#AI #ChatGPT #Grok: For more sturdy economic growth and less dangerous bank systems what’s better: risk weighted bank capital requirements or a leverage ratio?

I asked: 

In less than 300 words please opine on: Between the current risk weighted bank capital requirements and a simple leverage ratio, e.g., 10 percent against all assets, what helps to generate a higher and more sturdy general economic growth, without creating bigger dangers for bank systems at large?

ChatGPT answered:

A simple leverage ratio—e.g., requiring banks to hold 10% capital against all assets—would likely foster sturdier and more sustainable economic growth than the current risk-weighted capital requirements.

Risk-weighted frameworks, such as those under Basel accords, distort credit allocation by assigning very low capital requirements to assets deemed “safe” (e.g., government bonds, AAA securities, residential mortgages) and much higher requirements to loans to small businesses and entrepreneurs. This encourages banks to overinvest in assets with regulatory privileges, inflating sovereign debts and housing markets, while underfinancing productive sectors that drive real economic growth. The result is a misallocation of credit, weaker innovation, and more volatile growth cycles.

Moreover, risk weights are pro-cyclical: in good times, perceived risks fall, reducing required capital and fueling credit booms; in bad times, risks rise, forcing banks to deleverage when credit is most needed. This amplifies financial instability and recessions.

A flat leverage ratio, by contrast, treats all assets equally, pushing banks to assess risk and return based on market fundamentals rather than regulatory incentives. While critics argue it may discourage lending to low-risk borrowers, it would promote a healthier distribution of credit, more productive investment, and reduce systemic bubbles tied to regulatory favoritism.

In sum, a simple leverage ratio may modestly slow credit growth in the short term but supports steadier, more innovation-driven growth over time—without introducing the systemic fragilities risk-weighted rules have repeatedly failed to prevent.

Would you also like me to add a one-sentence conclusion explicitly stating which is safer for bank systems at large?

I said: Please do!

ChatGPT said:

In conclusion, a simple leverage ratio is safer for bank systems at large, as it limits overall leverage uniformly and avoids the concentration and systemic risks fostered by mispriced regulatory risk weights.

I said: Thanks!

It replied: You're welcome! 😊 Always glad to help—feel free to return anytime!

Grok answered: 

A simple leverage ratio, such as 10% against all assets, likely fosters higher and more robust economic growth compared to risk-weighted bank capital requirements, without significantly increasing systemic dangers. Risk-weighted frameworks, like Basel III, assign lower capital requirements to assets deemed "safe" (e.g., government bonds), incentivizing banks to overweight these assets. This can distort investment decisions, channeling funds away from riskier but potentially more productive ventures, like small business loans, stifling economic dynamism. Moreover, risk-weighting relies on subjective models that often fail to predict crises, as seen in 2008 when highly rated assets collapsed.

A uniform leverage ratio simplifies regulation, reduces gaming of risk models, and ensures banks hold sufficient capital against all assets, enhancing resilience. By not favoring specific asset classes, it promotes broader lending, supporting diverse economic activity and growth. For instance, a 10% ratio could encourage banks to finance innovative sectors without penalizing perceived risk, as risk-weighting does.

However, leverage ratios aren’t flawless. They might constrain lending during booms, potentially dampening growth, and could push risk-taking into unregulated sectors. Yet, their transparency and uniformity reduce complexity and regulatory arbitrage, which risk-weighted systems exacerbate, often masking vulnerabilities until crises hit.

Empirical data suggests economies with simpler capital rules recover faster from downturns. For example, post-2008, banks with higher leverage ratios weathered shocks better than those reliant on risk-weighted metrics. A 10% leverage ratio, while not perfect, balances growth and stability by enforcing discipline without distorting market signals. Risk-weighted systems, while sophisticated, often breed complacency and misallocation, undermining both economic vigor and systemic safety.

I said: Thanks

It replied: You’re welcome

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

FSB reports: “G20 reforms are building a safer, simpler, fairer financial system”. What a triple lie!

FSB reports to G20 Leaders on progress in financial regulatory reforms, and it starts with: G20 reforms are building a safer, simpler, fairer financial system

“Safer”? Major bank crises do not result from excessive exposures against what is perceived risky, but always from unexpected events or excessive exposures to what was ex ante perceived, decreed or concocted as safe, but that, ex post, turned out to be very risky.

In the FSB video they say “A safe banking system needs enough capital to absorb unexpected losses” and so my question is: So why require capital based on expected risks?

“Simpler”? Don’t be ridicule! Just have a look at the Basel Committee’s absurdly obscure “Minimum capital requirements for market risk” of January 2016, and on its consultative document for a "simplification" of July 2017.

The FSB video does not really even dare to explain the "simpler" factor.

“Fairer”? Forget it! The discrimination in the access to bank credit in favor of those perceived, decreed or concocted as safe, like the Sovereigns and the AAA-risktocracy is still alive and kicking; just like that one against “the risky”, the SMEs and entrepreneurs. It is an inequality driver.

No wonder the FSB video has the comments disabled.

G20 you want to understand what is wrong with current bank regulations? Start here!