During last week’s presidential debate, Jeb Bush offered one of the clearest policy proposals yet to emerge from the Republican field: Increase capital requirements to reduce the threat big banks can present to the economy. It’s a great idea. ADVERTISING
During last week’s presidential debate, Jeb Bush offered one of the clearest policy proposals yet to emerge from the Republican field: Increase capital requirements to reduce the threat big banks can present to the economy. It’s a great idea.
Capital often is misunderstood, portrayed as some kind of rainy-day fund banks must set aside, or as a sort of punishment for previous misbehavior. Actually, it’s equity banks get from shareholders — money they can use to make loans and other investments. Unlike debt, it doesn’t have to be paid back, so it has the advantage of absorbing losses. The more capital banks have, the more capable they are of taking the kinds of risks that make the economy dynamic.
Unfortunately, more than five years after the enactment of the Dodd-Frank financial reform legislation, banks’ capital levels remain troublingly low. Several of the largest U.S. financial institutions have less than $5 in equity for every $100 in assets, measured according to international accounting standards. That means a net loss of 5 percent would be enough to render them insolvent. …
Such a thin capital cushion places the interests of shareholders at odds with those of society at large. In good times, using more debt, or leverage, boosts banks’ performance — measured as the return on equity. In bad times, shareholders risk only the meager amount of equity they’ve put in. Beyond that, the banks’ losses become everyone’s problem, as the distress reverberates through the broader economy and necessitates taxpayer bailouts.
Raising equity requirements would have benefits far beyond making the system safer. … More equity also could allow regulators to simplify rules that burden smaller banks. Well-capitalized institutions that don’t get involved in trading and derivatives shouldn’t have to file lengthy reports sorting their assets into myriad risk categories.
All told, the benefits of boosting banks’ capital so outweigh the costs, the only question is: Why wait for the next president to do it?
— Bloomberg View
