#AI #OpenAI #ChatGPT Can differentiated bank capital/equity requirements set nations up for a long-term growth trap?

I asked ChatGPT:

In 400 words please opine on this: "Bank capital/equity requirements that are lower against “safe” public debt and residential mortgages, than against “risky” loans to small businesses and entrepreneurs, can that set up nations to a long-term growth trap?"

ChatGPT answered:

"Differentiated bank capital requirements — with lower equity held against "safe" assets like government bonds and residential mortgages than against "risky" loans to small businesses and entrepreneurs — can indeed risk setting nations up for a long-term growth trap. This structure incentivizes banks to allocate more funds to "safe" assets, given the reduced capital burden, which can skew overall investment away from productive, high-growth opportunities. While designed to stabilize the financial sector, these requirements can inadvertently dampen economic dynamism, as entrepreneurs and small businesses often serve as primary engines of innovation, job creation, and productivity growth.

When banks favor government bonds and residential mortgages, much of the economy's capital ends up tied in lower-yielding, less productive assets. While public debt may finance essential government programs, it does not directly stimulate the same private-sector productivity gains as entrepreneurial investment. Likewise, while housing investment supports construction and related industries, excessive mortgage lending can lead to real estate bubbles, driving up property prices without equivalent increases in broader economic productivity.

Further, the difficulty that small businesses face in accessing credit under such a regulatory framework can stunt innovation. Early-stage companies often have less collateral and higher initial failure rates, yet they also drive critical advancements and competition. Small enterprises and start-ups are central to bringing new technologies to market, creating disruptive business models, and stimulating wage growth. When these companies struggle to secure financing, a nation’s economic structure risks ossifying, reducing its adaptability and limiting its capacity for robust, long-term growth.

This allocation bias can ultimately lock economies into a cycle of dependence on low-yield, low-risk assets, fostering stagnant productivity and widening inequality. Wealthier individuals benefit from real estate and government bond returns, while entrepreneurs, who might otherwise innovate and expand economic opportunity, face higher barriers. Over time, this uneven capital distribution risks entrenching structural inequalities and stalling economic development.

Policymakers must recognize the implications of these regulations on broader economic growth and consider recalibrating capital requirements. Aligning capital charges more closely with the societal and economic benefits of different investment types could support a balanced approach to financial stability and economic growth. This might involve providing credit guarantees, targeted reliefs, or tax incentives to offset the capital costs of lending to small businesses, supporting both a resilient financial sector and a dynamic, inclusive economy capable of sustained growth."

I said: Thanks!

It answered: You're very welcome! I'm glad you found it helpful. Let me know if you'd like to explore more on this topic or anything else!

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

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

 

A pre-reading it comment on Mercatus Center’s Tyler Cowen’s “The Complacent Class”

Note: I have not read Tyler Cowen’s “The Complacent Class: The Self-Defeating Quest for the American Dream” yet, as it is still not available. If it contains something that would contradict the following comment that would be great welcomed news. 

In Foreign Affairs we can read: “Tyler Cowen’s timely and well-written book points to a central feature of contemporary American life: since the 1980s, U.S. society has become less dynamic and more risk averse. The quest for safety and predictability has made the country both more and less comfortable than before. Although many (perhaps even most) Americans enjoy the stability and security that the status quo provides, increasing numbers feel thwarted by the lack of opportunity and slow economic growth that characterize their increasingly static society.” 

And I ask, how could that not be when bank regulators introduced risk weighted capital requirements for banks? That primarily happened in 1988 with Basel I and in 2004 with Basel II. 

And the risk weights imposed were such as: Sovereign 0%, AAA-risktocracy 20%, residential houses 35%, We the People, like unrated SMEs and entrepreneurs 100%, and below BB-rated 150%.

That clearly gives banks all the incentives (higher allowed leverages) to finance and refinance much more what is ex ante perceived, decreed or concocted as safe, most often what derives from something that already is known and exists; and to stop financing the unknown riskier future. In other words those regulations imposed risk aversion on the Home of the Brave. 

That, in the short term, not only guarantees a static society, but worse, medium and long term, it causes a falling society. 

It is perfectly understandable that those with Statist inclinations, and who in the 0% risk weight for the sovereign must see their wet dreams come true, don’t say a word about the distortions in the allocation of bank credit those regulations cause… and this even though this regulation actually decrees that inequality they so much tell us they abhor. 

But, that professors from a Mercatus Center at George Mason University that presents itself as “the world’s premier university source for market-oriented ideas”, keeps hush about this all, really makes me sad. 

But, that professors from a Mercatus Center at George Mason University that presents itself as “the world’s premier university source for market-oriented ideas”, keeps hush about this all, really blows my mind. What keeps them from seeing the problem? A peculiar confirmation bias?

PS. In 2011 I already commented about this to Tyler Cowen, when sending him by email what I wrote to Martin Wolf with respect to his "The Great Stagnation"

PS. Here is another occasion in which the Mercatus Center, in my opinion, failed to speak up.

PS. And there is enough evidence on the web about how I have commented on this issue, time after time, on blogs run by Professors of the Mercatus Center.

The Basel Committee, Financial Stability Board and other frightened risk adverse bank nannies, they mandated stagnation.

When you allow banks to hold less capital when financing what’s perceived as safe than when financing the risky; banks earn higher expected risk adjusted returns on equity when financing the safe than when financing the risky; and so you are de facto instructing the banks to stop financing the riskier future and keep to refinancing the safer past… something which guarantees stagnation… a failure to develop, progress or advance… something which guarantees lack of employment for the young and retirement hardships for the old. 

I would prefer not to distort the allocation of bank credit but, if I had to, then I would try to ascertain that bank credit goes to where it could do the society the most good; in which case I would consider basing these on job creation ratings and environmental sustainability ratings, and not on some useless credit ratings already cleared for by banks with the size of their exposures and interest rates.

PS. If you want more explanations on the statist and idiotic bank regulations that are taking our Western society down, here is a brief aide memoire.

PS. If you want to know whether I have any idea of what I am talking about, here is a short summary of my early opinions on this issue since 1997.

It is prudent for our banks to take risks on the not so creditworthy, especially if these are up to something worthy

In a recent article in the Financial Times a bank was mentioned to be “an exemplar of prudence…[because] The target loan loss ratio is zero; [and] low loan losses, in turn, allow the bank to offer competitively priced loans and personalized service to creditworthy customers.”

To me that points clearly to what’s wrong with banks nowadays. “A target loan loss ratio of zero”… might allow “to offer competitively priced to creditworthy customers” but it will clearly not offer sufficient opportunities of credit to the not so creditworthy, those which includes too many risky SMEs and entrepreneurs, but also that could help provide the proteins the economy needs to move forward, in order not to stall and fall.

And the real truth is that, in the medium and long term, the creditworthy could benefit much more by banks taking much more risks on the not creditworthy, especially if these seem to be up to something worthy, than by they just getting low priced loans.

And if to the “zero loss loan target” you then add the distortion in the allocation of bank credit caused by the risk weighted capital requirements for banks, you might get a feel for why our economies seem to stagnate. 

Those regulations require the banks to hold more equity when lending to someone perceived risky, than when lending to someone perceived safe. And so that results in banks earning higher expected risk adjusted returns on equity when lending to someone perceived, decreed or concocted as safe, than when lending to someone perceived as risky. And that signifies that, around the world, millions of “risky” SMEs and entrepreneurs are not given the opportunity they might deserve and we might need for them to get.

As is, the banking system no longer finances the “riskier” future but only refinances the “safer” past, and that is as imprudent as can be, at least for our grandchildren.

Those bankers who with reasoned audacity take chances on the future are good servants of the society. Those who only maximize return on equity by diminishing the required capital and avoiding risks are, in the best of cases, absolutely boring.

And don’t get me wrong; I do not want to endanger our banking system, it is just the opposite. The forgotten truth is that major bank crises never ever result from banks building up excessive exposures to what ex ante is perceived as risky, it is not in the nature of bankers, as Mark Twain explained in terms of sun, rain and umbrellas.

The big crises always result from unexpected event of because of excessive exposures to something erroneously considered as safe.

PS. With their risk weighted capital requirements the regulators decreed inequality.

Mario Draghi, Stefan Ingves, Mark Carney, Jaime Caruana and other bank regulators, you should be ashamed

Thanks to theirs and other regulators’ credit risk weighted capital requirement for banks, the risks your banks now take, are that of dangerously excessive exposures to what’s deemed as “absolutely safe”; not the true risk-taking the economy needs; and, as a consequence, Europe, which was constructed upon true risk-taking, is now stalling and falling… and its youth condemned to be a lost generation.

You young Europeans, if you want to have a chance of a better world, or a least of a not too much worse world, then go tell your regulators to immediately stop basing their capital requirements for banks on some purposeless credit risk ratings, those which are already considered by banks; and to use instead creation-of-jobs-to-young-people ratings, sustainability of planet earth ratings, and, when lending to sovereigns, ethics and good governance ratings.

Tell them that they should know that secular stagnation, deflation, mediocre economy and all similar obnoxious creatures, are direct descendants of excessive risk aversion

PS. ​Of course the risk would then be that the rating of ethics and good governance falls into the wrong hands​.

Yes Mme. Lagarde. It matters much where banks are going, and they’re being directed in the wrong direction.

Yes Mme. Lagarde. It matters much where banks are going, and they’re heading the wrong way.

Christine Lagarde Managing Director, International Monetary Fund in “The IMF at 70: Making the Right Choices—Yesterday, Today, and Tomorrow” during The IMF/World Bank Annual Meetings, Washington, D.C. October 10, 2014, states: “It matters where we want to go in order to decide which way we go.”

Indeed it matters. And that is why I ask Christine Lagarde to use her influence to ask bank regulators: where do they want our banks to go.

I say this because in all their regulations there is not on single word about the destiny of the banks, in terms of the purpose of our banks. 

And that is of course why they have allowed themselves to impose on banks “credit-risk weighted capital requirements for banks”, which introduces a sissy silly risk aversion in the banking system and which completely distorts the allocation of bank credit to the real economy.

When Mme. Lagarde presents to us a choice between stability and fragility, that is a perfect opportunity to remind all of you that the search for stability can itself produce that stiffness, brittleness and lack of flexibility, that can lead to real monstrous fragility.

When Mme. Lagarde presents to us a choice between acceleration and stagnation that is not really a choice, since the lack of acceleration, moving forward, taking risks, will make the economy stall and fall, sooner or later.

And finally when Mme. Lagarde presents to us the choice between solidarity and seclusion, I would just note that, though there is a saying that goes “better alone than in bad company”, whenever you build a wall, you cannot be absolutely sure you end up on the right side of it.

IMF, and World Bank you have an important and urgent role to perform in holding bank regulators accountable for what they have done and are doing… please do not shy away from it.

And also never forget that secular stagnation, deflation, mediocre economy, unemployment, underemployment, managed depression and all similar obnoxious creatures, are all direct descendants of risk aversion.

“A ship in harbor is safe, but that is not what ships are for.” John Augustus Shedd, 1850-1926