, how can you help us have the wealthy 1% fall into the hands of really lousy investment managers, so as to fight inequality? :-)

@PerKurowski

FT, you are so utterly blind to the systemic risks intrusive bank regulations create.

Sir, with respect to the “US Treasury’s report on financial regulation reform” of June 14 you write: “The report does not propose doing away with any part of the regulatory regime wholesale. Capital and liquidity standards, stress testing, living wills, prudential regulation and the Volcker rule are all accepted in principle. In practice, though, the report urges that they be applied with less vigour, more discrimination and greater consultation with the industry”

Well that is bad! The report should take away most of it because “Capital and liquidity standards, stress testing, living wills, prudential regulation [and credit ratings]” is nothing but dangerous sources of systemic risks, introduced by regulators wanting to play bankers instead of acting like regulators.

For instance what do you think is gained by having all banks focusing on the same risk a la mode in a stress test, while ignoring if the real economy is getting the access to credit it needs in order to remain vibrant?

What would I propose instead of all that? Perhaps 3% capital requirements on all assets to cover for bankers’ ineptitude, and 7% capital requirements on all assets to cover for unexpected events, which comes up to the 10% proposed by the Financial Choice Act for smaller banks, but that I would love to see applied to all banks.

@PerKurowski

In terms of creating systemic risks for our banking system, current regulators are the undisputable champions

Sir, former banker and banking lawyer Martin Lowy writes: “Dodd-Frank and Basel III capital rules have made banks and their holding companies stronger.” “How the next financial crisis won’t happen”, June 10

Well I sure know that the next financial crisis will absolutely not be the result of excessive bank exposures to something perceived as risky, as to what is rated below BB-, that to which regulators assigned a risk weight of 150%. Much more likely it will be from excessive exposures to something rated as safe as AAA, that to which regulators only assigned a meager 20% risk weight.

Really big bank crises, except from really extraordinary unexpected events, are the result of the introduction of something that can grow into a systemic risk.

What systemic risk do I see?

I see credit ratings, like when in 2003 in a letter published by FT I wrote: “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds. Friends, please consider that the world is tough enough as it is”

I see risk weighted capital requirements, like those that allow banks to leverage more with what is “safe” than with what is “risky”., and therefore distorts, for no good reason, the allocation of bank credit to the real economy.

I see standardized risk weights that impose a single set of weights on too many.

I see regulators wanting to assure that banks all apply similar approved risk models, thereby again ignoring the benefits of diversification.

I see stress tests by which regulators make banks test against the some few same stresses, as if real stresses could be so easily identified.

I see living wills, as perfectly capable to create systemic risks that at this moment are hard to see.

In all, in terms of creating dangerous systemic risks, hubris filled bank regulators aee the undisputable champions.

The main cause for that is that our bank regulators find it more glamorous to concern themselves with trying to be better bankers, than with being better regulators.

Regulators, let the banks be banks, perceive the risks and manage the risks. The faster a bank fails if its bankers cannot be good bankers, the better for all.

Your responsibility is solely related to what to do when banks fail to be good banks.

And always remember these two rules of thumb:

1. The safer something is perceived to be, the more dangerous to the system it gets; and the riskier it is perceived, the less dangerous for the system it becomes.

2. All good risk management must begin by clearly identifying what risk can we not afford not to take. In banking the risk banks take when allocating credit to the real economy is precisely that kind of risks we cannot afford them not to take.

As in 1997 I wrote in my very first Op-Ed. “If we insist in maintaining a firm defeatist attitude which definitely does not represent a vision of growth for the future, we will most likely end up with the most reserved and solid banking sector in the world, adequately dressed in very conservative business suits, but presiding over the funeral of the economy. I would much prefer their putting on some blue jeans and trying to get the economy moving.”

@PerKurowski

Risk weighted capital requirements for banks, is a false solution that is destroying the western world

Sir, Martin Wolf writes: “By succumbing to the lure of false solutions, born of disillusion and rage, the west might even destroy the intellectual and institutional pillars on which the postwar global economic and political order has rested.”, “The march to world disorder” January 6.

Again Wolf prefers to ignore the perhaps most destructive false solution that has affected us.

Before 1988, bank credit, except for when criminal activity was involved, was allocated to what produced banks the highest expected risk adjusted return on equity.

But then, in order to make our banks safer, the regulators, with Basel I 1988 and Basel II 2004, imposed portfolio invariant risk weighted capital requirements for banks. Bank credit was thereafter allocated to what produced banks the highest expected risk and capital-requirement adjusted return on equity.

As a result banking changed dramatically, and the allocation of bank credit to the real economy became hugely distorted.

For a starter with risk weights of 0% for the Sovereign, and 100% for We the People, it introduced runaway regulatory statism, just while communism was disintegrating,

It also caused a dangerous risk aversion, which has bankers no longer financing the riskier future but only refinancing the safer past and present, something which of course is a driver of inequality.

How could it have happened? Six major factors stand out.

First, although hard to believe, bank regulators never defined what the purpose of banks is before regulating these. “A ship in harbor is safe, but that is not what ships are for.” John A Shedd, 1850-1926

Second, equally hard to believe, the regulators never researched what had caused bank crisis in the past; namely unexpected events, criminal doings and what were ex ante perceived as very safe but that ex post turned out very risky. What is perceived as very risky is, precisely because of that perception, what is least dangerous to the system. “May God defend me from my friends, I can defend myself from my enemies” Voltaire

Third, regulators completely missed out on that any risk, even if perfectly perceived, causes the wrong actions, if excessively considered, and doubled down on the ex ante perceived risks.

Fourth, an overreliance on data and models.

Fifth, not understanding that, as regulators, they could be introducing serious systemic risks.

Sixth, a general Groupthink, that which results from allowing experts to isolate themselves in a mutual admiration club.

The saddest part of the history though is how after so much evident failure, and evident waste of stimulus like QEs, the risk weighted capital requirements for banks is still discussed as part of a solution. To that we have many silencers, like you Sir and like Martin Wolf to thank for.

Sir, where would the western world have been if since Medici banks had used risk weighted capital requirements for banks

@PerKurowski