Are credit-risk weighted equity requirements for banks just regulators’ soothing blankets and teddy bears?

Bruce Hood, in “Essentialism” in “Thinking” edited by John Brockman, 2013, writes: “The reduction in funding in this country has impacted upon my field quite dramatically (behavioral sciences)… Now we have to justify with a view to application”.

Great! And do I have an application to suggest!

Bank regulators succumbed entirely to the intuition of if-more-risky-then-more-equity and if-less-risky-then-less-equity completely ignoring that for the banking system as such, what is ex ante perceived as risky poses little risks. It is what is perceived as “absolutely safe” but that later can pop up as very risky that which contains the true dangers.

And so regulators decided banks needed to hold much more equity against what is perceived as risky than against what is perceived as risky; and that resulted in that banks are now making much higher risk-adjusted returns on equity on what is perceived as safe than on what is perceived as risky.

And that leveraged the natural risk adverseness of banks into the skies; that one to which Mark Twain refers to as “they lend you the umbrella when the sun shines and what it back as soon it looks like it is going to rain”.

And, since our economies move forward thanks to for instance the risk-taking of banks on small businesses and entrepreneurs, the Western world is now stalling and falling.

Hood refers to among other to work he’s done with Paul Bloom about “bizarre behavior you find in children of the West [with their] emotional attachments to blankets and teddy bears [when] they need to self-soothe.” 

And it hit me that it could be an extraordinarily application if Hood and Bloom researched whether these bank regulations are the equivalent self-soothing instruments to regulators. Because if so then we would have some arguments in hands to go and tell the members of the Basel Committee for Banking Supervision and the Financial Stability Board that it is their role to regulate banks as society needs banks and not so to help them be calm when they suck their thumbs.

PS. The Western world was built upon a lot of risk-taking, among others by its banks... but in 1988 it got hit by the Basel Accord asteroid.

At what moment does intuition turn into an overpowering prejudice that blocks all deliberate decision making?

Intuitively bank regulators think “risky is risky and safe is safe” and impose on banks credit-risk-weighted capital (meaning equity) requirements… more risk more capital – less risk less capital.

But then, in the hope of provoking a better and more deliberate decision, I sit down with them and explain:

First, that what has always turned out really risky for the bank system, has never ever been something perceived as risky, but always something that ex ante was perceived as absolutely safe but that, ex post, turned out to be very risky.

And second, that discriminating this way for risk already perceived by bankers, and already cleared for through interest rates, size of exposures and other terms, dramatically distorts the allocation of bank credit to the real economy.

And they say: “Yes, you are entirely correct Per”… but still insist on doing the same… How come?

At what moment does intuition turn into an overpowering prejudice that blocks all deliberate decision making?

Have anyone of you who participated writing in “Think-ing” edited by John Brockman any idea of how to break through intuitions when these are too powerful?

I appreciate all the help I can get… as these regulations have introduced a very faulty and extremely dangerous risk aversion that is really messing up all the economies of the Western World. These regulations are stopping our banks from financing the risky future by keeping them busy profitably re-financing the safer past

I also read the following on the site of Edge.org founded by John Brockman:

“To arrive at the edge of the world's knowledge, seek out the most complex and sophisticated minds, put them in a room together, and have them ask each other the questions they are asking themselves.”

And that makes me want to ask anyone of you about when complex and sophisticates minds, put together in a room, could turn into a dangerous mutual admiration club?

I say this because there are such monstrous errors in these bank regulations that could perhaps only be explained by the possibility that no one dared to ask the questions… as these had to reflect too badly on a member of the club 

Thanks… and best regards

Per Kurowski

PS. I have discussed part of this regulatory mistake while reading Professor Daniel Kahneman’s “Thinking Fast and Slow”