Regulators wrongly believe that to increase the stability of banks, they must stimulate risk-aversion.

Sir, I refer to Martin Wolf’s “Make policy for real, not ideal, humans” December 17.

In it and with references to the World Bank’s latest World Development Report (WDR2015); and Daniel Kahneman’s “Thinking fast and slow” he writes, “most of our thinking is not deliberative but automatic; it is socially conditioned; and it is shaped by inaccurate mental models”.

Clearly, the socially conditioning of believing experts to be unable to totally get things wrong, have stopped most, Martin Wolf included, from accepting the fact that current bank regulators decided automatically with no deliberation and based on inaccurate mental models. Let me for the umpteenth time repeat the evidence:

Automatic thinking would be: Risky is risky, safe is safe, and therefore banks should be required to hold more capital against risky assets based on perceived risks.

Deliberative thinking would be: What is risky might not be risky if it is perceived as risky, while what is perceived as safe might be really dangerous if it turns out to be risky, and therefore perhaps banks should be required to hold more capital against what is perceived as safe, than against what is perceived as risky.

And an inaccurate mental model is one that is based on that the only purpose of banking is to serve as a safe mattress where to stash away our savings, while ignoring its fundamental social purpose of allocating bank credit as efficiently as possible. And because of that bank regulators did not care on iota about how with their credit risk weighted capital requirements for banks, they have caused huge distortions by allowing “safe” assets to produce much higher risk-adjusted returns on equity than “risky” assets.

WDR2015 mentions “the tendency of poor women to believe that the right treatment for diarrhea is to cut fluid intake, to stop their child ‘leaking’”.

Frankly, those in the Basel Committee, and in the Financial Stability Board, and most “experts” on regulations are just as wrong. They believe that the right thing to do for the stability of our banks (and our economies) is to stop the leakages… by increasing the risk-aversion.

Unfortunately, the power of “automatic” thinking is enormous. In July 2012 Martin Wolf wrote that I regularly reminded him of that “crises occur when what was thought to be low risk turns out to be very high risk” but, as we could see in his latest book “The Shifts and the Shocks”, he has yet not been able to internalize the meaning of it.