#AI ChatGPT: Risk weighted bank capital requirements with decreed weights of 0% government – 100% citizens is it anathema to neoliberalism?

I asked ChatGPT:

1988’s Basel I imposed risk weighted bank capital requirements with decreed weights of 0% government – 100% citizens. Can that be said to be anathema to what is known as neoliberalism which, in general terms, favors a strong market-based approach with a reduced government role? 

ChatGPT answered:

"Basel I, implemented in 1988, was primarily focused on establishing minimum capital requirements for banks to ensure their stability and resilience. While it did assign risk weights to different types of assets, including government and citizen exposures, it did not explicitly prescribe a specific ideology or political philosophy such as neoliberalism.

Neoliberalism is a broad term used to describe a political and economic philosophy that emphasizes free markets, limited government intervention, privatization, and deregulation. It advocates for reducing government involvement in the economy and promoting market-driven approaches.

In the context of Basel I, the risk weights assigned to government exposures and citizen exposures were intended to reflect the perceived riskiness of those assets. The 0% risk weight for government exposure was based on the assumption that investments in government securities were inherently risk-free. On the other hand, the 100% risk weight for citizen exposures indicated that such exposures were considered to carry the highest level of risk.

While the risk weights assigned under Basel I may appear to favor government exposures over citizen exposures, it is important to note that the framework aimed to establish a standardized approach to risk assessment and capital adequacy across international banks. The intent was to ensure banks held sufficient capital to withstand losses, regardless of the specific assets they held. It did not necessarily reflect an ideological bias towards government or citizens.

It is worth mentioning that subsequent Basel frameworks, such as Basel II and Basel III, introduced more sophisticated risk-based approaches that aimed to capture a broader range of risks, including credit, market, and operational risks. These frameworks incorporated more nuanced risk weights, which were not strictly binary (0% or 100%), and considered a variety of factors when assessing capital requirements.

In summary, while the risk weights assigned under Basel I may not align perfectly with the tenets of neoliberalism, it is important to view the framework in the context of its primary objectives: ensuring bank stability and capital adequacy. The subsequent Basel frameworks have further evolved to incorporate a more comprehensive and risk-sensitive approach."

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

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

PS. http://subprimeregulations.blogspot.com/2015/07/just-before-fall-of-berlin-wall.html

Small businesses (like restaurants) besides Covid-19 lockdowns, when it comes to bank credit, these have also for a long time suffered lockouts

Before Basel Committee’s risk weighted capital requirements, if a residential mortgages and loans small businesses produced the same risk adjusted expected net margin/return on asset (eROA), these would produce the same risk adjusted expected returns on equity (eROE)

That was then: Now, with Basel III a residential mortgage with e.g., a loan to value of 80% to 90%, has a risk weight of 40%; which times the basic 8% requirement, results in a capital requirement of 3.2%, which allows banks to leverage 31.25 times their capital (equity).

While a loan to small businesses have a risk weight of 100%; which results in a capital requirement of 8%, which allows banks to leverage 12.5 times their capital.

So, if the eROA for residential mortgages and loans to small businesses is 1%, then residential mortgages produce a eROE of 31.25%, while loans to small businesses only a eROE of 12.5%

And so, even if interest rates on residential mortgages were reduced by e.g. 0.5%, resulting in a lower risk adjusted expected ROA of 0.5%, residential mortgages, yielding banks a 15.625% risk adjusted eROE, would still be more interesting to banks than loans to small businesses

And therefore, small businesses, in order to access credit, must pay higher interest rates so as to increase the expected risk adjusted ROA, in order to produce banks a competitive risk adjusted eROE.

And so, though the less creditworthy (small businesses/entrepreneurs) always got smaller bank loans and paid higher interest rates but, with risk weighted bank capital requirements, the regulator also decreed them to be less worthy of credit.

What’s the net result of all this? Too much credit at too low interest rates for the purchase of houses, and too little credit to the small businesses/entrepreneurs who could generate the jobs/the incomes/the down-payments, for house buyers to service their mortgages and pay food and utilities.

Conclusion: The risk weighted bank capital requirements have, de facto, 0% to do with credit risk reduction, and 100% to do with risk generating distortions.

Basel Committee… Good Job!

PS. There has too be and adequate equilibrium between risk-avoidance and the risk-taking needed to sustain growth.

http://subprimeregulations.blogspot.com/2019/03/my-letter-to-financial-stability-board.html