Monday, October 3, 2011

The Role of Bank Capital

This is going to be a running post on articles talking about the need for bank capital.

I will also be posting articles under the arguments for and against a strict bank capital requirement. Like any policy we need to understand the costs and benefits of added bank capital. The costs are reduced lending, the benefits are a reduced likelihood of a financial crisis. Here are the results from the Basel panel.

Here is recent article from the WSJ talking about recent moves toward more bank capital. Of course Citi Bank does not like the requirements.

Here is the first article from The Economist. This article talks about increased bank capital during the onset of the financial crisis.  How much capital is enough?

The Basel Accord has been an attempt to standardize bank capital requirements across countries. Here is an article talking about Basel III.

A panel discusses the effects of bank capital requirements on economic growth. The pros are simple, more capital reduces the likelihood of a bank become insolvent due to large loan write downs. The costs are simple, the more capital reduces the return on equity for bank owners.

I'm in favor of strict capital requirements for all bank-like institutions. I believe the financial system in a large way acts as a public good. Because of the problems posed by banks failing to fully account for the costs of risky behavior (yes, largely created by the types of regulations we currently have) large banks do not recognize the costs to society. I view capital requirements as an easy but highly effectively way of minimizing regulations while allowing banks to serve society (i.e. channeling funds from borrowers to savers). I like these requirements mainly because banks still have a choice for the types of assets they want to hold. If banks want to undertake in subprime lending they can, but it needs to be supported by added capital. Will this slow down growth, probably in the short run, but in the long run it will lead to fewer financial crises. Given the recent number of crisis that could have been avoid if banks were holding adequately capital, I view the long run benefits as a necessary.

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