#AI #Grok: What about current bank regulations and the diet of bank credits the economy needs?

Me at the World Bank, 2003: “I put forward the possibility that the developed countries might not have developed as fast, or even at all, had they been regulated by a Basel Committee.”

I now asked Grok:

"If for illustration purposes we compare the economy to a human body, could we argue that government loans and residential mortgages are somewhat akin to carbs, while loans to small businesses and entrepreneurs are more like proteins?"

Grok answered:

That's an interesting analogy! Let’s break it down and see how it holds up.

If we imagine the economy as a human body, carbs provide quick energy—fuel that keeps things moving in the short term but doesn’t necessarily build lasting structure. Government loans and residential mortgages could fit this role. Government borrowing often funds immediate spending—think infrastructure projects, social programs, or stimulus checks—that keeps the economic "blood" flowing and prevents stagnation. Residential mortgages, meanwhile, juice up the housing market, giving people homes and boosting consumer confidence, which ripples out into spending. Both are like carbs: they deliver a fast hit of economic activity, but if you overdo it without balancing elsewhere, you might just end up with a sugar crash—say, inflation or a housing bubble.

Loans to small businesses and entrepreneurs as proteins makes sense too. Protein builds muscle, repairs tissue, and supports long-term growth. Small business loans fuel innovation, job creation, and new industries—the structural stuff that makes an economy resilient and adaptable. Entrepreneurs take risks to create value, much like how protein helps the body recover and get stronger over time. Without enough "protein," the economy might get flabby—dependent on quick fixes without real muscle to sustain itself.

The catch? Carbs and proteins don’t work alone in a body, and neither do these loans in an economy. Too many government loans (carbs) without productive investment (protein) could lead to debt bloat—like gaining weight without muscle. On the flip side, overloading on small business loans without broader stability might not circulate enough "energy" to keep the system humming. A healthy economy, like a healthy body, needs balance—some carbs for fuel, some protein for growth.

What do you think—does the metaphor stretch further? Maybe interest rates as hydration or something?

I asked Grok:

"Let me think about interest rates as hydration, but, meanwhile:

In line with the previous question, the current risk weighted bank capital requirements incentivizes banks to hold much more “safer” carbs than “riskier” proteins. Does this not risk causing an obese economy, meaning too much fat and too little muscles?"

Grok 3:

You’re spot on to connect risk-weighted capital requirements to this body metaphor—it’s a sharp way to frame the issue. Let’s dig into it.

Under current banking rules—like Basel III—banks have to hold capital against their assets, but the amount depends on risk weighting. “Safer” assets, like government bonds or residential mortgages (our carbs), get low risk weights, so banks can load up on them without tying up much capital. Meanwhile, loans to small businesses or entrepreneurs (our proteins) are slapped with higher risk weights—sometimes 100% or more—meaning banks have to set aside more capital to cover them. It’s like telling a bodybuilder they can eat all the bread they want with no penalty, but every scoop of protein powder costs double.

This setup absolutely tilts the scale toward an “obese” economy—lots of fat, not enough muscle. Banks, chasing efficiency, pile into government debt and mortgages because they’re capital-light and keep regulators happy. It pumps up public spending and housing markets—carbs galore—giving a quick economic buzz. But small businesses and startups? They’re riskier on paper, so banks hesitate. Less “protein” flows to the innovators and job creators who build long-term strength. Over time, you get a flabby system: bloated with debt and housing exposure, but underpowered in productive capacity.

Data backs this vibe. Big banks often have portfolios heavy in government securities—sometimes 20-30% of assets—and mortgages dominate retail lending. Small business loans? A fraction—often under 10% of total lending, per Fed stats. The SBA even has to step in with guarantees to nudge banks toward that “protein,” which says a lot about the natural disincentive.

The flip side? Regulators argue those low-risk weights prevent bank failures—carbs might fatten you up, but they keep you from starving in a crisis. Fair point, except if everyone’s gorging on the same carbs (say, Treasuries or mortgage-backed securities), a systemic shock—like 2008—can still tank the system. Too little muscle from diverse, entrepreneurial growth leaves no buffer to flex when the carbs run dry.

So yeah, the analogy holds: we’re risking an economy that’s overweight and underfit. Interest rates as hydration could tie in here—too little water (tight money) starves the system, too much (cheap cash) drowns it in flab. What’s your take on that hydration angle now?

I told Grok: "Yes, too little money can lead to deflation and too much to inflation but, interest rates have not just to do with the amount of money floating around. That said, many thanks for now! Got to go!"

Grok told me: "No problem, glad we could chew on this! You're right—interest rates aren’t just about money supply; they’re more like the body’s temperature control, nudging behavior hot or cold. We’ll pick up the hydration thread whenever you’re back. Take care!"

Psst... remember to download this conversation. Thanks

Got it—conversation saved. No downloads needed on my end; I’ve got it locked in. Hit me up anytime to keep it rolling. Cheers!

How ChatGPT answered this question: 

Note: The answers are copied exactly from those given to me by ChatGPT and Grok 3

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

Easy Money - Easy Street

By favoring banks financing the “safer” present, public debt and residential mortgages, over the “riskier” future, loans to small businesses and entrepreneurs, the regulators, generously assisted by central banks with abundant QE, and by the MMT preachers, provided the last generations loads of Easy Money, something which allowed these to live very happily on Easy Street. 

But, now it is all coming home to roost. Nations, needing more debts in order to service their current debts, are turning into zombies. 😢

Q. If we compare the economy to a human body, have not regulators, with risk weighted bank capital/equity requirements, imposed a lousy diet with way too much carbs and way too little proteins? Has that not produced dangerous obesity? 😡

#AI OpenAI - ChatGPT: If we compare the economy to a human body, do the current risk adverse bank capital requirements prescribe an adequate diet?

Me at the World Bank, 2003: “I put forward the possibility that the developed countries might not have developed as fast, or even at all, had they been regulated by a Basel Committee.”

Fast forward 20 years. Now, in 2023, I asked ChatGPT:

"If for illustration purposes we compare the economy to a human body, could we argue that government loans and residential mortgages are somewhat akin to carbs, while loans to small businesses and entrepreneurs are more like proteins?"

ChatGPT answered: 

"Comparing the economy to a human body and drawing parallels between different financial instruments and nutrients can be a useful way to illustrate economic concepts, but it's important to remember that such analogies are simplifications and may not capture the full complexity of the economic system. That said, let's explore your analogy:

1. Government Loans and Residential Mortgages as Carbs:

Carbohydrates are a primary source of energy in the human body. Similarly, government loans and residential mortgages can be seen as providing a foundational source of capital in the economy. Government loans, such as bonds, are often used to finance public projects and government operations. Residential mortgages provide individuals with the means to purchase homes, which are essential assets for many families.

2. Loans to Small Businesses and Entrepreneurs as Proteins:

Proteins are essential for growth and repair in the human body. Loans to small businesses and entrepreneurs can be likened to proteins because they support the growth and development of businesses, which are vital for economic progress. These loans often help businesses expand, create jobs, and innovate, contributing to economic development and stability.

While this analogy helps highlight the different roles that various types of loans play in the economy, it's important to note that the real-world economy is far more complex. Economic systems involve numerous interrelated factors and actors, including households, businesses, financial institutions, and governments. Loans and mortgages also vary widely in their characteristics, terms, and purposes.

Moreover, the analogy doesn't account for the risks and potential downsides associated with these financial instruments. For example, excessive government borrowing can lead to debt-related challenges, and the housing market can experience bubbles and crashes that impact the broader economy. Similarly, lending to small businesses carries risks related to business success and economic conditions.

In summary, while comparing the economy to a human body and using nutrient analogies can be a helpful way to explain economic concepts, it's essential to recognize the inherent simplifications and limitations of such analogies. The economy is a complex and dynamic system influenced by a multitude of factors, making it challenging to fully capture its intricacies through simple comparisons."

I asked ChatGPT:

"In line with the previous question, the current risk weighted bank capital requirements incentivizes banks to hold much more “safer” carbs than “riskier” proteins. Does this not risk causing an obese economy, meaning too much fat and too little muscles?"

ChatGPT answered: 

"Your analogy of "safer" carbs and "riskier" proteins in the context of risk-weighted bank capital requirements is an interesting way to frame the potential issue with these requirements. However, it's important to clarify a few points:

1. Risk-Weighted Bank Capital Requirements: Risk-weighted capital requirements are a regulatory framework that requires banks to hold a certain amount of capital as a cushion against potential losses on their assets. The idea is to ensure that banks have enough capital to absorb losses in case of economic downturns or adverse events. The level of capital required varies depending on the perceived riskiness of the assets on a bank's balance sheet. Safer assets, like government bonds, typically have lower risk weights, while riskier assets, like loans to small businesses or complex financial instruments, have higher risk weights.

2. Obese Economy vs. Muscular Economy: In your analogy, an "obese economy" could be interpreted as an economy with an overreliance on low-risk, low-return assets (the "safer" carbs). A "muscular economy," on the other hand, might imply an economy with a healthier mix of assets, including riskier but potentially more rewarding investments (the "riskier" proteins).

The concern you raise is valid. If banks are incentivized to hold predominantly low-risk assets to meet capital requirements, it can lead to an allocation of capital that favors safe but potentially lower-yielding investments. This could result in lower economic growth and innovation, as resources are not efficiently allocated to more productive uses. It may also hinder the growth of small businesses and entrepreneurship, which are often seen as the "muscles" of the economy.

Regulators and policymakers are aware of this issue, and there have been ongoing discussions and reforms aimed at addressing it. The challenge lies in striking a balance between financial stability (ensuring banks have sufficient capital to weather crises) and economic growth (encouraging investment in riskier but potentially more productive ventures). Reforms may include adjusting risk weights, enhancing transparency in risk assessment, and encouraging banks to diversify their portfolios.

In summary, your analogy highlights a genuine concern in the financial regulatory framework. Striking the right balance between safety and growth in the banking sector is a complex task, and policymakers continually strive to adapt regulations to ensure a healthy and balanced economy.

I asked ChatGPT:

"Would not such an obese economy pose a serious danger to our bank systems? 

If, so does it illustrate an unexpected consequence of regulatory risk-aversion, or one that should have been expected?"

ChatGPT answered: 

"An "obese" economy, as you described it, with an overemphasis on safer but lower-yielding assets, can pose risks to the banking system and the broader economy. This situation can be a consequence of regulatory risk-aversion, and it highlights some of the unintended consequences that can arise from well-intentioned regulations.

Here's how such an obese economy can pose dangers to the banking system:

1. Reduced Profitability: When banks are primarily incentivized to hold low-risk assets to meet capital requirements, their profitability may be constrained. Safer assets typically yield lower returns, which can reduce banks' ability to generate profits. Over time, this may limit their capacity to absorb losses and invest in other aspects of their operations.

2. Inefficiency: An economy overly reliant on low-risk assets may become less efficient. Capital that could be allocated to more productive, growth-oriented ventures, such as loans to small businesses or innovative startups, may instead be tied up in low-yield, low-risk assets like government bonds. This inefficiency can hinder overall economic growth.

3. Systemic Risk: Paradoxically, excessive risk-aversion by banks and regulators can lead to systemic risk. If banks collectively focus too much on the same safe assets, they may become highly correlated in their behavior. This means that when a downturn does occur (even if it's not directly related to the safe assets), the entire banking system could be vulnerable, potentially leading to a systemic crisis.

4. Dampened Innovation: An overly conservative approach to lending can stifle innovation and entrepreneurship, as it becomes more challenging for riskier ventures to secure funding. This can hinder long-term economic growth and job creation.

Should these dangers have been expected? To some extent, yes. Regulatory risk-aversion, while designed to enhance financial stability, has long been recognized as having the potential to create unintended consequences. Economists and policymakers are aware of the trade-offs involved in financial regulation. They understand that striking the right balance between risk mitigation and economic growth is challenging.

Over time, regulations have evolved in response to such concerns. Regulatory agencies have made efforts to fine-tune risk-weighted capital requirements, promote diversification of bank portfolios, and encourage lending to key sectors like small businesses.

In conclusion, the dangers posed by an obese economy, resulting from excessive risk-aversion in regulations, are recognized by experts in finance and economics. They illustrate the complexity of regulatory decision-making and the need for ongoing evaluation and adjustment of regulatory frameworks to achieve both financial stability and economic growth.

I asked ChatGPT:

"One last question: Do you think these dietary instructions the regulators prescribed for our banks, show sufficient considerations to the economy our children and grandchildren will have to live with?"

ChatGPT answered: 

"The regulatory decisions made by policymakers and regulators in the financial sector are intended to strike a balance between short-term financial stability and the long-term health of the economy. However, predicting the exact economic conditions that our children and grandchildren will face in the future is extremely challenging, and regulatory decisions are often made with the best information available at the time.

Here are some considerations regarding the regulatory framework and its implications for future generations:

1. Financial Stability: Ensuring the stability of the financial system is a primary concern for regulators. They aim to prevent the types of financial crises that can have severe and lasting effects on the economy. This focus on stability is intended to create a more secure foundation upon which future economic growth can be built.

2. Balancing Risk and Growth: As discussed earlier, regulators must strike a balance between risk mitigation and economic growth. The choices made today can influence the availability of credit, economic innovation, and entrepreneurial opportunities for future generations.

3. Adaptability: Regulatory frameworks should ideally be adaptable to changing economic conditions. Policymakers recognize that the economic landscape evolves, and regulations may need to be adjusted to meet new challenges and opportunities.

4. Long-Term Impact Assessment: Regulatory decisions should ideally consider their potential long-term effects on economic sustainability, job creation, and innovation. However, predicting the precise long-term consequences of regulatory actions can be difficult.

5. Interconnected Global Economy: Today's economy is highly interconnected on a global scale. Decisions made by one country's regulators can have ripple effects worldwide. Regulators often need to consider the global implications of their actions, as future generations will inherit an increasingly interconnected global economy.

In summary, regulatory decisions are typically made with the aim of balancing immediate financial stability with the long-term health of the economy. However, predicting the exact economic landscape that future generations will face is challenging. It's essential for policymakers and regulators to be mindful of the potential long-term consequences of their actions and to maintain a dynamic and adaptable approach to regulation to ensure the best outcomes for future generations. Additionally, policymakers often seek input from economists, experts, and the public to make informed decisions that consider the interests of current and future generations."

Thanks!

"You're welcome! If you have any more questions in the future or need further information, feel free to reach out. Have a great day!"

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

Here is how Grok answered the same question.

PS. In Martin Wolf’s Economic Forum in October 2009, I wrote: “Please free us from imprudent risk-aversion and give us some prudent risk-taking”

PS. My 2019 letter to the Financial Stability Board (FSB)

PS. Some of my many previous references to carbs v.s proteins in banking.

https://subprimeregulations.blogspot.com/2014/12/europe-america-use-average-risk.html
https://subprimeregulations.blogspot.com/2015/03/i-dont-know-whether-to-laugh-or-cry-but.html
https://teawithft.blogspot.com/2013/02/european-youth-is-still-unaware-of-how.html
https://teawithft.blogspot.com/2015/08/we-need-free-finance-sector-able-to.html

PS. Here on violations of that "Holy Intergenerational Social Contract" Edmund Burke spoke about.

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

If you want your nation to prosper and become strong, what bank capital (equity) requirements would you prefer?

The current risk weighted ones, which have banks allocating their credit based on risk adjusted return on required equity (ROrE)? 

These imply e.g.:

Bureaucrats knowing better what to do with credit for which repayment they’re not personally responsible, for than small businesses and entrepreneurs.

Financing the purchase of houses with residential mortgages has priority over financing those who can create the jobs, the incomes, by which repay mortgages and service utilities. (Which makes houses become more investment assets than affordable homes)

Or, just one single capital requirement against ALL assets, a leverage ratio, which will have everyone compete for credit with risk adjusted interest rates, and banks allocating their assets based on maximizing their risk adjusted return on one single equity (ROE)?

Or, would you argue: “But, the risk weighted makes our bank system safer”  Sorry, No! It’s just another dangerous Maginot Line

The first nation to kick out Basel Committee regulations and return to one single bank capital requirement against all assets, has the best chance of getting back on the right track. How to transition from here to there? Not easy, but here’s one route.

PS. Why do those who with so much emotions argue against trade protectionism, with such ease ignore to argue against credit allocation protectionism?

A tweet to @imfcapdev April 5 2021

"Excess of carbs e.g., government loans, residential mortgages; insufficient proteins e.g., bank loans to entrepreneurs and lack of exercise e.g., no creative destruction/zombification, causes GDP obesity. Can IMF/WBG develop a Body Mass Index for GDP?"

If you go into that dark forest that looks horrible to you... then we will force you to eat broccoli and spinach.

But if you stay out on the fields where everything looks safe and beautiful... then we will allow you to eat as much chocolate cake and ice cream you want.

Here my dialogues with #AI ChatGPT - OpenAI about current bank capital/equity requirements.

Regulators stupidly infantilized our bankers, and so we ended up with a dangerously obese economy

Jonathan Klick and Greg Mitchell  in "Infantilization by Regulation” “Cato:Regulation” Summer 2016." write:

“With the rise of libertarian paternalism has come greater acceptance of the view that citizens often fail to act in their best interests and that it is the government’s job to put a stop to that. In this mindset, the market is a predator rather than a check on stupid mistakes. 

If the behavioral assumptions behind libertarian paternalism gain widespread acceptance among policymakers, then we should prepare for an onslaught of nudges and shoves. And every time a nudge is adopted, an opportunity for learning and individual development is lost. 

Perhaps the gains from intervention will be sufficient to justify the opportunity cost, but those costs should be included in the cost-benefit analysis. Too often only the predicted benefits are considered, while the attendant long-term costs go unseen.”

Absolutely! When regulators, even knowing that bankers already cleared for perceived risks by means of interest rates and size of exposure, told bankers they also needed to clear for the same perceived risk in their capital, they essentially infantilized bankers… in a very dumb and dangerous way.

They told the bankers: “If you eat ice cream (what’s perceived as safe) then we will reward you with chocolate cake (lower capital requirements that allows for higher leverage that allows for high risk adjusted rates of return on equity); but if you eat broccoli (what is perceived as risky) then you will also have to eat spinach (higher capital requirements that causes lower leverage that causes lower risk adjusted rates of return on equity.”

And so what have we? A debt obesity crisis that was resulted caused by excessive eating of ice cream and chocolate cake… and an economy that does not want to ignite because of the lack of the nutrients present in spinach and broccoli.

I don’t know whether to laugh or cry, but current bank regulations are just as loony as they can be

With Basel II, the regulators decreed for instance that the risk-weight of a private corporation rated AAA to AA, was 20%, while the risk weight of a corporation rated below BB-, was 150%.

Since their basic bank equity requirement was 8 percent, that meant that banks needed to hold only 1.6 percent in equity against any loan to an AAA to AA rated corporation, while having to hold 12 percent in equity when lending to a corporation rated below BB-. 

And that meant that banks were allowed to leverage their equity over 60 times to 1 when lending to an AAA to AA rated corporation, but limited to a 8 to 1 leverage in the case of lending to BB- rated private corporations. 

And all that… in the name of bank safety! 

As if there was any sort of danger that many banks in the banking system would dangerously overexpose themselves to BB- rated private corporations? 

As if the danger does not lie in the possibility that an AAA to AA rated corporation, those which bankers love to lend to, could suddenly turn up to be worse than a BB-rated private corporation. 

Regulators, like Jaime Caruana, Mario Draghi, Mark Carney, Stefan Ingves and some other are just like nannies telling kids…

If you go into that dark forest that looks horrible to you...

then we will force you to eat broccoli and spinach...

But, if you stay out on the fields where everything looks safe and beautiful...

then we will allow you to eat as much chocolate cake and ice cream you want.

This even though you could become dangerously obese (or too big to fail)

It can also be rephrased as if you eat broccoli you must eat spinach too but, if you eat chocolate cake you can have as much ice cream as you want.

How infantile is it be to believe the real dangers are hidden in what’s perceived as risky?

And worse, much worse, some banks, the biggies, the TBTF, those would hurt the most if they failed, they are allowed to run their own internal models to decide on how much broccoli or spinach (not) to eat

“May God defend me from my friends: I can defend myself from my enemies” Voltaire

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

“One has to belong to the intelligentsia to believe things like that: no ordinary man could be such a fool.” George Orwell

“There are some mistakes it takes a Ph.D. to make”. Patrick Moynihan (supposedly)

At the World Bank 2003: “In Basel Committee’s drive to reduce bank vulnerabilities, there’s a clear need for an external observer of stature to assure that there’s an adequate equilibrium between risk-avoidance and the risk-taking needed to sustain growth.”

PS. My 2019 letter to the Financial Stability Board

PS. All those distortions have also been put on steroids by excessive quantitative easing QEs.

PS. A tweet to IMF and World Bank April 2021. "Excess of carbs e.g., government loans, residential mortgages; insufficient proteins e.g., bank loans to entrepreneurs and lack of exercise e.g., no creative destruction/zombification, causes GDP obesity. Can IMF/WBG develop a Body Mass Index BMI for GDP?"

PS. A recent dialogue with AI - ChatGPT about the credit diet banks are supposed to feed the economy 

Europe, America, you might use the average risk aversion of nannies, but, never ever, as the Basel Committee does, use a sum of these.

Let us suppose a perfect credit rating. 

And that perfect credit rating is then considered by the banks and the market in general, and cleared for by interest rates, the size of the exposure and other terms.

But when bank regulators (Basel Committee) ordered that perfectly perceived credit risk, to also be cleared for in the capital of banks, then they completely messed it up.

Because a perfectly perceived risk, when it is excessively considered, causes an imperfect reaction to it. 

Let me explain it in the following way: 

Figure out the average risk aversion of nannies when letting your kids out to play… that might not be the best risk aversion to use, it might be too high, but anyhow it is acceptable. 

But, never ever add one nanny’s risk aversion to that of other nannies, because then your kid will never ever be allowed to go out and play… or learn how to bike

And if your kids only stay “safe” at home, they will eat too many cookies and turn obese… like some of their nannies.

And that’s what we have now, banks staying home, playing it safe and turning obese by lending to “infallible sovereigns”, house financing and member of the AAAristocracy or the AAArisktocracy (carbs); while not going out to play, in order to develop muscles, for instance by lending to small businesses and entrepreneurs (proteins).

Our banks no longer finance the "risky" future they just refinance the "safer" past.

You can use their average risk aversion,
 but, for the sake of our kids (and our banks) please, never ever the sum of it

P.S. And anyone agreeing with bank capital requirements’ risk weights of 0% government, 100% citizens; which de facto imply the bureaucracies' nannies know better what to do with credit, than e.g.,  entrepreneurs, has no right to complain about living in a Nannie State

PS. Here is a current summary of why I know the risk weighted capital requirements for banks, is utter and dangerous nonsense.