#AI #ChatGPT #Grok: Five questions on: What if there was the same bank capital/equity requirement against all bank assets?

I asked ChatGPT"

"If instead of 1988 Basel Committee’s risk weighted capital requirements, banks needed to hold e.g., a same 10 percent in capital against sovereign debts, residential mortgages, securities rated AAA and loans to small businesses and entrepreneurs, please:  With a Yes or a No:

Would the sovereigns’ debts be as high as when compared to current GDPs?

Would house prices be as high as these currently are?

Would the 2008 GFC, which in much detonated by AAA rated MBS turning risky, have happened?

Would the GDP of nations be lower or higher than today?

Would we all be better off today?"

If you like, in max 200 words, explain each of your answers.

 

ChatGPT answered: Yes or No answers:

Would sovereigns’ debts be as high as when compared to current GDPs? No

Would house prices be as high as these currently are? No

Would the 2008 GFC, which in much detonated by AAA rated MBS turning risky, have happened? No

Would the GDP of nations be lower or higher than today? Higher

Would we all be better off today? Yes

Brief Explanation (within 200 words):

 

"If banks had been required to hold the same capital (e.g., 10%) against all assets—government debt, AAA securities, mortgages, and small business loans—credit allocation would have been more balanced and market-driven. Governments would have faced real financing costs, limiting their debt growth. Housing prices would have risen more modestly without the capital incentive to overload on mortgages. The 2008 Global Financial Crisis was triggered largely because AAA-rated mortgage-backed securities attracted minimal capital requirements while hiding systemic risk; under equal capital rules, banks would have held fewer such assets or been better cushioned.

 

With better risk distribution and more capital backing loans to entrepreneurs, productive investment would likely have increased, supporting more resilient and inclusive GDP growth. Fewer distortions and crashes would mean less inequality and instability, making society better off overall—economically and socially.

 

This is not utopia—but better regulation could have enabled more sustainable growth."

I said: Thanks!

ChatGPT replied: 

You're very welcome! Always glad to help clarify. If you'd ever like to explore how such capital rules could be reformed today—or their political barriers—just let me know.

 

I asked Grok exactly the same question, in exactly the same way:

 

Grok answered:

 

Below are the Yes/No answers followed by brief explanations (max 200 words each) for each question, 

 

Would the sovereigns’ debts be as high as when compared to current GDPs? No

A uniform 10% capital requirement would constrain banks’ ability to hold large volumes of sovereign debt, as they’d need more capital than under Basel’s low or zero risk weights for sovereigns. This would limit sovereign borrowing, forcing governments to curb deficits or seek alternative funding, likely reducing debt-to-GDP ratios. Historical data suggests Basel’s framework enabled high sovereign debt (e.g., Eurozone debt-to-GDP peaked at 92% in 2014). A stricter requirement would discourage reckless lending to governments, fostering fiscal discipline and lower debt levels relative to GDP.

 

Would house prices be as high as these currently are? No

A 10% capital requirement on residential mortgages would reduce banks’ lending capacity compared to Basel’s low risk weights (e.g., 35% for mortgages). Less credit availability would dampen housing demand, lowering price growth. For example, post-2008, tight credit conditions in some markets curbed house price surges. Higher capital needs would limit speculative bubbles, keeping prices more aligned with incomes and fundamentals.

 

Would the 2008 GFC, which in much detonated by AAA-rated MBS turning risky, have happened? No

A 10% capital requirement on AAA-rated mortgage-backed securities (MBS) would have reduced banks’ exposure to these assets, as Basel assigned them near-zero risk weights, encouraging overinvestment. This overreliance fueled the 2008 crisis when MBS turned toxic. Higher capital buffers would have limited leverage and forced better risk assessment, likely preventing the scale of the crisis. The crisis’s roots in misrated securities would have been mitigated by stricter capital rules.

 

Would the GDP of nations be lower or higher than today? Higher

A uniform 10% capital requirement would shift lending toward productive sectors like small businesses, which Basel penalized with high risk weights. Increased credit access for entrepreneurs would spur innovation and growth, boosting GDP. While reduced sovereign and mortgage lending might initially slow consumption, long-term economic efficiency would improve. Historical evidence shows SMEs drive job creation (e.g., 60% of U.S. jobs). Balanced capital rules would support sustainable growth over debt-fueled bubbles.

 

Would we all be better off today? Yes

A 10% capital requirement would promote financial stability by reducing sovereign debt, housing bubbles, and risky MBS exposures, averting crises like 2008. More lending to small businesses would foster innovation, job creation, and equitable growth. While short-term consumption might dip, long-term economic resilience and fairer capital allocation would benefit society. Reduced inequality from less rent-seeking in housing and sovereign debt markets would enhance overall well-being.

Thanks!

 

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 – Grok on bank regulations.

Lord Adair Turner’s awakening as a bank regulator has at least begun, and that’s good news.

In June 2010, during a conference given by Adair Turner at the Brookings Institute, I asked him the following: 

"Big companies in consolidated sectors, like BP in oil, tend to have much better credit ratings than those participating in developing markets, like wind energy. Do you really think the banks will perform better their societal capital allocation role if regulators allow them to have much lower capital requirements when lending to the consolidated sectors than when lending to the developing? Do you think we can reach a meaningful financial regulatory reform without opening up the discussion on the issue of risk in development?"

Lord Turner responded: "The point about lending to large companies development, I'm not sure. I'm trying to think about that. I mean we try to develop risk weights, which are truly related to the underlying risks. And the fact is that on the whole, lending to small and medium enterprises does show up as having both a higher expected loss but also a greater variance of loss. And, of course, capital is there to absorb unexpected loss or either variance of loss rather than the expected loss. I think, therefore, it's quite difficult for us to be as regulators, skewing the risk weights to achieve, as it were, developmental goals. There are some developmental goals, for instance, in a renewable energy, which I'm very committed to wearing one of my other hats on climate change, where I do think you may need to do, you know, in a straight public subsidy rather than believing that we can do it through the indirect mechanism of the risk weights. So I may have misunderstood your question, but I'm sort of cautious of the sort of the leap to introducing developmental roles into -- I thinks we, as regulators, have to focus simply on how risky actually is it?"

Lord Turner did not understand what I was referring to, and what was wrong:

Lord Turner: “we try to develop risk weights which are truly related to the underlying risks”. No! The real underlying risk with banks is not the risk of their assets, but how banks manage the perceived risks of their assets.

Lord Turner: “capital is there to absorb unexpected loss or either variance of loss rather than the expected loss”

Yes “capital is there to absorb unexpected loss”, and that is why it is so ridiculous to base the capital requirements for banks on something expected, like the perceived credit risks.

Now Lord Turner in his recent book, “Between Debt and the Devil”, though he still evidences he does not understand the distortions in the allocation of bank credit to the real economy the risk weighted capital requirements produce, he seems to become more flexible about using other criteria. From the “I think we, as regulators, have to focus simply on how risky actually is it” he now states: “We need to manage the quantity and influence the allocation of credit bank create… Capital requirements against specific categories of lending should ideally reflect their different potential impact of financial and macroeconomic stability. 

Though Turner has not yet reached as far as banks actually having a social purpose more important than that of just not failing, like financing job creation and the sustainability of our planet, this is a good and welcome start. And I say so especially because Lord Turner’s awakening might reflect what hopefully might be going on in other regulators' minds.

Lord Turner even though he gets it that “it is rational for banks to maximize their own leverage, increasing the returns on equity”, still fails to understand how allowing different leverages, much higher for safe assets than for risky, make banks finance more than usual what is perceived as safe, and much less than usual what is perceived as risky… which is precisely why banks finance so much houses and so little the SMEs and entrepreneurs, those that help create the jobs needed to pay mortgages and utilities.

Lord Turner also mentions in his book the issue of inequality. For the hopefully revised and corrected sequel to his book, I would suggest he thinks about the following quote from John Kenneth Galbraith’s “Money: Whence it came where it went” 1975. 

“The function of credit in a simple society is, in fact, remarkably egalitarian. It allows the man with energy and no money to participate in the economy more or less on a par with the man who has capital of his own. And the more casual the conditions under which credit is granted and hence the more impecunious those accommodated, the more egalitarian credit is… Bad banks, unlike good, loaned to the poor risk, which is another name for the poor man.”

But clearly Galbraith was referring to credit to producers and not to consumers. 

And of course I wish Lord Turner, like so many other, stops referring to the financial crisis as a result of free markets running amok. Free markets would never ever have authorized banks to leverage over 60 to 1 when investing in AAA rated securities, or when lending to Greece. Markets were not free. Banks were not deregulated. Banks were utterly misregulated.

PS. Cross your fingers. There might be something there that wasn't there before :-)

Per Kurowski’s (that’s me) Paris COP21 action plan, would have much more immediate environmental (and job creating) impact

Regulators currently tell banks: “More credit risk, more capital (equity) – less credit risk, less capital. 

And so right now our banks earn much higher risk adjusted return on equity on what is perceived or made out to be safe, than on what is perceived as risky. All for no good reason at all. 

Q. What has credit risk to do with the worthiness of something having access to bank credit? A. Nothing! 

Q. What assets are least likely to detonate major banks crises? A. Those ex ante perceived as safe!

In Paris, during COP21, I would have suggested that we tell bank regulators to stop favoring the access to bank credit of The Safe, and quit discriminating against the access to bank credit of The Risky.

Instead they should base their capital requirements of banks on sustainability and job creation – Sustainable Development Goal’s (SDGs) ratings. That way banks would earn higher risk adjusted returns on equity when financing what we most need and want them to finance. Otherwise, why on earth should society support banks so much?

Of course SDGs ratings could be gamed, as credit risk ratings often are, as carbon trading often is. But yet there would be much more oversight about the SDG ratings of projects than what there currently is of the credit risk ratings produced by 3 human fallible credit rating agencies.

Friends, would it not be nice to put some much needed worthy social impact purpose back into our banks?

Please help me stop our banks from mostly refinancing our safer past, and make them work harder on our sustainable future.

On risk-taking, retirement accounts, and lousy bank regulations.

What would have happened with anyone’s retirement plan if, when a young professional and starting to save, his instructions would have included paying his investment manager much higher commissions on returns produced by safe investments, than on returns produced by riskier investments. 

There is no doubt that in such circumstances, his investment manager would have played it overly safe, and he, the beneficiary, would probably have had to retire on a very meager income.

But, by means of their credit-risk weighted equity requirements, which allow banks to earn much higher risk adjusted returns on their equity when lending to something “safe”, than when lending to something “risky”, the regulators are instructing the banks to act in precisely this way.

Whether we like it or not, banks have a very important role to play as investment managers for our economies. And the reason we taxpayers implicitly agree to support banks, is not for them to avoid risks, but to, with reasoned audacity, take intelligent risks on our behalf. 

And so, even if we have to pay banks high commissions, we need them to act much more like aggressive growth funds taking risks but looking to produce for us investors better returns; and for our economies sturdier growth; and for our young better good future employment opportunities.

So let's get these regulators out of our way!

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​.

If bank regulators cannot refrain themselves from meddling, why do they not at least meddle in a more useful way?

Current capital requirements of the banks are based on the information provided in credit ratings, something that makes no sense because bankers and markets have already seen that information and considered it when they set their interest rates, decide how much to lend or invest, and under what terms. 

Therefore I often ask: “Bank regulators why do you use credit ratings in your capital requirements and not something like job creation potential ratings, or environmentally friendly ratings?” 

I am sure that if banks were allowed to hold a bit less capital... and therefore be allowed to leverage their equity more... and therefore be able to obtain a higher risk-adjusted return on equity… whenever lending or investing in something especially good from a job creation or sustainability point of view, then the banks would be performing better for the whole society. 

As is, the banks are only performing better for those who possess good credit ratings, for “The Infallible” leaving all “The Risky” out in the cold.

Other unanswered questions

It’s the stupid bank regulations stupid!

Those perceived as “not risky”, they have always paid lower interest rates, gotten larger loans, on softer terms, and attracted that type of large bank exposures that has caused all major bank crises, when some of them turn out to be very-risky. And so why, Mr. Bright Bank Regulator, do you allow the banks to hold less capital when lending to the “not risky”? That way the "not risky" get even lower interest, even larger loans, on even softer terms and we risk an even major systemic crisis, when some of these “not-risky”, like the triple-A rated securities, the infallible sovereigns like Greece, Icelandic banks, Spanish real estate borrowers and what awaits us, turn out to be very risky. Why are you so chummy with the dangerous not-risky, are you stupid? 

Those perceived as “risky”, like the small businesses and entrepreneurs, they have always paid higher interest rates, gotten smaller loans, on harsher terms, and never ever caused a major bank crisis. And so why, Mr. Bright Bank Regulator, do you require the banks to hold more capital when lending to the “risky” than when to the “not risky”, and so that the "risky" get charged even higher interests, get even smaller loans, on ever hasher terms, and so have even less chance of helping us to generate the growth and job opportunities we need, and, like now, help us out of the crisis generated by some “not-risky” ex-ante, turning very-risky, ex-post. Why do you treat the useful risky so bad, are you stupid? 

Mr. Bright Bank Regulator, if you absolutely must mess around with market signals, so you feel you have earned your salary, then why do you not at least base the capital requirements for banks on job creation and environmental sustainability ratings. That way these would at least serve a purpose.