#AI #CharGPT #Grok Can lower bank capital/equity requirement against residential mortgages cause house prices to be higher than what the real economy can justify?

I asked ChatGPT:

Answer with about 300 words or less:

"If with lower bank capital/equity requirements you make banks hold more residential mortgages than loans to small businesses and entrepreneurs, will not house prices, in the long term, become higher than what the real economy can justify?"

ChatGPT answered:

Yes, lower bank capital requirements can lead to an overallocation of credit to residential mortgages at the expense of loans to small businesses and entrepreneurs. When banks face lower capital requirements for mortgages compared to business loans, they have an incentive to prioritize lending for housing. This increased credit availability for homebuyers drives up demand and, consequently, house prices.

Over the long term, this dynamic can push housing prices above levels justified by fundamentals like wage growth, productivity, and overall economic output. Since small businesses and entrepreneurs are crucial drivers of economic expansion, their reduced access to credit can limit job creation, innovation, and GDP growth. This imbalance can create a situation where housing prices rise faster than the broader economy, making homeownership less affordable and increasing financial instability.

Such credit distortions have been observed in past financial crises. For instance, in the years leading up to the 2008 financial crisis, favorable capital treatment for mortgage lending contributed to excessive credit growth in housing, fueling a price bubble that eventually collapsed.

Thus, if policymakers want to ensure sustainable house prices aligned with real economic growth, they should consider capital requirements that do not disproportionately favor mortgage lending over productive business investment.

I said: Thanks!

It answered: You're welcome! Let me know if you ever want to dive deeper into this or anything else.

I asked Grok 3:

Answer with about 300 words or less:

"If with lower bank capital/equity requirements you make banks hold more residential mortgages than loans to small businesses and entrepreneurs, will not house prices, in the long term, become higher than what the real economy can justify?"

Grok 3 answered:

Lower bank capital or equity requirements reduce the amount of "skin in the game" banks must have, making it easier for them to lend. If this incentivizes banks to favor residential mortgages over loans to small businesses and entrepreneurs—say, due to perceived lower risk or regulatory nudges—then yes, it could skew credit allocation. More mortgage lending pumps demand into housing markets, driving up house prices. Over time, if this outpaces growth in the "real economy"—like wages, productivity, or business output—prices could detach from fundamentals, creating a bubble.

Small businesses and entrepreneurs, starved of credit, might stagnate, slowing innovation and job creation, which underpin sustainable economic growth. Mortgages, being asset-backed, feel safer to banks, especially with government guarantees (e.g., Freddie Mac, Fannie Mae in the U.S.), while small business loans are riskier and less collateralized. Lower capital requirements amplify this bias by letting banks stretch thinner, prioritizing volume in "safe" lending like mortgages over riskier, growth-oriented loans.

Data backs this: post-2008, U.S. banks held mortgage-heavy portfolios (about 30-40% of assets) while small business lending hovered below 20%, per Fed stats. Basel III’s risk-weighting rules also assign lower capital charges to mortgages than unsecured business loans, reinforcing the tilt. If sustained, this floods housing with cheap credit, bidding up prices beyond what incomes or economic output can support. Look at places like Canada or Australia—loose credit and mortgage booms have left house prices at 10x median income, double historical norms.

So, yes, long-term, house prices could climb higher than the real economy justifies, risking instability when the gap corrects. It’s not inevitable—depends on policy details and bank behavior—but the mechanism holds.

I said: Thanks!

It said:You’re welcome! Glad I could help. Anything else on your mind?

Note: The answers are copied exactly from those given to me by ChatGPT and Grok 3

Here my many other questions to ChatGPT on bank regulations

Here is an old comment I made on this issue, based on a letter published  by the Washington Post.

“Assets for which bank capital requirements were low, were what had most political support…home mortgages” Paul Volcker 

In that class war between those who have houses as investment assets, and those who just want affordable homes, where do you stand?"

https://subprimeregulations.blogspot.com/2018/12/affordable-homes-or-investment-assets.html

https://x.com/PerKurowski/status/1684285924404764674

PS. Do all want affordable homes? No! Some millions of home owners could think that’s not in their best interest.

#AI - ChatGPT: Is regulatory risk aversion weakening the economy?

I asked ChatGPT:

"For the economy, in terms of providing it more energy or more laziness, if you had to, how would you qualify bank loans to small businesses and entrepreneurs, as compared to residential mortgages or loans to the public sector?"

ChatGPT answered:

"Bank loans to small businesses and entrepreneurs generally provide more "energy" to the economy compared to residential mortgages or loans to the public sector. Here's why:

1. Small Business and Entrepreneurial Loans:

• Economic Multiplier Effect: These loans tend to have a strong multiplier effect. Small businesses and entrepreneurs often use the funds to invest in new products, services, or technologies, which can lead to innovation, job creation, and increased productivity. This generates more economic activity and growth.
• Job Creation: Small businesses are major job creators, and supporting them helps to reduce unemployment and increase consumer spending, further boosting the economy.
• Flexibility and Dynamism: Entrepreneurs and small businesses are often more flexible and responsive to market demands. Loans to these sectors encourage economic dynamism and adaptability.

Summary: Lending to small businesses and entrepreneurs energizes the economy by driving innovation, creating jobs, and stimulating further economic activity.

2. Residential Mortgages:

• Stability and Consumption: Residential mortgages support homeownership, which contributes to economic stability and boosts consumer spending on household-related goods and services. Homeownership can also lead to long-term wealth building, but it doesn’t directly stimulate productive capacity like business investments do.
• Asset Growth: While mortgages support asset growth for individuals and stability in housing markets, they don’t necessarily lead to immediate economic growth in terms of innovation or productivity improvements.

Summary: Residential mortgages provide economic stability but have a less direct impact on growth compared to business loans. They promote consumption and asset building, which are important but less dynamic.

3. Public Sector Loans:

• Infrastructure and Services: Loans to the public sector can finance infrastructure projects, which are essential for long-term economic growth. However, public sector loans may also fund services that, while necessary, don't directly generate economic growth.
• Lower Economic Dynamism: While necessary for maintaining public services, these loans are generally less efficient at generating rapid economic energy compared to private sector investments.

Summary: Public sector loans provide necessary support for infrastructure and public services, but they typically generate less economic dynamism than loans to small businesses or entrepreneurs.

Conclusion: Bank loans to small businesses and entrepreneurs inject more energy into the economy by promoting innovation, job creation, and economic dynamism. Residential mortgages and public sector loans provide stability and essential services but have a more passive impact on economic growth."

I asked ChatGPT: 

"If, as you just opined here today, loans to small business and entrepreneurs provide more energy to the economy than public sector debts and residential mortgages, could one argue bank regulators, by much favoring the latter, are suffering of risk aversion that could weaken and endanger the economy?"

ChatGPT answered:

Yes, one could argue that bank regulators' preference for lending to safer, lower-risk sectors like residential mortgages and public sector debt may be driven by risk aversion, and this could have unintended consequences for the broader economy. Here’s how that argument could be made:

1. Risk Aversion and Economic Growth:

• Favoring Lower-Risk Lending: Bank regulators often favor residential mortgages and public sector debt because these loans are perceived as lower-risk. Home loans are secured by real estate, and government loans have a very low likelihood of default. This focus on risk minimization can lead to an underallocation of resources to higher-risk, higher-reward sectors, like small businesses and startups.
• Stifling Innovation: By not encouraging or incentivizing banks to lend more to small businesses and entrepreneurs, regulators may inadvertently stifle innovation, which is crucial for long-term economic growth. These sectors are often the most dynamic and contribute disproportionately to job creation and productivity improvements.
• 
  
• 2. Weakening Economic Dynamism:

• Concentration of Capital: A disproportionate focus on safer loans can lead to a concentration of capital in sectors that, while stable, do not generate as much economic dynamism. This could result in a slower-growing economy with fewer opportunities for new businesses to emerge and fewer jobs being created.
• Missed Opportunities: While lending to small businesses involves higher risk, it also offers higher potential rewards in terms of economic growth. Over-regulation or excessive caution can lead to missed opportunities for economic expansion, particularly in industries that are innovative or disruptive.
• 
  
• 3.Potential Long-Term Risks:

• Economic Fragility: If banks and regulators prioritize safety to the point where they underfund entrepreneurial ventures, the economy could become more fragile in the long run. Without new businesses and industries emerging, the economy may struggle to adapt to new challenges, technological changes, or shifts in global demand.
• Overdependence on Stability: A heavy reliance on low-risk lending can create an overdependence on sectors like housing or government spending, which may not be sufficient to drive sustained economic growth. If these sectors face downturns, the broader economy could suffer due to a lack of diversified economic drivers.
• 
  
• 4. Balancing Regulation and Risk:

• Incentivizing Productive Risk-Taking: A balanced regulatory approach that encourages banks to take calculated risks on small businesses and entrepreneurs, while still managing systemic risk, could be more beneficial to the economy. Policies that encourage lending to high-potential but riskier sectors could help inject more energy into the economy.
• Encouraging Innovation: Regulators could also play a role in fostering innovation by creating frameworks that reduce the perceived risk of lending to small businesses, such as through loan guarantees, tax incentives, or specialized funding programs.

Conclusion:

Yes, one could argue that the risk aversion of bank regulators, by favoring lower-risk sectors like residential mortgages and public sector debt, could lead to a weakening of economic dynamism and long-term growth. While risk management is crucial, an overemphasis on safety at the expense of innovation and entrepreneurship could indeed endanger the broader economy by stifling growth and reducing its ability to adapt to future challenges. The key is finding a balance that promotes both stability and economic vitality.

I said: Thanks!

ChatGPT answered: You're welcome! If you have any more questions or thoughts in the future, feel free to reach out. Have a great day!

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

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

Mario Draghi, President of the ECB and Chair of the European Systemic Risk Board shows, again, he has dangerous little understanding about the true nature of systemic risks.

“Systemic risk refers to the risk of a breakdown of an entire system rather than simply the failure of individual parts. In a financial context, it captures the risk of a cascading failure in the financial sector, caused by interlinkages within the financial system, resulting in a severe economic downturn.”

I refer to Mario Draghi’s welcome remarks at the third annual conference ofthe European Systemic Risk Board (ESRB), September 27, 2018

1. “The need for high-quality data: Policymakers’ ability to act hinges crucially on the availability of high-quality data. Data allow policymakers to identify, analyse and quantify emerging risks. Data also provide policymakers with the necessary knowledge to be able to target and calibrate their tools and to be aware of possible spillovers, or attempts to circumvent regulations”

a. The more you believe you are in possession of “high-quality data” the more you set yourself up for a systemic risk, like when banks were led by their regulators to believe that risk of assets rated AAA were minimal.

b. The more regulators might be tempted to “target and calibrate their tools” without considering how the markets might already have calibrated and targeted that “high-quality data”, the more they might generate the systemic risk of giving that “high-quality data” excessive consideration. Like when bank regulators, ignoring the conditional probabilities, based their risk weighted capital requirements basically on the same credit risk bankers were already perceiving and clearing for.

2. “Reflecting the targeted nature with which macroprudential policy can be applied, some countries have considered varying implementation by geographical area, to strengthen the impact on local hotspots. These policy actions have helped mitigate movements in real estate prices.”

But trying to contain “hotspots” and not allowing the market to determine the movements of real estate prices contains the clear and present systemic risk of pushing credit into “weak-spots” and not where it could be mots useful for the economy. Like when bank regulators by giving preferential risk weights to the “safe” sovereign and “safe” houses, negates credit to the “risky” entrepreneurs.

3. “Non-bank finance is playing an increasingly important role in financing the economy. Policymakers need a comprehensive macroprudential toolkit to act in case existing risks migrate outside the banking sector or new risks emerge.And that means widening the toolkit so that policymakers are able to effectively confront risks emerging beyond the banking sector.”

No, regulators who have not been able to regulate banks, and caused the 2008 crisis, and caused the tragedy of Greece, have not earned the right to expand their regulatory franchise anywhere.

4. “Conclusion: Policymakers across Europe have proven willing to use macroprudential policy to address risks and vulnerabilities. These measures have helped counter the build-up of risks”

NO! Regulators who still use risk weighted capital requirements based on that what is perceived as risky is more dangerous to our bank system than what is perceived as safe, have no idea about basic macroprudential policies.

NO! Regulators who still believe that with their risk weighted capital requirements for banks they can distort the allocation of credit without weakening the real economy; and who do not understand how dangerously pro cyclical the risk weighted bank capital requirements are, have no idea about basic macroprudential policies.

PS. My views on some systemic risks, as expressed at the Board of the World Bank in 2003.

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

30 years after the introduction of risk weighted capital requirements for banks, the European Commission's Action Plan, finally spills the beans on that these can distort the allocation of bank credit, for a good (or for a bad) purpose.

The European Commission's Action Plan for a greener and cleaner economy, of March 8, 2018 includes the following statement:

“Incorporating sustainability in prudential requirements: banks and insurance companies are an important source of external finance for the European economy. The Commission will explore the feasibility of recalibrating capital requirements for banks (the so-called green supporting factor) for sustainable investments, when it is justified from a risk perspective, while ensuring that financial stability is safeguarded.”

To my knowledge this is the first time in 30 years, since the introduction in 1988 of risk weighted capital requirements for banks, that an official entity has recognized that by distorting the allocation of bank credit, in favor or against something, regulators can make banks serve a purpose different from safeguarding financial stability.

PS. Sadly though not even “safeguarding financial stability” was well served as all this regulation did was to doom banks to dangerously overpopulate safe-havens holding especially little capital

PS. In October 2013 I discussed this issue on my "Our-piead-a-terre blog"

PS. And on Earth Day 2015 I made a proposal exactly like what the EC will now study, namely to base the capital requirements for banks based on the Sustainable Development Goals SDGs, which of course include environmental sustainability.

@PerKurowski

Basel III - sense and sensitivity”? No! Much more “senseless insensitivity”

I refer to the speech titled “Basel III - sense and sensitivity” on January 29, 2018 by Ms Sabine Lautenschläger, Member of the Executive Board of the European Central Bank and Vice-Chair of the Supervisory Board of the European Central Bank.

“Senseless and insensitive” is how I would define it. It evidences that regulators have still no idea about what they are doing with their risk weighted capital requirements for banks.

Ms Lautenschläger said: With Basel III we have not thrown risk sensitivity overboard. And why would we? Risk sensitivity helps align capital requirements with actual levels of risk and supports an efficient capital allocation. It prevents arbitrage and risk shifting. And risk-sensitive rules promote sound risk management.

“Risk sensitivity helps align capital requirements with actual levels of risk and supports an efficient capital allocation” No! The ex ante perceived risk of assets is, in a not distorted market aligned to the capital by means of the size of exposure and the risk premium charged. Considering the perceived risk in the capital too, means doubling down on perceived risks; and any risk, even if perfectly perceived, if excessively considered causes the wrong actions.

“It prevents arbitrage” No! It stimulates arbitrage. Bankers have morphed from being diligent loan officers into too diligent equity minimizers. 

“It prevents risk shifting.” No! It shifts the risks from assets perceived as risky to risky excessive exposures to assets perceived as safe.

“It promote sound risk management” No! With banks that compete by offering high returns on equity, allowing some assets to have lower capital requirements than other, makes that impossible.

Ms Lautenschläger said: “for residential mortgages, the input floor increases from three basis points to five basis points. Five basis points correspond to a once-in-2,000 years default rate! Is such a floor really too conservative?”

The “once-in-2000 years default rate on residential mortgages!” could be a good estimate on risks… if there were no distortions. But, if banks are allowed to leverage more their capital with residential mortgages and therefore earn higher expected risk adjusted returns on residential mortgages then banks will, as a natural result of the incentive, invest too much and at too low risk premiums in residential mortgages… possibly pushing forward major defaults from a “once-in-2000 years default” to one "just around the corner". That is senseless! Motorcycles are riskier than cars, but what would happen if traffic regulators therefore allowed cars to speed much faster?

I guess Basel Committee regulators have never thought on how much of their lower capital requirement subsidies are reflected in higher house prices?

Then to answer: “Does this mean that Basel III is the perfect standard - the philosopher's stone of banking regulation? Ms Lautenschläger considers “What impact will the final Basel III package have on banks - and on their business models and their capital?”

Again, not a word about how all their regulations impacts the allocation of bank credit to the real economy… as if that did not matter… that is insensitivity!

Our banks are now financing too much the “safer” present and too little the “riskier” future our children and grandchildren need and deserve to be financed.

PS. In 2015 I commented another speech by Ms Lautenschläger on the issue of “trust in banks”.

The Finalization of Basel III’s is just a photo-op for the Committee members to go home for Christmas with, as it does nothing to correct the fundamental flaws of current bank regulations.

The Basel Committee’s “Finalizing Basel III” brief states: 

1. “What is Basel III? The Basel III framework is a central element of the Basel Committee’s response to the global financial crisis. It addresses a number of shortcomings in the pre-crisis regulatory framework and provides a foundation for a resilient banking system that will help avoid the build-up of systemic vulnerabilities. The framework will allow the banking system to support the real economy through the economic cycle.”

Since the risk weighted capital requirements are kept, that is simply not true! The global financial crisis was a direct consequence of regulations that allowed banks to leverage immensely their capital as long as they kept to “safe” assets: limitless leverage with exposures to friendly sovereigns, 62.5 times with private sector exposures rated AAA to AA, and 35.7 times with residential mortgages. 

The exaggerated demand these regulations created for residential mortgages and highly rated securities, which caused serious deteriorations in their quality, and of loans to low risk decreed sovereigns, like Greece, explains 99.9% of the financial crisis.

In contrast when lending to an entrepreneur or an unrated small or medium size enterprise, as that was (is) considered risky, banks were only allowed to leverage 12.5 times. The differences in potential risk adjusted returns on equity between “safe” and “risky” assets hindered, and hinders, the banking system from adequately supporting the real economy

2. “What do the 2017 reforms do? “The 2017 reforms seek to restore credibility in the calculation of risk-weighted assets (RWAs) and improve the comparability of banks’ capital ratios. RWAs are an estimate of risk that determines the minimum level of regulatory capital a bank must maintain to deal with unexpected losses. A prudent and credible calculation of RWAs is an integral element of the risk-based capital framework.”

But the fundamental question of why it should be prudent to require banks to hold more capital against what is perceived risky, when the real dangers to the bank system is when something perceived as safe turns out risky, remains unanswered.

3. “Credibility of the framework: A range of studies found an unacceptably wide variation in RWAs across banks that cannot be explained solely by differences in the riskiness of banks’ portfolios. The unwarranted variation makes it difficult to compare capital ratios across banks and undermines confidence in capital ratios. The reforms will address this to help restore the credibility of the risk-based capital framework.

Internal models should allow for more accurate risk measurement than the standardised approaches developed by supervisors. However, incentives exist to minimise risk weights when internal models are used to set minimum capital requirements. In addition, certain types of asset, such as low-default exposures, cannot be modelled reliably or robustly. The reforms introduce constraints on the estimates banks make when they use their internal models for regulatory capital purposes, and, in some cases, remove the use of internal models.” 

Where do regulators get the idea that if there are less-variations in RWAs, the standardized RWAs, based on how regulators perceive risks, are any more accurate? Excessive hubris? Have they forgotten their own “Standardized” risk weights? Alzheimer? 

Also, since banks should clear for perceived risks in the size of the exposures and interest rates, making them clear for those same risks in the capital too, causes an excessive consideration of perceived risks. The regulators clearly keep on ignoring that any risk, even if perfectly perceived, causes the wrong actions, if excessively considered.

That regulators now, at long last, have understood that “incentives exist to minimise risk weights when internal models are used to set minimum capital”, serves little as consolation, as it just evidences their original naiveté.

PS. As an aide memoire for the regulators to take home for Christmas here’s a list of their mistakes. Am I being nasty? No! How many millions of entrepreneurs have over the years been negated access to the life changing opportunities of a bank credit, only because of these regulators? How many young must live in the basement of their parents houses without jobs, only because regulator think it is safer to finance houses than job creation opportunities? Let’s pray all the Ebenezer Scrooge in the Basel Committee will see light one day... or at least have the decency to fade away.  

“If you see something say something”. Yes, but it’s not easy to be a whistleblower on our too inept bank regulators.

Sir, never ever has a bank crisis of any important magnitude resulted from excessive exposures to something that was perceived as risky when placed on the balance sheets of banks.

These have always resulted from unexpected events, like major devaluations, criminal behavior or excessive exposures to something that was perceived as safe when incorporated in the balance sheets of banks but that ex post turned out to be risky.

So when bank regulators, like with their Basel II of 2004 set the risk weights for what is rated AAA at 20%, and that of the below BB- rated at 150%, then this is a too serious clue of them not knowing what they’re doing.

And the above is far from being their only mistake or the only proof of that.

I have been shouting my lungs out about this basically since 1997, but it is very difficult for an ordinary citizen, even for someone who for some years was an Executive Director at the World Bank, to have someone to listen to him, when he holds that our supposed expert bank regulators left a bomb in our real economy.

PS. I will send the above letter to as many editors I can.

Financial Times

New York Times

Wall Street Journal

Washington Post

Svenska Dagbladet

The Economist

And here is my letter to the Financial Stability Board, March 2019

The litmus test any aspiring central banker or bank regulator should have to pass

Fact: Banks are allowed to leverage more with assets considered safe, like loans to sovereigns, the AAArisktocracy and mortgages, than with assets considered risky, like loans to SMEs and entrepreneurs.

So ask the candidates:

Does that mean “the safe” have even more and easier access to bank credit than usual; and “the risky” have even less and on more expensive terms access to bank credit than usual?

If the answer is no, disqualify the candidate.

If the answer is yes, then ask: 

Do you think that might dangerously distort the allocation of bank credit to the real economy? Or impede QE stimulus flow to where it could be most productive?

If the answer is no, disqualify the candidate.

If the answer is yes, then ask: 

In terms of what can pose the greatest risk to the bank system, would you agree with Basel II’s risk weights of 20% for what is rated AAA to AA and 150% for what is rated below BB-?

If the answer is yes, disqualify the candidate.

If the answer is no, then ask: 

Do you agree with a 0% risk weighting of sovereigns?

If the answer is yes, the candidate should be classified as an incurable statist, not independent at all, and accordingly dismissed.

If the answer is no, then one could proceed applying any other criteria considered relevant.

As a relevant criteria, the way the world looks, being a lucky person seems a quite valid one.

PS. How many of those currently in central banks, or in the Basel Committee for Banking Supervision, or in the Financial Stability Board would pass this test?

@PerKurowski

Even perfectly perceived risks cause wrong decisions if excessively considered

Should banks consider risk factors, such as the probability of default (PD) and the expected loss given a default (LGD), when setting the interest rates it charges clients? Of course, higher perceived risk-higher interests, lower risks-lower interest rates. 

But regulators curiously decided that these risks should also be cleared for in the capital requirements for banks, and decreed: higher perceived risk-higher capital, lower risks-lower capital.

So now banks clear for these risks both with risk adjusted interest rates and risk adjusted capital. That’s a real serious problem because any risk excessively considered, will produce the wrong decision, even if the risk is perfectly perceived.

Now a higher interest rate perfectly set in accordance to a perfectly perceived higher risk translates, because of higher capital requirement, meaning a lower leverage, into a lower risk adjusted expected return on equity. 

Now a lower interest rate perfectly set in accordance to a perfectly perceived lower risk translates, because of a lower capital requirement, meaning a higher leverage, into a higher risk adjusted expected return on equity.

So now banks, even when the risks are perfectly perceived, lend too little to the risky, or in order to compensate for lower ROEs, at too high risk adjusted interest rates; and lend too much to the safe, or thanks to higher ROEs, at too low risk adjusted interest rates.

This is insane! It produces dangerous misallocation of bank credit to the real economy. Too little financing of the "riskier" future and too much refinancing of the "safer" present.

PS. There is still a possibility of credit being allocated efficiently to the real economy, but that requires that what's perceived as safe to be much safer and what’s perceived as risky to be much riskier. What credit rating agencies could guarantee us such mistakes?

Regulators and bankers looking out for the same risks 

AI Watson, would you ever feed robobankers those algorithms current bank regulators feed human bankers?

The normal real world rules banks had to follow for about 600 years before 1988, in order to become and remain successful bankers, was to while carefully considering their portfolio, to lend or invest in whatever they perceived would produce them the highest risk adjusted returns on equity. One dollar of equity lost in an operation perceived as risky would hurt just as much as a dollar lost in an operation perceived as safe. 

And even though bankers in general suffered from a risk aversion bias, expressed well by Mark Twain’s “a banker is one to lend you the umbrella when the sun shines and wanting it back when it seems it could rain”, that obviously served our economies well. 

As John Kenneth Galbraith argued, even when in some cases “Banks opened and closed doors and bankruptcies were frequent, as a consequence of agile and flexible credit policies, the failed banks left a wake of development in their passing.”

But then came the Basel Committee for Banking Supervision, and out of the blue decided to assume bankers did not perceive risks; and so came up with their risk weighted capital requirements. These instructed banks, with no consideration to their portfolio, to hold more capital (equity) against what is perceived risky and less against what is perceived safe.

As an example of their crazy regulatory algorithm, it suffices to mention they assigned a risk weight of 20% for the so dangerously AAA rated while one of 150% to the so innocous below BB- rated.

As a consequence of this bankers had to morph from being mainly risk perceivers into also having to be capital (equity) minimizers. Being able to leverage more the “safe “ than the “risky” allowed them to obtain higher risk adjusted returns on equity lending with the safe than with the risky.

As a consequence we have already suffered major bank crisis resulting from excessive exposures to what was erroneously perceived, decreed or concocted as safe, like AAA rates securities and sovereigns like Greece.

As a consequence of not enough lending to the “risky”, like SMEs and entrepreneurs, development is coming to a halt.

Since regulators refuse to listen to little me, I can’t wait for IBM’s Watson developing lending and investment algorithms for robobankers. These would help show bank current regulators how dangerously wrong they are.

Watson would understand that with current distortions banks go wrong even if they perceive the risks absolutely correct.

Watson would understand that what is perceived risky ex ante becomes by that fact alone less dangerous ex post; and that what is perceived safe ex ante becomes by that fact alone more dangerous ex post.

“May God defend me from my friends, I can defend myself from my enemies” Voltaire.

Regulator Watson, in contrast to the Basel Committee, would not be looking in the same direction the bankers look

PS. Here on the regulators' confirmation bias

PS. Here my letter to the Financial Stability Board

PS. How do you regulate a regulators' algorithm?