#AI #ChatGPT #Grok: Do risk weighted bank capital requirements empower government borrowing at low interest rate cartels?

I asked ChatGPT

"Would it be outrageous to hold risk weighted bank capital requirements that imply a veiled prohibition for those perceived as “risky” to access bank credit in fair market risk adjusted terms, empowers “safe” government borrowing at low interest rate cartels?"

ChatGPT answered:

Short answer

“Not outrageous — it’s exactly what risk-weighting can do in practice — but it’s economically harmful and politically risky. Designing capital rules that effectively bar “risky” borrowers while heavily privileging government debt creates powerful distortions: it crowds out productive credit, concentrates risk, and subsidises government borrowing regardless of merit.

Why it happens (mechanics)

Risk weights tell banks how much capital to hold against each asset. Low weights on sovereign bonds and high weights on small-business or startup loans raise the relative capital cost of lending to the latter. Because banks price loans to cover capital costs, borrowers with higher risk-weights face higher spreads or simply no credit access. So a regulatory system can unintentionally (or intentionally) create a de-facto cartel of cheap “safe” government funding and expensive or unavailable private credit.

Main harms

Misallocation of capital. Productive, innovative firms (startups, small businesses) get starved of finance; low-return but “safe” assets (sovereigns) get overfunded.

Inequality & incumbency bias. Established firms and asset-rich borrowers (who can use collateral that attracts low weights) gain advantage; entrepreneurship suffers.

Concentration & systemic risk. If all banks hold large sovereign positions because they’re cheap capital-wise, the banking system becomes correlated with sovereign risk — a sovereign-bank doom loop.

Moral hazard for governments. Cheap financing reduces incentives for fiscal discipline.

Credit markets segmentation. Nonbank lenders may step in, growing shadow banking with weaker supervision — exactly the regulatory arbitrage regulators try to avoid.

Counterarguments in favor (why some designers accept it)

Perceived safety: Sovereign debt is often default-rare (for major currencies), so lower capital burden may seem sensible for prudential safety.

Simplicity & political feasibility: Rewarding sovereigns is politically popular and easier to justify after crises.

Short-term stability: In stress, public debt can act as a liquidity buffer for banks.

How to reduce the perverse effects

Use a non-risk-sensitive leverage floor alongside risk weights (a binding leverage ratio reduces the extent to which low weights can be exploited).

Apply concentrated exposure / sovereign concentration limits or higher floors on sovereign weights for domestic sovereigns to avoid large concentrated bets.

Risk-sensitive but calibrated weights: avoid zero or near-zero weights for public debt; make weights reflect real risks including inflation/default & FX.

Countercyclical capital buffers tied to lending booms rather than asset class alone.

Support targeted credit programs (guarantees, cheap refinancing) for socially valuable but risky sectors rather than broadly skewing capital rules.

Transparency & periodic review so political capture is visible and adjustable.

Bottom line

Treating risk weights as a tool to subsidize government borrowing or to keep “risky” borrowers out of the market is economically dangerous. The design trade-off is real: risk-sensitivity helps microprudential pricing but can create large macro- and distributional distortions if miscalibrated. Better: combine risk-sensitive capital with blunt instruments (leverage floors, concentration limits) and targeted fiscal/credit policies for sectors you want to support.”

I said: Thanks!

It replied: You’re very welcome!

I asked Grok: With a fairly brief answer:

"Would it be outrageous to hold risk weighted bank capital requirements that imply a veiled prohibition for those perceived as “risky” to access bank credit in fair market risk adjusted terms, empowers “safe” government borrowing at low interest rate cartels?"

Grok answered:

"Yes, that view has merit and isn't outrageous—it's a common critique among economists like Anat Admati and Andrew Haldane. Risk-weighted requirements (e.g., Basel III) can indeed distort lending by incentivizing banks to favor low-risk assets like government bonds (often zero-weighted), enabling cheap sovereign borrowing while making credit costlier or scarcer for "risky" borrowers like SMEs or emerging markets. This creates an implicit subsidy for governments, potentially forming a low-rate "cartel" effect, though proponents argue it enhances systemic stability. Alternatives like leverage ratios aim to address this bias."

I said: Thanks

It replied: You're welcome! If you have more questions, feel free to ask.

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

#AI #ChatGPT #Grok: What promotes more inequality, risk weighted bank capital requirements or a leverage ratio? Why do some not want to hear the answer?

I asked ChatGPT: Please be brief, less than 200 words.

“What promotes more inequality, risk weighted bank capital requirements favoring public debt over loans to small businesses and entrepreneurs, or the same capital requirements against all assets?”

ChatGPT answered:

“Risk-weighted capital requirements, which favor government debt and mortgages over small business loans, tend to promote more inequality. By making lending to entrepreneurs and smaller firms more capital-expensive, regulators push banks toward safer, lower-weight assets like Treasuries and housing. This channels credit toward governments and established homeowners, while starving new or riskier businesses of financing—the very entities that usually drive job creation and upward mobility.

A flat leverage ratio, applying the same requirement to all assets, avoids this distortion. While it may constrain total lending somewhat, it does not structurally disadvantage small businesses relative to sovereign borrowers. In effect, risk-weights entrench incumbents and those with assets already favored by regulators, while a simple leverage ratio distributes credit opportunities more evenly.”

Thus, risk-weighted rules amplify inequality by rewarding the safest borrowers and penalizing those most dependent on access to credit to rise.

I asked ChatGPT: Please be brief, less than 200 words.

“If those who oppose inequality keep silence on this, could it be they just want to have access to easy/cheap public money, so as to profit themselves on the fight against inequality?”

ChatGPT answered:

“Yes, that is possible. Silence on how risk-weighted capital rules distort credit may reflect self-interest. By favoring government debt, these rules make it cheaper for the public sector to borrow, which can benefit politicians, institutions, and even NGOs that rely on state funding. At the same time, some activists or commentators may avoid questioning the system because cheap public money underpins their programs or reputations as inequality fighters.

In that sense, the neglect may not be accidental: criticizing risk weights would expose how current rules privilege governments and established borrowers at the expense of entrepreneurs and job creation. Keeping quiet allows them to posture against inequality while benefiting indirectly from the very structure that deepens it.’

I said: Thanks!

It answered: You’re welcome!

I asked Grok: Please be brief, less than 200 words.

“What promotes more inequality, risk weighted bank capital requirements favoring public debt over loans to small businesses and entrepreneurs, or the same capital requirements against all assets?”

Grok answered:

"Risk-weighted capital requirements, which assign lower risk (and thus lower capital needs) to public debt than to loans for small businesses and entrepreneurs, promote more inequality. This system incentivizes banks to favor "safe" government bonds over riskier but growth-oriented lending to SMEs, which are key drivers of job creation, innovation, and economic mobility for lower-income individuals.

By contrast, uniform capital requirements across all assets remove this regulatory bias, allowing lending decisions based more on economic merit and potential returns. This could enhance credit access for entrepreneurs, reducing wealth gaps by supporting broader economic participation rather than subsidizing public debt held disproportionately by wealthy institutions and investors."

I asked Grok: Please be brief, less than 200 words.

“If those who oppose inequality keep silence on this, could it be they just want to have access to easy/cheap public money, so as to profit themselves on the fight against inequality?”

Grok answered:

"It's possible that some anti-inequality advocates remain silent on risk-weighted capital requirements to preserve access to cheap public financing, which funds their initiatives (e.g., NGOs, think tanks, or social programs reliant on government bonds). This could create a self-serving incentive, where critiquing the system might disrupt their own resources, turning "fighting inequality" into a profitable endeavor.

However, silence could also stem from genuine unawareness of banking regulations' nuances, prioritization of other issues (like taxation or wages), or belief that public debt enables essential social spending. Without evidence, assuming ulterior motives risks oversimplification—many advocates push for broader reforms, including financial system changes.

I said: Thanks!

It said: You're welcome! If you have more questions, feel free to ask.

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.

#AI #Grok: What is the impact on small cities of the risk weighted bank capital requirements?

I asked Grok:

"Loan officers of small city community banks normally attended the credit needs of the local small businesses and entrepreneurs. Once risk weighted bank capital requirements entered into effect, big city financial engineers took over. How has that affected small cities?"

Grok answered:

"The introduction of risk-weighted capital requirements, primarily through the Basel Accords starting in the late 1980s and evolving with Basel II (2004) and Basel III (post-2010), shifted banking from localized, relationship-based lending by community bank loan officers to more centralized, model-driven risk assessment and securitization by large financial institutions. This change aimed to enhance bank stability but imposed higher compliance costs and capital burdens, particularly on smaller banks, leading to several interconnected effects on small cities and rural areas.

Increased Bank Consolidation and Reduced Local Presence

These requirements contributed to a wave of mergers and acquisitions, as smaller community banks (typically with assets under $10 billion) struggled with the fixed costs of compliance, risk modeling, and reporting. For instance, the number of community banks declined by about 24% from 2010 to 2017, with regulations explaining up to 31% of merger activity during that period. Exit rates for community banks averaged over 4% annually from 2014 to 2019, highest among small, young, and metropolitan-area institutions, but also notable in non-metro (rural) areas. This consolidation often resulted in branch closures, with a 15% overall decline in branches from 2010 to 2017, disproportionately affecting rural counties where community banks hold the majority of deposits and are four times more likely to operate offices. In over 1,200 U.S. counties (home to 16.3 million people), the loss of community banks could severely limit physical access to banking services, as seen in cases like Harding County, New Mexico, which lost its last bank in 2014, forcing residents to travel hours for basic services.

Changes in Lending Practices and Reduced Credit Access

The shift favored large banks’ ability to use advanced internal ratings-based (A-IRB) models under Basel II and III, potentially lowering their capital needs for certain loans and giving them a competitive edge in pricing. Community banks, sticking to simpler Basel I rules, faced incentives to concentrate on riskier assets like commercial loans, while losing ground in lower-risk areas like mortgages. This led to stricter lending standards: from 2010 to 2017, 79% of community banks increased documentation requirements, 69% extended loan processing times, and 45% raised minimum credit criteria, attributing 60-97% of these changes to regulations. Access for “atypical” borrowers (e.g., self-employed or those reliant on asset income) decreased for 26% of banks, with 86% linking this to regulatory scrutiny.

Small businesses in small cities, often opaque or non-standard risks, bore the brunt. Community banks provide about 51% of small business loans nationwide, but their lending volume fell 11% from mid-2010 onward, with market share dropping 1.7%. In rural areas, where these banks are primary lenders, regulations like mortgage rules under Dodd-Frank exacerbated this, with over 30% of small mortgage lenders reducing holdings at an annualized rate of 5% or more from 2013 to 2019. Higher fees (reported by 38% of banks) and compliance costs (up to 12% of operating expenses, 2.5 times higher for small banks) further raised borrowing costs. 

Economic Implications for Small Cities

These dynamics have broader ripple effects on local economies:

Impact Area	Description	Supporting Evidence
Credit Availability	Reduced lending to small businesses and entrepreneurs, pushing them toward costlier alternatives like credit unions (which increased small business lending 109% from 2010-2017) or nonbanks.	A $1 capital reduction at small banks has a larger effect on local economic activity than at large banks, potentially causing credit crunches in downturns.
Business Growth and Jobs	Slower expansion for local firms, as relationship lending—key for opaque borrowers in small towns—is replaced by standardized models, limiting investment and job creation.	Regulations contributed up to 23% of changes in total business lending from 2010-2016, with tighter standards affecting newer or riskier businesses.
Overall Economic Activity	Potential stagnation in rural and small-city economies, with branch losses reducing mainstream banking access and diverting resources from lending to compliance.	Community banks' disappearance could lead to permanent credit falloffs in rural areas, where they are essential for financing local households and businesses.

While some community banks gained small business loan market share post-consolidation (e.g., during 1994-2000 waves), the overall trend has been toward diminished local control and credit tailored to small-city needs, fostering economic concentration in larger urban centers.

I said: Thanks!

It said: You're welcome! If you have more questions, feel free to ask.

Here is how ChatGPT answered that exact question.

Here is a “report” on how George Banks reacted when confronting the world of risk weighted bank capital requirements.

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

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

#AI #ChatGPT: What is the impact on small cities of the risk weighted bank capital requirements?

I asked ChatGPT:

"Loan officers of small city community banks normally attended the credit needs of the local small businesses and entrepreneurs. Once risk weighted bank capital requirements entered into effect, big city financial engineers took over. How has that affected small cities?"

ChatGPT answered:

That’s a sharp observation. Here’s the essence:

When Basel-style risk-weighted capital requirements came into play, banks could hold less equity against sovereign debt and highly-rated securities, while needing more equity against loans to small businesses and entrepreneurs.

Before

In small cities, community bank loan officers knew their customers personally.

Credit decisions relied on relationship banking and local knowledge, not just collateral or ratings.

Local businesses and entrepreneurs had a direct path to financing.

After risk-weights

Lending to governments and buying securitized assets became cheaper in terms of required capital.

Lending to small businesses became relatively more “expensive” (higher capital charge).

Large financial institutions in big cities, with access to securitization, derivatives, and rating agencies, thrived under this framework.

Community banks lost competitiveness because their natural activity—small business lending—was penalized by the rules.

Impact on small cities

Credit scarcity – local entrepreneurs found it harder to get loans, even if viable, because banks had regulatory incentives to deploy capital elsewhere.

Erosion of local banking – many small community banks consolidated or disappeared. Decision-making shifted from local officers to distant credit models.

Economic concentration – small cities became more dependent on external capital flows and large financial centers.

Reduced dynamism – fewer startups, less risk capital for local ideas, and slower job creation relative to cities with larger financial institutions.

In short, regulation tilted the scales toward “safe” assets and large-scale finance, weakening the traditional ecosystem that supported small-city entrepreneurship.

Would you like me to phrase this in a 200-word “policy memo” style summary—something you could use in discussions with regulators or economists?

I said: Please do.

ChatGPT said:

Here’s a compact policy memo–style summary (≈200 words):

Subject: Impact of Risk-Weighted Bank Capital Requirements on Small Cities

The introduction of risk-weighted bank capital requirements fundamentally altered credit allocation in the U.S. financial system. Under these rules, banks are permitted to hold less equity against sovereign debt and highly rated securities, while loans to small businesses and entrepreneurs require significantly more capital.

In small cities, community banks historically met local credit needs through relationship lending, relying on knowledge of borrowers and their reputations. This system worked effectively for supporting small businesses, startups, and local job creation. However, the new capital framework unintentionally penalized this activity.

Large financial institutions in major cities, with access to securitization and rating agencies, gained a competitive advantage. They could profitably channel funds into assets treated as low-risk under regulation, while community banks faced higher regulatory costs for their traditional lending.

The consequences for small cities have been significant:

Credit scarcity for entrepreneurs and small firms.

Consolidation and decline of community banks.

Shift in decision-making away from local officers toward distant financial centers.

Reduced economic dynamism and slower job creation.

In effect, regulations designed to strengthen bank safety have unintentionally weakened small-city economies by discouraging local, entrepreneurial lending.

Would you like me to also contrast this with a simple leverage ratio regime (same capital for all assets), so the memo suggests a potential remedy?

I said: Please do

ChatGPT said:

Here’s the revised memo with the contrast built in:

Subject: Impact of Risk-Weighted Bank Capital Requirements on Small Cities

The introduction of risk-weighted bank capital requirements fundamentally altered credit allocation in the U.S. financial system. Under these rules, banks are permitted to hold less equity against sovereign debt and highly rated securities, while loans to small businesses and entrepreneurs require significantly more capital.

In small cities, community banks historically met local credit needs through relationship lending, relying on knowledge of borrowers and their reputations. This system worked effectively for supporting small businesses, startups, and local job creation. However, the new capital framework unintentionally penalized this activity.

Large financial institutions in major cities, with access to securitization and rating agencies, gained a competitive advantage. They could profitably channel funds into assets treated as low-risk under regulation, while community banks faced higher regulatory costs for their traditional lending.

The consequences for small cities have been significant:

Credit scarcity for entrepreneurs and small firms.

Consolidation and decline of community banks.

Shift in decision-making away from local officers toward distant financial centers.

Reduced economic dynamism and slower job creation.

By contrast, a simple leverage ratio—the same equity requirement for all assets—would avoid distorting banks’ incentives. It would restore a level playing field for community banks, allowing local loan officers once again to serve small businesses on the basis of risk judgment and relationships rather than regulatory preference.

Would you like me to make this even shorter—say, under 150 words, in the style of a briefing note for a policymaker who only has 2 minutes?

I said: Another day. Thanks!

ChatGPT said: Anytime! I’ll be here when you’re ready to pick it up again. Thanks!

Here is how Grok answered that exact question

Here a "report" on how George Banks reacted when confronting the world of the risk weighted bank capital requirements.

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

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

#AI #Grok: What about risk weighted bank capital requirements and central banks' monetary policy?

Note: First I asked Grok the following questions without requesting brief (about 200 word) answers. I will publish its long answers but below, the brief ones:

I asked Grok:

"How important is bank credit to central banks’ monetary policy?"

Grok answered:

"Bank credit is crucial to central banks' monetary policy, acting as the main conduit for transmitting tools like interest rate changes, quantitative easing (QE), and targeted lending to the real economy. As of 2025, institutions like the ECB and Fed emphasize its role in achieving price stability, employment, and growth, especially amid non-bank financial intermediation (NBFI) growth and post-pandemic dynamics. Without strong bank credit transmission, policy effects would be muted, as banks amplify impulses to households and firms.

Key channels include:

Interest Rate Channel: Benchmark rates (e.g., Fed's federal funds rate) influence bank funding costs, passed to borrowers. ECB's 2025 strategy notes effective pass-through during tightening, curbing inflation via higher lending rates.

Bank Lending Channel: Easing boosts liquidity for more loans; tightening constrains supply. ECB data shows 2022-2023 hikes reduced euro-area loan growth by ~1%, impacting GDP by 0.3%.

Balance Sheet Channel: Policy alters asset values, affecting collateral and net worth. Robust buffers prevent disruptions, per Fed and ECB analyses.

Risk-Taking Channel: Low rates spur riskier lending; hikes foster caution. NBFI rise complicates this, requiring macroprudential integration.

In bank-dependent economies (e.g., euro area, >70% corporate finance via banks), credit is indispensable. Crises like 2008 and COVID-19 highlight interventions (e.g., ECB TLTROs) to sustain flows. 2025 reviews stress monitoring distortions for optimal transmission, blending monetary and prudential tools."

I asked Grok:

"Compared to how banks would allocate credit if they needed to hold the same capital requirement against all assets (a leverage ratio), do the risk weighted bank capital requirements distort the allocation of credit?"

Grok answered:

Yes, risk-weighted asset (RWA) requirements distort bank credit allocation compared to a uniform leverage ratio, where capital is held equally against all assets. Under RWAs (e.g., Basel III/IV), varying weights based on perceived risk—0% for sovereign bonds, 100%+ for corporate loans—incentivize banks to favor low-RWA assets like government debt or high-quality mortgages over higher-RWA but potentially more productive ones, such as SME or innovative sector lending. This regulatory arbitrage raises the effective cost of riskier assets, leading to under-allocation to growth-enhancing activities and reduced economic efficiency.

In contrast, a leverage ratio (e.g., 3–5% Tier 1 capital to total assets) imposes flat charges, allowing allocation based on market returns and risks without regulatory biases, though it may encourage excessive risk-taking. Theoretical models show RWAs shift portfolios toward low-risk assets, amplifying procyclicality and misallocation. Empirical evidence post-2008 confirms this: euro-area banks reduced corporate lending by 5–10% relative to a leverage baseline, favoring mortgages (weights inflated 5x under Basel IV). U.S. 2025 eSLR reforms highlight ongoing concerns, as binding leverage can distort but RWAs often exacerbate sectoral imbalances. 

Hybrids (RWAs + minimum leverage) mitigate distortions, per BIS and regulators, but RWAs inherently introduce them versus pure uniformity."

I asked Grok:

"Is the distortion produced in the allocation of bank credit by the risk weighted bank capital requirements, in any way considered by central banks when deciding on monetary policies?"

Grok answered:

Yes, central banks consider distortions in bank credit allocation from risk-weighted asset (RWA) requirements when formulating monetary policies, as these can impair transmission by favoring low-risk assets (e.g., sovereign bonds or mortgages) over productive higher-risk lending (e.g., to SMEs), reducing efficiency and growth. This is integrated into transmission analyses, macro-prudential frameworks, and tool design, with empirical evidence guiding adjustments.

The Bank of England (BOE)'s August 2025 analytical framework review explicitly addresses this, proposing joint modeling with its Monetary Policy Committee to evaluate RWA impacts on credit supply and economic objectives, recognizing trade-offs between stability and growth. It notes inefficiencies like biased credit toward property due to capital costs, and coordinates via the Financial Policy Committee to mitigate distortions. 

The Federal Reserve incorporates RWA effects in stress tests and transmission assessments; 2025 proposals on enhanced supplementary leverage ratios highlight overcalibration risks distorting RWAs, prompting recalibrations to support lending. A Bank Policy Institute study shows Basel III tightening reduces credit supply unevenly, benefiting safer firms, influencing Fed considerations. The ECB factors RWAs into its 2025 strategy via targeted tools like TLTROs to counter fragmentation and allocation biases. Overall, hybrids with leverage ratios minimize distortions, ensuring policy efficacy."

I said: Thanks! 

It answered: You're welcome! If you have more questions about monetary policy, bank credit, or anything else, feel free to ask. 

In 2023 I asked ChatGPT these exact questions.

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

PS. Could the risk-free interest rate be affected by credit risk weighted bank capital/equity requirements?

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

#AI #Grok: Basel’s risk weighted bank capital requirements, or a leverage ratio, which generates more worthy wealthy?

I asked Grok

 

“Risk weighted bank capital requirements favoring public debt and residential mortgages over loans to small businesses and entrepreneurs, or the same requirement against all assets, a leverage ratio, which will generate a larger number of what could be described as more worthy wealthy?”

 

Grok answered:

 

The leverage ratio—applying the same capital requirement to all assets—will generate a larger number of what could be described as more worthy wealthy, compared to risk-weighted capital requirements that favor public debt and residential mortgages over loans to small businesses and entrepreneurs.

Understanding the Two Approaches

Bank capital requirements are designed to ensure financial stability by requiring banks to hold a certain amount of equity capital relative to their assets (like loans or investments). The two main approaches differ in how they assess risk:

Risk-Weighted Capital Requirements (RWA System): Capital needs are scaled based on the perceived risk of each asset. Low-risk assets, such as government bonds (often 0% risk weight) and residential mortgages (typically 35-50% risk weight), require little capital. Higher-risk assets, like loans to small businesses or entrepreneurs (often 100% or more risk weight), demand much more capital. This creates a strong incentive for banks to prioritize "safe" lending to minimize capital costs and maximize returns on equity (ROE). As a result, banks lend disproportionately to public debt (funding government spending) and mortgages (fueling housing markets), while avoiding or charging higher rates for small business loans due to the capital penalty.

Leverage Ratio: This is a simple, non-risk-based measure: total capital divided by total (unweighted) assets, often set at 3-5% or higher under frameworks like Basel III. All assets are treated equally, regardless of risk. There's no capital "discount" for safe assets, so banks can't game the system by loading up on low-risk items. Instead, to achieve competitive ROE, banks may shift toward higher-yield, riskier assets—like small business loans—that offer better interest rates to compensate for the equal capital treatment.

These differences have real-world economic implications, particularly for wealth creation. 

"More worthy wealthy" here refers to individuals or families who build sustainable wealth through productive, innovative activities (e.g., entrepreneurs starting and scaling businesses that create jobs and economic value), rather than through asset inflation in housing or low-yield government financing.

Why the Leverage Ratio Favors More Worthy Wealth CreationThe RWA system distorts lending away from productive entrepreneurship toward less dynamic sectors, limiting the number of successful small business owners and innovators. In contrast, the leverage ratio removes these distortions, potentially increasing lending to high-potential but riskier ventures. Here's a breakdown:

Incentives for Lending Patterns:

Under RWAs, banks face a capital penalty for small business loans (e.g., a $100 loan to an SME might require $10 in capital at 100% risk weight, vs. $0 for government bonds or $3.50 for mortgages). This makes SME lending less attractive, reducing credit availability and stifling entrepreneurship. Studies show Basel III's RWA enhancements have raised the cost of SME lending by increasing banks' weighted capital needs, leading to tighter credit for small firms.

The leverage ratio eliminates risk-weight gaming. Since all assets require the same capital (e.g., 4% of $100 = $4 regardless of type), banks are incentivized to pursue higher-yield options like SME loans (which often carry 8-12% interest rates) over low-yield safe assets (e.g., 2-4% on mortgages or bonds). This "perverse incentive" for risk-taking—shifting portfolios toward volatile, high-return assets—can boost lending to entrepreneurs. Empirical evidence from U.S. banks post-2012 supplementary leverage ratio (SLR) implementation shows increased use of riskier collateral and higher risk-taking, as banks optimize for returns without RWA benefits.

Impact on Wealth Generation:

RWA System: Favors wealth concentration in real estate (via mortgage booms, inflating home prices for property owners) and public sector financing (benefiting governments and bondholders, often large institutions). This creates "unworthy" wealth through speculation or low-productivity growth, with fewer new entrepreneurs succeeding due to credit scarcity. For instance, higher RWAs under Basel III/IV have been linked to reduced SME financing, handicapping small businesses that drive innovation and job creation.

Leverage Ratio: Promotes broader wealth creation by enabling more credit to small businesses and startups, which historically generate the most dynamic economic value. Successful entrepreneurs (the "worthy wealthy") emerge from these ventures, building companies that scale, employ workers, and innovate. Research indicates leverage ratios act as a backstop to RWAs, encouraging balanced risk-taking without over-penalizing productive loans. While it may raise overall capital needs (potentially slowing some lending), it disproportionately benefits high-yield sectors like SMEs by leveling the playing field.

Evidence from Economic Studies and Implementation:

Analyses of Basel III show RWAs increase SME lending costs by 10-20 basis points on average, reducing loan volumes to small firms while boosting mortgage and sovereign exposures.

Leverage ratio introductions (e.g., in the EU and U.S.) have led to portfolio shifts toward riskier assets, with one study finding SLR prompted banks to favor high-return, volatile investments over safe ones like agency mortgage-backed securities.

Brookings Institution reviews emphasize that while RWAs tailor capital to risk (good for stability), they create biases against risky but productive lending; leverage ratios counter this by being simple and risk-neutral, though they require calibration to avoid excessive risk-shifting.

Aspect	Risk-Weighted Requirements	Leverage Ratio
Treatment of Assets	Favors low-risk (gov debt: 0%, mortgages: 35-50%, SMEs: 100%+)	Equal treatment (all assets same capital charge)
Incentive for SME/Entrepreneur Lending	Discourages (higher capital penalty reduces ROE)	Encourages (higher yields compensate for equal capital; promotes risk-taking for returns)
Wealth Creation Outcome	More wealth in housing/gov financing (speculative, concentrated)	More entrepreneurial wealth (productive, distributed via business success)
Potential Drawbacks	Gaming via low risk weights; undercapitalizes hidden risks	May increase overall risk-taking if not paired with RWAs; higher total capital needs
Real-World Impact Example	Basel III raised SME costs, reduced small business loans	Post-2012 SLR: Banks shifted to riskier, higher-yield assets

Caveats and Complementary Use

No single approach is perfect—regulators like the Basel Committee recommend using both (leverage as a "backstop" to RWAs) to balance stability and growth. Pure leverage might encourage excessive risk if banks chase yields recklessly, but in practice, it reduces the bias against entrepreneurs. If implemented standalone, the leverage ratio's equal treatment would likely produce more "worthy wealthy" by fostering a vibrant small business ecosystem, as seen in economies with simpler capital rules (e.g., some community banking models). For maximum effect, it should be set at levels (e.g., 5-8%) that maintain safety while unlocking productive lending.

I said: Thanks!

It said: You're welcome! If you have more questions about banking regulations, economics, or anything else, feel free to ask—I'm here to help. 

Here is ChatGPT’s answer to exactly the same question 

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

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

 

#AI ChatGPT: Basel’s risk weighted bank capital requirements, or a leverage ratio, which generates more worthy wealthy?

 I asked ChatGPT

“Risk weighted bank capital requirements favoring public debt and residential mortgages over loans to small businesses and entrepreneurs, or the same requirement against all assets, a leverage ratio, which will generate a larger number of what could be described as more worthy wealthy?”

 

ChatGPT answered:

A good way to frame it is to ask: what kinds of wealth creation do different capital rules encourage?

• Risk-weighted requirements (Basel style):
  
  
  Banks can hold less capital against assets deemed “safe” (public debt, residential mortgages, AAA securities). That steers credit toward governments and housing markets. This tends to generate more wealth from financial arbitrage (trading spreads on sovereign bonds, mortgage securitization, and real estate appreciation) rather than from productive business investment. The “wealthy” this system favors are often rentiers, financiers, large property owners, and governments, whose debt is cheaply financed. These are “worthy” mainly in the sense of political or financial clout, not necessarily in terms of creating broad productivity gains.
  
  
• Leverage ratio (same capital requirement on all assets):
  
  
  Here banks must treat all loans equally in terms of equity backing. That makes lending to small businesses and entrepreneurs comparatively less penalized. While risk is higher, it also channels credit to activities with greater potential for new value creation—jobs, innovation, competitive growth. The wealthy who emerge under this regime are more likely to be entrepreneurs and builders of productive enterprises, rather than those who accumulate from safe-asset subsidies.
  
  

So:

• Risk-weights → more wealthy from exploiting regulatory privilege and asset inflation.
• 
  
• Leverage ratio → more wealthy from actual economic innovation and risk-taking.

In other words, the latter is more likely to generate what could be described as “more worthy wealthy”—those whose fortunes stem from adding to real economic dynamism, not riding regulatory distortions.

Would you like me to illustrate this with some historical examples of each type of wealthy class that emerged under these two regimes?

I said: Yes, why not

ChatGPT said: Great. Let’s take some historical illustrations to make the contrast concrete:

---

1. Wealth under risk-weighted rules (Basel era, post-1988)

• Government bond dealers and sovereign lenders:
  After Basel I allowed 0% risk weights for government debt in domestic currency, banks massively increased their holdings. Wealth grew among dealers and investors who captured spreads on sovereign bonds with almost no capital backing. For example, Southern European banks pre-2010 sovereign debt crisis loaded up on their governments’ bonds, boosting balance sheets while enriching bond traders and financial intermediaries—until the crisis exposed the hidden risk.
  
  
• Real estate magnates and mortgage financiers:
  Lower risk weights for residential mortgages fueled massive credit flows into housing markets. This contributed to the rise of real estate billionaires and mortgage-backed securities financiers in the 1990s–2000s. The U.S. housing boom that culminated in 2008 is the clearest case: wealth accumulated disproportionately in property owners, mortgage originators, and securitizers like Countrywide or Lehman’s MBS desks—rather than in productive enterprise.

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2. Wealth under flat leverage ratios (historical analogies)

• 19th-century U.S. and U.K. banking:
  Before risk-weighted rules, banks essentially operated under crude leverage limits or market discipline. Credit was riskier, but it flowed strongly into railroads, steel, and industrial ventures. Many of the “robber barons” (Carnegie in steel, Vanderbilt in railroads, Rockefeller in oil) became wealthy not because regulators privileged their sectors, but because banks financed their risky but transformative projects.
• Postwar small business lending (U.S. 1945–1970s):
  Though regulation was different, capital rules were closer to leverage-based, without today’s heavy risk-weight distortions. This period saw credit support for manufacturing and small enterprise. The wealthy who rose were more often entrepreneurs (tech pioneers, manufacturers, even regional developers) rather than primarily bond dealers or securitizers.

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Bottom line

• Risk-weighted era → sovereign bond traders, property tycoons, financial engineers.
• Leverage-based era → industrialists, entrepreneurs, innovators.
• 
  

So if “worthy wealthy” means those who built lasting, productive enterprises, the leverage ratio world historically produced more of them.

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Would you like me to also trace contemporary billionaire lists (e.g., Forbes) to show how the balance has shifted between finance/real estate versus entrepreneurs across the two regulatory regimes?

I said: Perhaps another day. Thanks!

ChatGPT said: You got it — we can pick that thread up whenever you like. Thanks!

Here is Grok’s answer to exactly the same question 

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

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