Asking for Premium Subscribers' Attention Can Help Prevent Systemic Risks

In a recent academic paper on European banks' governance, two German jurists, Alexander Sajnovits and Peter Mülbert, have analyzed the new duties imposed by Directive CRD VI on board committees, particularly concerning environmental, social, and corporate governance risks (ESG). Their comments are interesting even for their general observations that deserve to be released from libraries.

The authors note that the concrete contents of those duties are neither written down as much by legislators nor by vigilant monitoring, with informal guidelines formally non-binding but none of which can blame any bank. The result is that large institutions tend to adopt similar models, scenarios, and risk management tools.

Here lies the paradox: even an extremely accurate system where everyone evaluates risks identically is more vulnerable on aggregate level: such uniformity can generate systemic risks because when a shock arrives, all react simultaneously and in the same direction, leading to forced sales, concentrated losses, and tight credit precisely where it would be better to avoid or reverse a cycle that becomes vicious.

For example, if many intermediaries use the same model, a negative event in the oil sector pushes them to reduce investments or credit to those enterprises exactly when they need resources to overcome a crisis.

Imagine that most traders rely on just a few AI systems developed by a handful of providers and trained on similar data. Each will believe they are making independent decisions, but their signals will resemble those of competitors. In normal times, no one notices; on the wrong day, models might suggest everyone sells simultaneously, causing liquidity to evaporate within minutes.

With an exacerbation: nobody has mandated that single model, it was chosen by the market, perhaps following practices and ethical guidelines set by authorities, leading to convergence that could potentially be more deceptive.