ChatGPT - OpenAI: Should bank regulators/supervisors be aware of risks with US Treasury long term bonds?

I asked ChatGPT:

"Should bank regulators or supervisors be aware of the duration risk, interest rate risk with US Treasury long term bonds?"

ChatGPT answered:

"Yes, bank regulators or supervisors should be aware of the duration risk and interest rate risk associated with long-term US Treasury bonds held by banks.

Duration risk refers to the risk that a bond's price will decline due to changes in interest rates. When interest rates rise, the price of a bond with a longer duration will fall more than that of a bond with a shorter duration. Banks that hold long-term US Treasury bonds are exposed to duration risk because if interest rates rise, the value of these bonds will fall, leading to a decline in the bank's capital.

Interest rate risk refers to the risk that changes in interest rates will impact the bank's earnings and capital. If interest rates rise, the value of a bank's bond portfolio will decline, leading to a reduction in the bank's capital. Banks that hold long-term US Treasury bonds are exposed to interest rate risk because these bonds are highly sensitive to changes in interest rates.

Therefore, bank regulators or supervisors should be aware of the duration risk and interest rate risk associated with long-term US Treasury bonds held by banks. They should monitor the bank's bond portfolio and ensure that the bank has sufficient capital to withstand potential losses due to changes in interest rates. Additionally, regulators may require banks to conduct stress tests to evaluate the impact of changes in interest rates on their capital and profitability."

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

PS. My most recent takes on this:

1988 30 pages long Basel I stated: “36. Claims on central OECD governments will attract a zero weight (or a low weight if the national supervisory authority elects to incorporate interest rate risk).” So, for 35 years, why did national regulators not consider that risk?

https://subprimeregulations.blogspot.com/2023/04/helping-fts-gillian-tett-and-other-to.html

https://subprimeregulations.blogspot.com/2023/03/bank-supervisorsexaminers-as-well-as.html

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

Bank supervisors/examiners as well as the banks’ own risk managers, find themselves between a rock and a hard place.

Note: This post is based on to “How Bank Oversight Failed: The Economy Changed, Regulators Didn’t” by Andrew Ackerman, Angel Au-Yeung and Hannah Miao, WSJ March 24, 2023, but it could refer to many of the articles currently being published on #SVB,

“If examiners thought the bank should prepare for a scenario such as rapid growth, soaring interest rates and abrupt loss of deposits, as later happened to SVB, examiners would be hobbled by the absence of explicit regulatory guidance calling for such preparations”

Worse! They would be hobbled by the presence of explicit regulatory guidance, namely the risk weighted bank capital/equity requirements (RWCR) based on perceived credit risks, not on misperceived risks, unexpected events or ignored risks, such as duration risk. To top it up, these requirements are based on that what’s perceived as risky is more dangerous to bank systems than what’s perceived.

That places the supervisors/examiners and the banks’ own risk managers between a rock and a hard place. 

What bank risk manager, wanting to keep his job and be paid a bonus, would currently want to address his Board of Directors with: “Our model, because of too many assets we have perceived as safe could now turn out risky, indicates that you have to raise a substantial amount of equity”?

What supervisors/examiners, would dare to argue that the Basel Committee and their other superiors, have not the faintest idea of how to regulate banks? Among other because they all clearly missed their lectures on conditional probabilities?

“Banking regulators will spend months, if not years, getting to the bottom of what happened.” Of course, they will. They do not want the world to understand what hair-raising regulatory mistake they committed.

The GFC, 2008 crisis, was much caused by the excessive exposures US investment banks and European banks held of AAA to AA rated mortgage-backed securities (MBS), against which they were required by Basel II to hold only 1.6% in capital/equity. 

Basel III introduced new capital and liquidity requirements but let the RWCR intact, which meant that on the margin, there were it most counts, the distortive effect of these were even strengthened. (Think of the “Drowning pool”)

What if an investment bank had reported to a little old lady her long-term bond holdings based on value on maturity (as banks are allowed to do), and she then suffered unexpected unaffordable losses when selling these, would it be fined? Just asking.

And what about all journalists? Will they admit they were duped/lulled into a false sense of security by reporting on strong and satisfactory levels of capital based on the naïve assumption that the risk weighted assets reported (RWA), were a valid measure of the banks' risk exposure.

Here's much more on the issue

Bailouts, which could carry significant costs to taxpayers, to be justified, must have a great purpose.

Note: I’m simultaneously sending out this type of "J'accuse" letter to Financial Times, Washington Post, New York Times, Wall Street Journal, The Globe and Mail, and The Economist.

SVB was holding a high number of Treasury and other government bonds — amounting to more than half of its assets. When will one dare ask regulators: How much capital/equity/skin-in-the game, were SVB's shareholders required to hold against that?

Bailouts, which could carry significant costs to taxpayers, to be justified, must have a great purpose.

We do not need “tougher” rules for our banks, we need better rules. Risk weighted bank capital/equity requirements based on what’s perceived as risky being more dangerous to bank systems than what’s perceived as risky, make absolutely no sense. 

Not only, by feeding the creation of excessive exposures to what’s “safe”, these put the dangers to bank systems on steroids but also, by distorting the allocation of credit, make it much harder for the economy to reach its true potential.

By incentivizing banks to refinance much more the "safer present" than to finance the "riskier future" it effectively imposes a reverse mortgage on the economy that will be very costly for future generations.

 

Additionally, by de-facto declaring the more creditworthy more worthy of credit, and as a consequence the less creditworthy to be less worthy of credit, they hinder equality of opportunities.

And since banks are one if not the most important channel to transmit central banks’ monetary policies, these regulations impede those to work as expected. Just think about how these distort the risk-free interest rate.

To top it up, with decreed risk weights of 0% governments – 100% citizens, as if bureaucrats/apparatchiks know better what to do with credit, for which repayment they’re not personally responsible for than e.g., small businesses, that’s communism or fascism, that has empowered a Bureaucracy Autocracy.

And I could go on and on.

Therefore, assisting the banks in need during a conversion from risk weighted bank equity requirements to solely a strong leverage ratio, 10% equity against all assets, has a great purpose. Especially if it stimulates and democratizes new bank equity.

A Chilean styled bailout could do. Zero bonuses, dividends and buy-backs, until the bank’s shareholders have 10% of equity in it against all assets, and until all the financial assistance provided has been repaid with some interest.

In short: The world needs to rescue its banks from the hands of equity minimizing / leverage maximizing creative financial engineers, much empowered by regulators, and return these to old style “know your client” bank loan officers. Welcome back George Banks.

PS. I might not be a PhD, and I have never been a regulator, but I'm not a newcomer to these issues.

@PerKurowski