Is it possible to describe banking as a joint venture between bank regulators and financial engineers?

I asked ChatGPT: Consider banks having to hold e.g., 10% in capital/equity against all assets (leverage ratio) or, alternatively, be subjected to risk weighted capital/equity requirements. Which alternative would empower and generate more jobs for bank regulators and bank supervisors? 

This is what it said:

So I ask, over the last decades, does banking not seem like a joint venture between its regulators, and capital/equity minimizing – leverage maximizing creative financial engineers?

Though I’m sure it was not purposely planned so, the incentives provided by risk weighted bank capital/equity requirements to both regulators and financial engineers have, unwittingly but de facto, created a joint venture between regulators and financial engineers.

All us other, we’ll pay dearly for that. In way too many ways.

#AI #OpenAI #ChatGPT – What kind of bank capital/equity requirements generates more jobs for regulators and supervisors?

I asked ChatGPT:

Consider banks having to hold e.g., 10% in capital/equity against all assets (leverage ratio) or, alternatively, be subjected to risk weighted capital/equity requirements. Which alternative would empower and generate more jobs for bank regulators and bank supervisors?

ChatGPT answered:

Implementing risk-weighted capital/equity requirements would likely empower and generate more jobs for bank regulators and bank supervisors compared to a simple leverage ratio requirement. Here’s why:

1. Complexity and Expertise

• Risk-Weighted Requirements: This approach involves assessing the risk profile of each asset class and assigning different capital requirements accordingly. Regulators would need to develop, update, and enforce complex models and risk assessments, which require specialized knowledge and skills in risk management, finance, and statistics.
• Leverage Ratio: A straightforward leverage ratio requires banks to hold a fixed percentage of capital against total assets, irrespective of the risk. This simplicity means fewer specialized roles are necessary.

2. Continuous Monitoring and Adjustments

• Risk-Weighted Requirements: Continuous monitoring of the risk profiles of banks’ assets is necessary. Regulators need to evaluate changes in market conditions, update risk weights, and ensure compliance. This creates ongoing work and the need for continuous training and updates.
• Leverage Ratio: Once set, a leverage ratio requires less frequent adjustments and monitoring, resulting in fewer ongoing regulatory activities.

3. Regulatory Reporting and Compliance

• Risk-Weighted Requirements: Banks need to report detailed risk assessments of their asset portfolios regularly. This requires regulators to review and audit these reports, leading to more regulatory scrutiny and thus more jobs.
• Leverage Ratio: Reporting is simpler, focusing primarily on total asset values and capital held, leading to less regulatory oversight.

4. Innovation and Development of Risk Models

• Risk-Weighted Requirements: The development and improvement of risk models is an ongoing process. Regulators would need teams dedicated to research, model validation, and stress testing.
• Leverage Ratio: There is minimal need for complex model development, reducing the demand for specialized regulatory roles.

5. Training and Certification

• Risk-Weighted Requirements: The complexity necessitates specialized training programs for regulators and supervisors, creating additional roles in training and certification.
• Leverage Ratio: Basic training suffices, resulting in fewer roles dedicated to education and certification.

Conclusion

Risk-weighted capital/equity requirements would generate more jobs for bank regulators and supervisors due to the need for specialized skills, continuous monitoring, complex reporting, and the development of risk models. The leverage ratio approach, while simpler and easier to implement, would not create as many specialized regulatory roles.

I finalized with: Thanks!

ChatGPT replied: You're welcome! If you have any more questions or need further clarification on any topic, feel free to ask!

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

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

 

Basel I, July 1988 = 28 pages

Basel II, June 2006 = 333 pages

Basel III, July 2024 = 1,910 pages

And we have not seen the endgame yet. And each time we understand less and less.

“If one is pretending to knowledge, one does not have, one cannot ask for explanations to support possible objections” John Kenneth Galbraith 

Ground control to Major Tom

https://x.com/PerKurowski/status/1809268636487467309

#AI #OpenAI #ChatGPT: Can bank regulations empower differently loan officers and financial engineers?

I asked ChatGPT:

Consider banks having to hold e.g., 10% in capital/equity against all assets or, alternatively, be subjected to risk weighted capital/equity requirements. Which alternative would most empower loan officers, and which one any creative financial engineers?

ChatGPT answered:

Let's break down the two alternatives and their implications for loan officers and financial engineers:

1. Fixed Capital/Equity Requirement (e.g., 10% for all assets)

Under this system, banks must hold a fixed percentage of capital against all their assets, regardless of the risk level of those assets.

Implications:Loan Officers: This system could empower loan officers because it simplifies the lending process. They would not need to consider complex risk weightings for different types of loans and assets. Instead, they could focus on originating loans without having to navigate a complicated regulatory framework.

Financial Engineers: This system is less favorable for financial engineers because there is limited scope for arbitrage or optimization. The simplicity of the rule means fewer opportunities to manipulate capital structures or asset classifications to reduce capital requirements.

2. Risk-Weighted Capital/Equity Requirements

Under this system, banks must hold capital based on the risk level of their assets. Higher-risk assets require more capital, while lower-risk assets require less.

Implications: Loan Officers: This system might constrain loan officers more because they would need to be aware of the risk weightings assigned to different assets. It could complicate the lending process and potentially limit the types of loans they can offer without incurring higher capital charges.

Financial Engineers: This system empowers financial engineers. They can devise strategies to minimize capital requirements by structuring assets and liabilities in ways that optimize risk-weighted calculations. This could involve creating complex financial products or finding ways to reclassify assets to achieve lower capital charges.

Summary:

Empowerment of Loan Officers: A fixed capital/equity requirement (e.g., 10%) would likely be more empowering for loan officers as it simplifies the lending process and reduces the need to navigate complex risk assessments.

Empowerment of Financial Engineers: Risk-weighted capital/equity requirements would provide more opportunities for financial engineers to apply their skills in optimizing the bank's capital structure and creating innovative financial products.

Overall, a fixed capital/equity requirement benefits loan officers by providing simplicity and clarity, while risk-weighted requirements benefit financial engineers by offering opportunities for creative financial structuring.

I finalized with: Thanks!

ChatGPT replied: You're welcome! If you have any more questions or need further clarification on any topic, feel free to ask.

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

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

PS. In 2003, at the World Bank I opined: "A mixture of thousand solutions, many of them inadequate, may lead to a flexible world that can bend with the storms. A world obsessed with Best Practices [ bank regulations] may calcify its structure and break with any small wind."

PS. Another early opinion on risk management: In "Against the Gods" Peter L. Bernstein writes that the boundary between the modern times and the past is the mastery of risk, since for those who believe that everything was in God’s hands, risk management, probability, and statistics, must have seemed quite irrelevant. Today, when seeing so much risk managing, I cannot but speculate on whether we are not leaving out God’s hand, just a little bit too much.

PS. 2004 at the World Bank: “I believe that much of the world’s financial markets are currently being dangerously overstretched, through an exaggerated reliance on intrinsically weak financial models, based on very short series of statistical evidence and very doubtful volatility assumptions” Two decades later that has gotten only so much worse.