#AI #ChatGPT #Grok: Do risk weighted bank capital requirements empower government borrowing at low interest rate cartels?

I asked ChatGPT

"Would it be outrageous to hold risk weighted bank capital requirements that imply a veiled prohibition for those perceived as “risky” to access bank credit in fair market risk adjusted terms, empowers “safe” government borrowing at low interest rate cartels?"

ChatGPT answered:

Short answer

“Not outrageous — it’s exactly what risk-weighting can do in practice — but it’s economically harmful and politically risky. Designing capital rules that effectively bar “risky” borrowers while heavily privileging government debt creates powerful distortions: it crowds out productive credit, concentrates risk, and subsidises government borrowing regardless of merit.

Why it happens (mechanics)

Risk weights tell banks how much capital to hold against each asset. Low weights on sovereign bonds and high weights on small-business or startup loans raise the relative capital cost of lending to the latter. Because banks price loans to cover capital costs, borrowers with higher risk-weights face higher spreads or simply no credit access. So a regulatory system can unintentionally (or intentionally) create a de-facto cartel of cheap “safe” government funding and expensive or unavailable private credit.

Main harms

Misallocation of capital. Productive, innovative firms (startups, small businesses) get starved of finance; low-return but “safe” assets (sovereigns) get overfunded.

Inequality & incumbency bias. Established firms and asset-rich borrowers (who can use collateral that attracts low weights) gain advantage; entrepreneurship suffers.

Concentration & systemic risk. If all banks hold large sovereign positions because they’re cheap capital-wise, the banking system becomes correlated with sovereign risk — a sovereign-bank doom loop.

Moral hazard for governments. Cheap financing reduces incentives for fiscal discipline.

Credit markets segmentation. Nonbank lenders may step in, growing shadow banking with weaker supervision — exactly the regulatory arbitrage regulators try to avoid.

Counterarguments in favor (why some designers accept it)

Perceived safety: Sovereign debt is often default-rare (for major currencies), so lower capital burden may seem sensible for prudential safety.

Simplicity & political feasibility: Rewarding sovereigns is politically popular and easier to justify after crises.

Short-term stability: In stress, public debt can act as a liquidity buffer for banks.

How to reduce the perverse effects

Use a non-risk-sensitive leverage floor alongside risk weights (a binding leverage ratio reduces the extent to which low weights can be exploited).

Apply concentrated exposure / sovereign concentration limits or higher floors on sovereign weights for domestic sovereigns to avoid large concentrated bets.

Risk-sensitive but calibrated weights: avoid zero or near-zero weights for public debt; make weights reflect real risks including inflation/default & FX.

Countercyclical capital buffers tied to lending booms rather than asset class alone.

Support targeted credit programs (guarantees, cheap refinancing) for socially valuable but risky sectors rather than broadly skewing capital rules.

Transparency & periodic review so political capture is visible and adjustable.

Bottom line

Treating risk weights as a tool to subsidize government borrowing or to keep “risky” borrowers out of the market is economically dangerous. The design trade-off is real: risk-sensitivity helps microprudential pricing but can create large macro- and distributional distortions if miscalibrated. Better: combine risk-sensitive capital with blunt instruments (leverage floors, concentration limits) and targeted fiscal/credit policies for sectors you want to support.”

I said: Thanks!

It replied: You’re very welcome!

I asked Grok: With a fairly brief answer:

"Would it be outrageous to hold risk weighted bank capital requirements that imply a veiled prohibition for those perceived as “risky” to access bank credit in fair market risk adjusted terms, empowers “safe” government borrowing at low interest rate cartels?"

Grok answered:

"Yes, that view has merit and isn't outrageous—it's a common critique among economists like Anat Admati and Andrew Haldane. Risk-weighted requirements (e.g., Basel III) can indeed distort lending by incentivizing banks to favor low-risk assets like government bonds (often zero-weighted), enabling cheap sovereign borrowing while making credit costlier or scarcer for "risky" borrowers like SMEs or emerging markets. This creates an implicit subsidy for governments, potentially forming a low-rate "cartel" effect, though proponents argue it enhances systemic stability. Alternatives like leverage ratios aim to address this bias."

I said: Thanks

It replied: You're welcome! If you have more questions, feel free to ask.

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

Bank regulators fixed the game, bribed the players, and got us the crisis they paid for.

Before the current set of bank regulations, all borrowers could be treated equally good or bad by the bankers, though Mark Twain held there was a natural risk-adverseness among bankers that played out in a strong bias against those perceived as “risky”. 

But the Basel Committee for Banking Supervision, thinking it was doing its duty as a nanny, paid the bankers to treat those perceived as “safe” borrowers so much better than those perceived as “risky”. And this they did by allowing the bank to hold much less capital against the first, and thereby obtaining a much higher risk adjusted return on equity when lending to “The Infallible” than when lending to “The Risky”. 

And of course, the banks accumulated excessive exposures to what was ex-ante perceived as safe but that ex-post turned out to be very risky, against very little capital, and the crisis exploded. 

And of course, since these dumb regulations remain in place, banks do not finance those borrowers that find themselves on the margin of the real economy, like small businesses and entrepreneurs, and who are extremely important if we want to get out of the crisis. 

Poor us! How do we get rid of these crazy nannies?