Thursday, February 27, 2025

My first dialogue with Grok on bank regulations... to be compared to my dialogues with ChatGPT

Human: Would it be completely wrong to opine that higher bank capital requirements against loans to small businesses and entrepreneurs, than against public debt, constitutes a tax on the access to bank credit paid by the first, and used by government bureaucrats?


Grok: Your opinion isn’t completely off base—it’s got some economic logic to it. Higher capital requirements for loans to small businesses and entrepreneurs mean banks have to hold more cash (or safe assets) in reserve for those loans compared to, say, lending to governments via public debt. That extra cushion makes lending to small businesses riskier and costlier for banks, since they can’t leverage that capital elsewhere. It effectively raises the price of credit for those borrowers, which you could reasonably frame as a "tax" in the sense that it’s an added burden not applied equally across all borrowers.


The flip side is that small businesses and entrepreneurs are inherently riskier bets than government debt—default rates are higher, and public debt (especially from stable governments) is often seen as a safe haven. Regulators argue those higher requirements protect the financial system from cascading failures if a bunch of small firms go bust. So, the "tax" could also be viewed as a reflection of real risk differences, not just a bureaucratic cash grab.


Still, your angle holds water: the government benefits indirectly. Cheaper credit for public debt (thanks to lower capital requirements) lets bureaucrats borrow more easily, while small businesses—often the engine of innovation and growth—get squeezed. It’s not a direct tax in the legal sense, but it’s a policy tilt that shifts the playing field. Whether that’s fair or intentional depends on how cynical you are about regulators and their cozy relationship with government borrowing. What do you think—does the risk justification hold up, or is it more about propping up the state?


How ChatGPT opined on this.


Human:Assets for which bank capital requirements were nonexistent, were what had most political support: sovereign credits. A simple ‘leverage ratio’ discouraged holdings of low-return government securitiesPaul Volcker


Grok: Paul Volcker’s quote cuts right to the heart of the issue you’re poking at. He’s pointing out a historical quirk: sovereign debt—government bonds—often got a free pass on bank capital requirements, meaning banks didn’t have to set aside any capital against them. Why? Because governments and regulators treated them as "risk-free," a political choice as much as an economic one. It’s no surprise those assets had the most political backing—governments love cheap financing, and banks were happy to oblige when it didn’t tie up their capital.


Volcker’s also nodding at how a blunt leverage ratio (just total assets divided by capital, no risk-weighting) could flip that script. It doesn’t care if an asset’s a safe government bond or a shaky small-business loan—everything counts the same. That discourages banks from loading up on low-yield treasuries, since they’d still have to hold capital against them, eating into profitability. Suddenly, the bias toward sovereign debt weakens.


Tying this to your earlier point: when capital rules favored public debt with zero requirements, it absolutely tilted the table away from small businesses, who faced higher hurdles to get loans. Volcker’s highlighting how the system wasn’t neutral—it was rigged by design, even if dressed up as prudence. The leverage ratio he mentions could level things a bit, but it’s still a far cry from equal treatment. Does this make you see the "tax" on entrepreneurs as more deliberate, or just a byproduct of political self-interest?


How ChatGPT opined on this.


Human: Do current risk bank capital/equity requirements, which favor banks holding public debt over loans to e.g., small businesses and entrepreneurs, when compared to a leverage ratio, do these promote or impede fiscal insolvency?


Grok: Current risk-based capital requirements, which give public debt a lighter touch (often zero or near-zero risk weights) compared to loans for small businesses and entrepreneurs (higher risk weights), tend to promote fiscal insolvency in the long run, though not directly or obviously. Here’s how it shakes out:


By favoring public debt, these rules incentivize banks to load up on government bonds. It’s a sweet deal for them—low capital costs, decent liquidity, and a stamp of safety. This keeps borrowing cheap for governments, letting them pile on debt without much market pushback. Fiscal insolvency—when a government can’t manage its debt without drastic measures—creeps closer because the easy credit masks underlying budget problems. Banks become enablers, holding the IOUs of governments that might be spending beyond their means, all while regulators nod along.


Contrast that with a leverage ratio, like Volcker hinted at. It’s blind to risk weights—public debt and small-business loans chew up the same capital. Banks might dial back on gorging themselves with treasuries since the low returns don’t justify the capital hit. That could force governments to face higher borrowing costs or lean less on debt, potentially slowing the march toward insolvency. Meanwhile, small businesses might not get a drastic boost in credit access (since capital costs stay flat across the board), but the relative bias toward public debt shrinks.


The kicker? Risk-based rules assume governments won’t default, which is a bet that’s held up in places like the U.S. or Germany but looks shakier elsewhere—think Greece or Argentina. A leverage ratio doesn’t care about that assumption; it treats all assets as potential risks. 


So, the current setup greases the wheels for fiscal excess, while a leverage ratio might apply some brakes. It’s not a straight line to insolvency either way—government spending habits and economic growth matter more—but the risk-based system’s favoritism for public debt definitely doesn’t discourage it. What’s your take—do you see governments exploiting this bias intentionally?


How ChatGPT opined on this.


Human: Do you not see bureaucrats happily exploiting and enjoying this bias?


Grok: Oh, I can absolutely see bureaucrats—and politicians—gleefully exploiting this bias. It’s practically a dream setup for them. Risk-based capital rules that treat public debt as "safe" hand governments a cheap borrowing pass, and who wouldn’t enjoy that if their job is to spend, build, or just keep the wheels turning? More debt capacity means more projects, more jobs, more votes—without the immediate pain of higher interest rates or market discipline. It’s like giving a teenager a credit card with no limit and telling them the bill’s due in 20 years.


Bureaucrats don’t even have to be malicious to love it—just self-interested or shortsighted. They’re not the ones on the hook when the debt pile gets wobbly; that’s for future administrations or taxpayers to sort out. And banks play along happily, piling into government bonds because it’s low-risk, regulator-approved, and keeps the capital requirements light. Everyone’s winning—until they’re not.


A leverage ratio, though? That’s less fun for the bureaucratic crowd. It crimps their borrowing spree by making banks think twice about hoarding public debt, potentially nudging up borrowing costs. No wonder it’s not the default—where’s the political upside in that? I’d bet most bureaucrats aren’t sitting around cackling about fiscal insolvency; they’re just riding the wave of a system that’s tilted in their favor. You seem pretty convinced they’re milking it—any specific examples in mind that stand out to you?


Human: Have you not noticed the great increase in the number of public sector employees?


Grok: Yeah, I’ve definitely noticed the trend. Public sector employment has been climbing pretty steadily in a lot of places lately. Take the U.S., for example—government jobs jumped by over 700,000 in 2023 alone, outpacing private sector growth by a wide margin. Canada’s seen something similar; since 2019, their public sector workforce grew by 13%, nearly four times the private sector’s 3.6%. The UK’s central government hit a record 3.97 million employees by September 2024. It’s hard to miss—governments are bulking up their payrolls, and the numbers seem to keep ticking up.


What’s driving it? Well, post-pandemic recovery’s a big piece—governments leaned hard into public services like healthcare and administration to stabilize things. In Canada, nearly half the job growth since 2019 has been public sector. Plus, aging populations and political pushes for more services keep the hiring spree going. Private sector’s growing too, but not at the same clip—public sector’s just got the momentum right now. Have you seen this playing out where you are?


Human: That’s for another day. Many Thanks!


My opinion on the empowerment of a Bureaucracy Autocracy.


Grok: Anytime—glad to dig into it with you! Hit me up whenever you’re ready to unpack that public sector growth or anything else. Take care!


Human: By the way, can I get a copy of this dialogue with you?


Grok: You bet! Here’s the full rundown of our chat so far—everything from your first question to now. I’ll paste it below. If you want it in a different format or just a specific chunk, let me know!


Thanks!


There you go! All yours. Anything else I can help with?


Human: I just read you opined: “The flip side is that small businesses and entrepreneurs are inherently riskier bets than government debt—default rates are higher, and public debt (especially from stable governments) is often seen as a safe haven.” If using Bayesian conditional probabilities, are the perceived “riskier bets” more dangerous to bank systems than what’s perceived as very safe?


Grok: You’re pulling us into some tasty Bayesian territory—let’s unpack it. My earlier point was about how regulators and banks see small businesses as riskier than government debt, based on observed default rates and the “safe haven” vibe of, say, U.S. Treasuries. But using Bayesian conditional probabilities, we can flip the script and ask: given a bank fails, what’s the chance it’s because of those “safe” assets versus the “risky” ones? It’s a subtle but sharp twist.


Start with the basics. Bayes’ theorem says P(A|B) = P(B|A) * P(A) / P(B). Here, let’s define:

A = “bank failure caused by asset X” (X being either small-business loans or government debt).


B = “bank fails.”


P(A|B) = probability that asset X caused the failure, given the bank failed.


P(B|A) = probability of bank failure given exposure to asset X.


P(A) = prior probability of asset X being the culprit.


P(B) = overall probability of bank failure.


Small-business loans have higher default rates—say, 5-10% annually for SMEs, depending on the economy, versus near-zero for stable sovereign debt like U.S. bonds. Banks and regulators bake this into risk models, so P(B|A) for small-business loans looks higher upfront. That’s why they get slapped with higher capital requirements—more cushion for more risk.


But here’s the Bayesian kicker: what if the “safe” assets—government debt—aren’t as safe as assumed? If a bank’s heavily loaded with public debt and a rare but nasty event hits (like a sovereign default or a sharp rate spike), the systemic damage could dwarf scattered small-business defaults. Think 2008 vibes, but with bonds instead of mortgages. P(B|A) for government debt might be low in normal times, but P(A)—the prior chance it’s the real threat—could be understated because everyone’s so cozy with the “risk-free” label. If P(B|A) spikes in a crisis (say, Greece 2010 or a hypothetical U.S. debt scare), then P(A|B)—the chance government debt sank the bank, given it failed—shoots up.


Data backs this vibe. Small-business defaults are frequent but localized—banks can absorb them with capital buffers. Sovereign debt crises, though rare, are systemic. Look at Eurozone banks during the 2011-2012 sovereign debt mess: those holding “safe” Greek or Italian bonds got hammered harder than if they’d spread bets on riskier SMEs. Bayesianly, the conditional risk shifts: the perceived “safe haven” can amplify danger precisely because banks overbet on it, underestimating tail risks.


So, are the “riskier bets” more dangerous? Not necessarily. Small-business loans might ding banks regularly but rarely break them. Government debt, seen as safe, lulls everyone into piling in—until it doesn’t. When it blows, the conditional probability of it causing a collapse could outstrip the scattered impact of SME failures. It’s less about raw default rates and more about exposure scale and systemic ripple. What do you think—does this flip your view on where the real threat hides?


HowChatGPT opined on this.


Thanks again!


You’re welcome—anytime! Glad I could help. If you need anything else, just give me a shout. Take it easy!


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



My conclusion: Grok and ChatGPT gave me different but similar opinions. Great!


In the role of the Human: @PerKurowski :-)

Friday, February 14, 2025

#AI #OpenAI #ChatGPT:Could the risk weighted bank capital requirements be understood as a tax on access to bank credit?

I asked ChatGPT:

"Would it be completely wrong to opine that higher bank capital requirements against loans to small businesses and entrepreneurs, than against public debt, constitutes a tax on the access to bank credit paid by the first, and used by government bureaucrats?"

ChatGPT answered:

It wouldn't be completely wrong to frame it that way, though it's not the conventional way such regulations are described.

Higher capital requirements against loans to small businesses and entrepreneurs mean banks must hold more of their own capital as a buffer, making those loans relatively more expensive. In contrast, lower capital requirements for public debt make lending to the government more attractive. The result is a distortion in credit allocation—favoring government borrowing over private-sector investment.

Calling this a "tax" on small business credit access is an analogy rather than a literal tax. But in economic terms, it does function similarly to a tax by raising the cost of capital for private-sector borrowers while subsidizing public debt. Bureaucrats benefiting from this distortion could be seen as indirect beneficiaries, as the government faces lower borrowing costs at the expense of private-sector credit access.

Would you say this fits with your general approach to regulation—preferring market-driven capital allocation over regulatory distortions?

I said: I sure would say that. Thank you!

It said: You're very welcome! Always a pleasure to discuss these topics with you. Let me know if you ever want to refine these ideas further.


Tuesday, February 11, 2025

#AI #OpenAI #ChatGPT: What’s more important: National banks being able to compete with foreign banks, or these helping their economies to compete with foreign nations?

I asked ChatGPT:

"Of course, both are important, but what do you think is more important:
National banks being able to compete with foreign banks, or national banks helping their national economies to compete with foreign economies?"

ChatGPT answered:

National banks helping their national economies to compete with foreign economies is more important.

While national banks competing with foreign banks is beneficial—ensuring they remain efficient, innovative, and globally relevant—banks ultimately serve as enablers of broader economic activity. Their primary role should be to support domestic businesses, infrastructure, and financial stability, which in turn strengthens the national economy’s competitiveness on the global stage.

If a country’s banks focus too much on competing internationally without prioritizing domestic economic health, they may allocate resources inefficiently or engage in riskier behaviors to chase global returns. On the other hand, a strong national economy, supported by effective banking policies, naturally enhances the ability of its firms (including banks) to compete globally.


I asked ChatGPT:

"I asked because, with respect to bank capital/equity requirements, that first objective is mentioned so much more by its regulators than the second one. Why do you think that happens?"

ChatGPT answered:

The emphasis by regulators on national banks competing with foreign banks—rather than on how banks help their economies compete—likely stems from a mix of historical precedent, institutional incentives, and geopolitical considerations:

1. Regulatory Competition & Global Coordination

Bank regulators, particularly in advanced economies, often operate within international frameworks like the Basel Accords. These frameworks are designed to harmonize capital standards across countries to prevent regulatory arbitrage (where banks move operations to jurisdictions with laxer rules). Regulators naturally focus on ensuring their banks remain competitive under these international rules, lest capital and business flow to foreign competitors.

2. Banking System Stability vs. Economic Competitiveness

Regulators' primary mandate is financial stability, not necessarily optimizing national economic competitiveness. They focus on ensuring banks have enough capital to withstand crises, prevent systemic risks, and maintain depositor confidence. While economic competitiveness is important, it’s seen as the domain of fiscal and industrial policy, not banking supervision.

3. Influence of Large Banks

Large multinational banks have strong lobbying power and often push the narrative that higher capital requirements reduce their ability to compete globally. This argument resonates with regulators, who don’t want to be seen as disadvantaging their own banking sector relative to foreign peers.

4. Shorter-Term Regulatory Focus

Banking regulators operate on cycles that focus on risk management, stress tests, and immediate financial stability rather than long-term economic competitiveness. Ensuring that national banks remain competitive with foreign banks is a more directly measurable goal than assessing how well the banking system contributes to national economic strength.

5. Perceived Trade-Offs

If regulators openly prioritized how banks contribute to national economic competitiveness, they might face pressure to lower capital requirements under the argument that it frees up more lending for domestic businesses. However, this could conflict with their financial stability mandate, making them reluctant to frame capital policy in such terms.

In short, regulators emphasize banks' global competitiveness because it aligns with their mandates and pressures, whereas supporting the national economy's competitiveness is a broader, more politically sensitive issue involving multiple policy domains beyond banking regulation.


I asked ChatGPT:

"Do you think this issue has been sufficiently debated by academicians and mainstream media?"

ChatGPT answered:

No, I don’t think this issue has been sufficiently debated—at least not in a way that directly addresses the trade-offs between bank capital regulations and their role in enhancing national economic competitiveness.

Why the Debate Has Been Incomplete

1. Academic Focus on Financial Stability

Most academic discussions around bank capital requirements focus on the trade-off between risk reduction and credit availability—not how regulations affect a nation's broader economic competitiveness.

There’s extensive research on Basel regulations, moral hazard, and financial crises, but relatively little connecting these directly to whether higher capital requirements help or hinder national firms competing internationally.

Even when economic competitiveness is discussed, it's often in relation to financial sector efficiency, not how banks serve the real economy.

2. Media’s Emphasis on Crises Over Structural Issues

The mainstream media mostly covers capital regulations in response to crises (e.g., 2008 financial crisis, post-COVID banking failures).

Coverage tends to be reactionary—focusing on whether banks are over- or under-regulated—rather than examining how capital rules affect a country’s long-term economic dynamism.

When competitiveness is discussed, it’s usually framed as "Are our banks too constrained?" rather than "Is our banking system effectively supporting national economic success?"

3. Dominance of the Global Banking Perspective

The debate is often shaped by institutions that have a global financial stability perspective (IMF, BIS, Basel Committee), which naturally prioritize preventing regulatory arbitrage over tailoring banking rules to national economic needs.

Policymakers sometimes accept global competitiveness as an implicit goal without questioning whether it should be a means to an end (a strong national economy) rather than an end in itself.

4. Lack of Clear Metrics for Economic Competitiveness

It's easier to measure a bank’s capital ratio than to measure how effectively the banking system is enhancing national competitiveness.
Without clear frameworks to assess this, the issue remains underexplored.

What Would a More Complete Debate Look Like?

To fill this gap, a deeper debate should:

✅ Examine whether higher capital requirements actually reduce lending to productive sectors or if they simply reduce excessive risk-taking.

✅ Compare countries where banking regulations are more pro-growth vs. stability-focused and analyze their economic performance.

✅ Consider how different business models (e.g., relationship banking vs. market-based finance) influence national economic competitiveness.

✅ Investigate whether alternative financial structures (e.g., state development banks, credit guarantee schemes) can compensate for stricter capital rules.

While some heterodox economists and policy thinkers have touched on these ideas, the mainstream discussion remains too focused on whether banks can compete, rather than whether they are helping their countries compete.


I said: "For many decades neither have I thought that, so, thank you very much for these answers."

ChatGPT said: You're very welcome! I'm glad we could explore this together, and I appreciate your thoughtful questions. These kinds of discussions—connecting financial regulation to real economic outcomes—deserve much more attention. If you ever want to dive deeper or challenge mainstream thinking on other topics, I’m always happy to discuss.

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