Tuesday, August 26, 2025

#AI ChatGPT: Basel’s risk weighted bank capital requirements, or a leverage ratio, which generates more worthy wealthy?

 I asked ChatGPT

“Risk weighted bank capital requirements favoring public debt and residential mortgages over loans to small businesses and entrepreneurs, or the same requirement against all assets, a leverage ratio, which will generate a larger number of what could be described as more worthy wealthy?”

 

ChatGPT answered:


A good way to frame it is to ask: what kinds of wealth creation do different capital rules encourage?


  • Risk-weighted requirements (Basel style):

    Banks can hold less capital against assets deemed “safe” (public debt, residential mortgages, AAA securities). That steers credit toward governments and housing markets. This tends to generate more wealth from financial arbitrage (trading spreads on sovereign bonds, mortgage securitization, and real estate appreciation) rather than from productive business investment. The “wealthy” this system favors are often rentiers, financiers, large property owners, and governments, whose debt is cheaply financed. These are “worthy” mainly in the sense of political or financial clout, not necessarily in terms of creating broad productivity gains.

  • Leverage ratio (same capital requirement on all assets):

    Here banks must treat all loans equally in terms of equity backing. That makes lending to small businesses and entrepreneurs comparatively less penalized. While risk is higher, it also channels credit to activities with greater potential for new value creation—jobs, innovation, competitive growth. The wealthy who emerge under this regime are more likely to be entrepreneurs and builders of productive enterprises, rather than those who accumulate from safe-asset subsidies.

So:

  • Risk-weights → more wealthy from exploiting regulatory privilege and asset inflation.

  • Leverage ratio → more wealthy from actual economic innovation and risk-taking.


In other words, the latter is more likely to generate what could be described as “more worthy wealthy”—those whose fortunes stem from adding to real economic dynamism, not riding regulatory distortions.


Would you like me to illustrate this with some historical examples of each type of wealthy class that emerged under these two regimes?


I said: Yes, why not


ChatGPT said: Great. Let’s take some historical illustrations to make the contrast concrete:


1. Wealth under risk-weighted rules (Basel era, post-1988)

  • Government bond dealers and sovereign lenders:
    After Basel I allowed 0% risk weights for government debt in domestic currency, banks massively increased their holdings. Wealth grew among dealers and investors who captured spreads on sovereign bonds with almost no capital backing. For example, Southern European banks pre-2010 sovereign debt crisis loaded up on their governments’ bonds, boosting balance sheets while enriching bond traders and financial intermediaries—until the crisis exposed the hidden risk.

  • Real estate magnates and mortgage financiers:
    Lower risk weights for residential mortgages fueled massive credit flows into housing markets. This contributed to the rise of real estate billionaires and mortgage-backed securities financiers in the 1990s–2000s. The U.S. housing boom that culminated in 2008 is the clearest case: wealth accumulated disproportionately in property owners, mortgage originators, and securitizers like Countrywide or Lehman’s MBS desks—rather than in productive enterprise.

2. Wealth under flat leverage ratios (historical analogies)

  • 19th-century U.S. and U.K. banking:
    Before risk-weighted rules, banks essentially operated under crude leverage limits or market discipline. Credit was riskier, but it flowed strongly into railroads, steel, and industrial ventures. Many of the “robber barons” (Carnegie in steel, Vanderbilt in railroads, Rockefeller in oil) became wealthy not because regulators privileged their sectors, but because banks financed their risky but transformative projects.
  • Postwar small business lending (U.S. 1945–1970s):
    Though regulation was different, capital rules were closer to leverage-based, without today’s heavy risk-weight distortions. This period saw credit support for manufacturing and small enterprise. The wealthy who rose were more often entrepreneurs (tech pioneers, manufacturers, even regional developers) rather than primarily bond dealers or securitizers.

Bottom line

  • Risk-weighted era → sovereign bond traders, property tycoons, financial engineers.
  • Leverage-based era → industrialists, entrepreneurs, innovators.

So if “worthy wealthy” means those who built lasting, productive enterprises, the leverage ratio world historically produced more of them.


Would you like me to also trace contemporary billionaire lists (e.g., Forbes) to show how the balance has shifted between finance/real estate versus entrepreneurs across the two regulatory regimes?


I said: Perhaps another day. Thanks!


ChatGPT said: You got it — we can pick that thread up whenever you like. Thanks!


Here is Grok’s answer to exactly the same question 


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