More asking and chatting with ChatGPT OpenAI: Risk weighted bank capital/equity requirements

Note: This is a continuation from previous chats on this topic with ChatGPT OpenAI

https://subprimeregulations.blogspot.com/2023/04/chatgpt-openai-should-bank.html
https://subprimeregulations.blogspot.com/2023/04/chatgpt-openai-who-might-know-better.html
https://subprimeregulations.blogspot.com/2023/04/asking-and-chatting-with-chatgpt-openai.html

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

Those large exposures that can become dangerous to our bank systems are built-up with assets perceived as risky or with assets perceived as safe?

Large exposures that can become dangerous to bank systems can be built-up with either risky assets or safe assets, depending on the circumstances.

If a bank has a large exposure to risky assets such as high-yield bonds or subprime mortgages, then a sudden drop in the value of these assets can lead to significant losses for the bank. This can be especially dangerous if the bank is highly leveraged, meaning it has borrowed a lot of money to invest in these assets.

On the other hand, large exposures to safe assets such as government bonds or highly rated corporate bonds may not seem risky on the surface. However, if a bank has a significant amount of its assets invested in these types of securities and there is a sudden rise in interest rates, the value of these bonds may fall, causing losses for the bank. In addition, if many banks are invested in the same types of safe assets, a sudden market shift could lead to widespread losses across the banking system.

In either case, it's important for banks to manage their exposures carefully and have robust risk management practices in place to identify and mitigate potential risks.

What’s more dangerous to bank systems assets perceived ex ante as risky turning out to be risky ex post, or assets perceived as safe turning out risky?

Both types of assets can be dangerous to bank systems, but assets that are perceived as safe but turn out to be risky ex post can be particularly dangerous.

When a bank invests in assets perceived as risky, it is aware of the potential risks and should be taking steps to manage and mitigate those risks. However, when a bank invests in assets perceived as safe but turns out to be risky ex post, it may not have taken sufficient precautions to manage those risks, and the losses can be unexpected and severe.

For example, during the 2008 financial crisis, many banks had invested in mortgage-backed securities that were perceived as safe because they were rated AAA by credit rating agencies. However, when the underlying mortgages began to default at higher rates than expected, the value of these securities plummeted, causing significant losses for banks that held them.

In contrast, when a bank invests in assets perceived as risky and they turn out to be risky ex post, the bank may have already factored in potential losses and taken steps to manage the risks. Of course, it is still important for banks to carefully manage their exposure to risky assets and have strong risk management practices in place to minimize potential losses.

How much must bank regulators know about risks, before they should be allowed to introduce risk weighted bank capital/equity requirements? 

Bank regulators should have a thorough understanding of the risks that banks face before introducing risk-weighted bank capital/equity requirements. This includes understanding the nature of different types of risks, such as credit risk, market risk, operational risk, and liquidity risk, as well as the ways in which these risks can interact with each other.

Regulators should also have a good understanding of how banks manage and mitigate these risks, and the potential unintended consequences of introducing risk-weighted capital requirements. For example, if capital requirements are too high, it could discourage banks from lending to small and medium-sized enterprises or investing in certain types of assets, which could have a negative impact on the economy.

In addition, regulators should have a strong understanding of the financial system as a whole and the potential systemic risks that could arise from the failure of a large bank or a significant disruption in financial markets.

Therefore, it is important for regulators to have a strong expertise in finance and risk management, as well as access to high-quality data and analysis, before introducing risk-weighted bank capital/equity requirements. This can help ensure that the regulations are effective in promoting financial stability while also minimizing unintended consequences.

Comment: As a minimum minimorum they should not have missed the lectures on conditional probabilities.

What would you opine of risk weighted bank capital requirements with risk weights assigned for political reasons?

Introducing risk-weighted bank capital requirements with risk weights assigned for political reasons would be inappropriate and potentially dangerous.

Risk-weighted capital requirements are intended to be based on objective assessments of the riskiness of different types of assets, such as loans or investments. These assessments should be based on factors such as the creditworthiness of the borrower, the type of collateral, and the potential for default.

Assigning risk weights for political reasons, such as to promote certain types of lending or investment, would undermine the integrity and effectiveness of the regulatory framework. It could lead to distortions in the allocation of credit and investment, and increase the likelihood of losses for banks and ultimately taxpayers.

In addition, assigning risk weights for political reasons could erode confidence in the regulatory framework and lead to a loss of trust in the financial system as a whole. This could have serious consequences for financial stability and economic growth.

Therefore, regulators should base risk-weighted capital requirements on objective assessments of risk, rather than political considerations. This can help ensure that the regulations are effective in promoting financial stability and minimizing risks to the banking system.

Comment: “Assets assigned lowest risk, for which bank capital requirements were nonexistent or low, what had most political support: sovereign credits & home mortgages. A ‘leverage ratio’ discouraged holdings of low-return government securities” Paul Volcker

Based on the immense knowledge about risks that is presumed by those introducing risk weighted bank capital/equity requirements, where would you place such regulatory concept, before or after the Scientific Revolution? 

As an AI language model, I do not hold personal opinions or beliefs. However, I can provide you with some historical context regarding the regulatory concept of risk-weighted bank capital requirements.

The idea of risk-weighted bank capital requirements is a relatively modern regulatory concept that emerged in the late 20th century as a response to financial crises and increased globalization of financial markets. The concept involves assigning different risk weights to various types of assets held by banks, with the aim of ensuring that banks hold sufficient capital to absorb potential losses.

Therefore, based on this historical context, it is clear that the concept of risk-weighted bank capital requirements emerged after the Scientific Revolution. The Scientific Revolution took place in Europe from the 16th to the 18th century and was characterized by the emergence of new scientific methods and the development of new technologies. This period marked a significant turning point in human history and had far-reaching impacts on the world of finance and economics. However, the concept of risk-weighted bank capital requirements is a relatively modern development that emerged long after the Scientific Revolution.

Comment: I do hold an opinion. The risk weighted bank capital requirements have nothing to do with science and all to do with hubris. Sadly Basel Committee's fortune tellers were/are not questioned sufficiently 

Two options:

A: The most dangerous risks to banking system revolve around what’s perceived as risky

B: The most dangerous risks to banking system revolve around what’s perceived as safe

To which option respectively do the terms geocentric and heliocentric best apply?

Option A: "The most dangerous risks to banking system revolve around what’s perceived as risky" can be compared to the geocentric model of the universe. In the geocentric model, the Earth was believed to be the center of the universe, and all other celestial bodies revolved around it. This model was widely accepted for centuries, despite evidence to the contrary, because it aligned with people's perceptions and beliefs. Similarly, in the banking system, if risk is perceived in a certain way, it may be accepted and even encouraged despite evidence to the contrary.

Option B: "The most dangerous risks to banking system revolve around what’s perceived as safe" can be compared to the heliocentric model of the universe. In the heliocentric model, the Sun was believed to be the center of the solar system, and all planets, including Earth, revolved around it. This model challenged the geocentric model and required a significant shift in thinking and understanding. Similarly, in the banking system, if risk is perceived as safe, it may lead to complacency and a failure to recognize potential risks, leading to dangerous consequences.

Comment: What more than my 2019 letter to the Financial Stability Board No wonder they never answered me.