#AI ChatGPT - OpenAI: Are the risk weighted bank capital requirements some form of populism?

I asked OpenAI:

"Basel Committee, ignoring how it could distort credit allocation, de facto stated: 

'To make your banking system safer, we give you our risk weighted bank capital requirements'

Does that not contain a hefty dose of a populism? One that even confounds the intelligentsia?"

OpenAI answered:

"The statement you mentioned does not appear to contain elements of populism. The Basel Committee on Banking Supervision, an international regulatory body, aims to promote financial stability and strengthen the resilience of the banking system. Risk-weighted bank capital requirements are one of the tools used to achieve this objective.

The implementation of risk-weighted capital requirements is not driven by populism but rather by the need to align capital levels with the riskiness of bank assets. The intention is to ensure that banks hold sufficient capital buffers to absorb potential losses and maintain financial stability.

It is true that the implementation of risk-weighted capital requirements has been a subject of debate and criticism. Critics argue that the approach may have unintended consequences, such as distorting credit allocation or creating incentives for regulatory arbitrage. These concerns are rooted in the complexities and challenges associated with accurately assessing and weighting risks.

However, it is important to note that the Basel Committee comprises experts from central banks and regulatory authorities who work towards the stability and soundness of the banking system. Their decisions and recommendations are based on careful analysis, research, and extensive consultation with industry stakeholders.

The discussions and debates around risk-weighted capital requirements involve perspectives from various experts, including academics, economists, and industry professionals. While differing viewpoints can exist, it is not accurate to label the Basel Committee's efforts as populist or confounding to the intelligentsia.

In the realm of finance and banking regulation, the goal is to strike a balance between risk management, financial stability, and the efficient allocation of credit to support economic growth. This involves considering various factors, including systemic risks, market dynamics, and the long-term sustainability of the financial system."

I asked OpenAI:

"Assets assigned lowest risk, for which bank capital requirements were nonexistent or low, were what had most political support: sovereign credits and home mortgages". Paul Volcker.

Could that not qualify as regulatory populism? 

OpenAI answered:

"The statement made by Paul Volcker highlights a phenomenon where certain asset classes, such as sovereign credits and home mortgages, were assigned lower risk weights and had relatively lower capital requirements compared to other assets. This situation can indeed be seen as an example of regulatory considerations influenced by political and economic factors. However, labeling it as "regulatory populism" requires a more nuanced analysis.

The determination of risk weights and capital requirements involves complex considerations, including the potential impact on financial stability, credit availability, and economic growth. Political and economic factors can influence these decisions, as policymakers seek to balance various objectives and stakeholder interests.

In the case of sovereign credits, governments often enjoy a special status in terms of credit risk assessment due to their ability to tax, print money, or access bailout funds. This special treatment reflects political and economic considerations that aim to maintain stability in the financial system and protect the government's ability to finance its operations.

Similarly, home mortgages have historically been viewed as relatively low-risk assets due to their collateralization by real estate. Encouraging home ownership and providing liquidity in the mortgage market are often considered important policy goals to support economic growth and societal well-being. However, the 2008 global financial crisis highlighted the risks associated with underestimating the systemic impact of mortgage-related assets.

The term "regulatory populism" can be subjective and may imply a derogatory connotation, suggesting that political considerations override prudential risk management. While political and economic factors can influence regulatory decisions, it is important to recognize that risk weighting methodologies and capital requirements are also shaped by technical considerations, international standards, and expert input.

The ongoing evolution of regulatory frameworks, such as the Basel Accords, reflects efforts to strike a balance between addressing systemic risks, ensuring financial stability, and aligning regulations with the changing dynamics of the financial industry.

Overall, while political and economic considerations can influence regulatory decisions in the financial sector, characterizing them solely as "regulatory populism" oversimplifies the complex nature of these decisions and the objectives they aim to achieve."

Note: The answers are copied exactly from those given to me by OpenAI

Here my many other questions to ChatGPT – OpenAI on bank regulations

My conclusion:

Artificial intelligence does not see risk weighted bank capital requirements as some kind of populism. 

"Regulatory populism can imply a derogatory connotation, suggesting that political considerations override prudential risk management" Is it scared? :-) 

What says human intelligence?

A tweet:

"To make your bank system safer, here our risk weighted bank capital requirements. These decree the more creditworthy, me & my Pigs, more worthy of credit, and you, less creditworthy, as less worthy of it. 

The animals on Orwell’s farm said: Thanks Napoleon!"

https://twitter.com/PerKurowski/status/1654847401893453825?s=20

The subsidized risk-free rate

PD. A confession that shall not be heard: “Assets for which bank capital requirements were nonexistent; sovereign credits. A ‘leverage ratio’ discouraged holdings of low-return government securities” “Keeping at it” 2018, Paul Volcker

Translated from El Universal 

A theoretical rate, and a major benchmark in the world of finance, is the one which is known as the "risk free rate". Of course, since nothing is completely free of risk, it is normal, as an approximation, to use as that the interest rate which country perceived to have the strongest economies need to pay in order to service their debt, for example the United States. 

But I argue that this "risk free rate" has been consciously or unconsciously (I pray for the latter) manipulated by the Basel Committee on Banking Supervision, the Committee which seeks to be the manager of all world’s banking risks. 

This committee came up with, and the imposed, capital requirements for banks which depend on the risk of the various assets, primarily as perceived by the credit rating agencies and to whom they outsourced much credit analysis. 

When doing so the committee completely ignored, consciously or without thinking (I pray for the latter) that the perceived risks were already considered by banks when setting the interest rates, the amount of the loans and all other terms, let us say of the numerator. Consequently, when the regulators decided the same perception of risks also needed to be reflected in the capital, let us say in the denominator, they condemned the entire banking system to overdose on perceived risk. 

And that has meant that all those who are perceived as being more risky, be they countries, companies or citizens, have to pay higher interest rates and receive smaller loans, than what would have been the case in the absence of these regulations. 

And so also that all who are perceived as less risky, like “solid” sovereigns and corporations with high credit ratings, will pay much lower interest rates and receive many more and larger loans, than what would have been the case in the absence of these regulations. 

And the above distorted and dislocated world economies more than you could believe. Not only did it encourage a dangerous overcrowding of all safe-havens, but also by dangerously ignoring that risk-taking is the oxygen of any development, and that the "absolutely not risky "of today, were almost always the "risky" of yesterday. 

And this means that the "risk free rate" which we today observe in the market, is actually the "risk-free rate less the value of the Basel Committee’s regulatory subsidy”. 

And this means that the flight instruments which the markets and the central banks in the world use, simply do not give correct readings. 

How is this possible? "One has to belong to the intelligentsia to believe things like that: no ordinary man would be such a fool" George Orwell, Notes on Nationalism, 1945. 

Or, as Patrick Moynihan would have explained it: "There are some mistakes it takes a Ph.D. to make”

Here in Spanish:

http://bombaaaa.blogspot.com/2013/01/la-subsidiada-tasa-libre-de-riesgo.html

PS.

https://subprimeregulations.blogspot.com/2015/07/the-financial-stability-board-makes.html

https://subprimeregulations.blogspot.com/2016/10/since-bank-regulators-in-1988-decreed.html
https://subprimeregulations.blogspot.com/2016/11/olivier-blanchard-agrees-there-is-need.html

http://perkurowski.blogspot.com/2019/09/financial-communism.html

And here in 2023 AI: ChatGPT and Grok opining on this:

The Basel Committee Lunacy

First answer: What poses the larger risk to create a major bank crisis, those that can only result from major bank exposures? Exposures to what is rated below BB-, non investment grade and speculative, or exposures to what is rated AAA to AA, high grade and better? 

And then consider that Basel II requires banks to hold 12 percent in capital when lending or investing in something rated below BB-, an authorized 8.3 to 1 leverage of bank equity; and only 1.6 percent when lending or investing to what is rated AAA to AA, an authorized leverage of 62.5 to 1. 

Let me offer you a hint: Mark Twain described bankers as those who lend you the umbrella when the sun shines but want it back as soon as it looks it is going to rain. 

As I see, what I qualify as the Basel Lunacy, only guarantees that when a real sizable financial explosion occurs, those which can only result from excessive bank exposures, those excessive banks exposures that can only result to something being perceived as absolutely safe, that then the banks will stand there absolutely naked with no capital to speak of between them and the depositors or the taxpayers. 

In “Notes on Nationalism”, George Orwell wrote “one has to belong to the intelligentsia to believe things like that: no ordinary man could be such a fool.” Indeed no ordinary man would be such fools as our current bank regulators, those in The Basel Committee for Banking Supervision or those in the Financial Stability Board.

"No ordinary man could be such a fool"

My daughter Alexandra, an art fanatic, on hearing my explanation about the mistake of the Basel Committee, pointed me to “The forger’s spell”, a book by Edward Dolnick about the falsification of Vermeer paintings. Boy was she right! 

In that book Dolnick makes a reference to having heard Francis Fukuyama in a TV program saying that Daniel Moynihan opined “There are some mistakes it takes a Ph.D. to make”. And he also speculates, in the footnotes, that perhaps Fukuyama had in mind George Orwell’s comment, in “Notes on Nationalism”, that “one has to belong to the intelligentsia to believe things like that: no ordinary man could be such a fool.” 

And that comprises about the most appropriate explanation I have yet seen so as to understand why our bank regulators were able to commit their huge mistake that got us into this financial and economic crisis that threatens the Western World, namely to base their risk weighted capital requirements on the expected and not on the unexpected.

No “ordinary man” would have told his children to beware about what he knew his children were afraid of, and stimulated them to go more where they already wanted to go as it seemed safe to them… which is precisely what the current risk weighted capital requirements for banks do. They cause too large bank exposures whenever the perceived risk of default of the borrower is low, and too small or even nonexistent exposures whenever the perceived risk of default is high. 

And then, just like to force it down our throats, Dolnick writes “Experts have little choice but to put enormous faith in their own opinions. Inevitably, that opens the way to error, sometimes to spectacular error.”

Dolnick also mentions that the psychologist Leon Festinger once marveled: “A man with conviction is a hard man to change. Tell him you disagree and he turns away. Show him facts or figures and he questions your sources. Appeal to logic and he fails to see your point”. 

All of which also leaves me with the problem that seemingly no ordinary financial reporters, like those in FT, can really come to grips with believing, or even daring to believe, that experts could be such fools.

PS. And of course, John Kenneth Galbraith and Upton Sinclair Jr added explanations

PS. No matter how insightful Francis Fukuyama seems to be, with his "End of History", he shows he did not see the statism introduced in the Western world in 1988 by bank regulators, with their Basel Accord

PS. Alexandra Kurowski 2016, M.A. in Modern and Contemporary Art and the Market, Christie’s Education New York,

PS. Here is a memo on the abundant lunacy contained by the risk weighted capital requirements for banks