There’s a surprisingly large and vocal group of people who think that capital ratio requirements for large banks should be much higher than they are now (like, 15+%), and that those ratios should be based on total assets rather than any sort of regulatory risk-weighting. It’s surprising not because those are especially bad or counterintuitive ideas, but because who would have guessed a year ago that that would be a thing that people talked about? Good work, Admati & Hellwig.1
- Every U.S. bank would have to have a minimum 10% capital ratio,
- The biggest banks – those with over $400 billion in assets – would have to have up to 15%,
- The ratio is just (Tangible Common Equity) ÷ (Total Assets plus some off-balance-sheet things including lending commitments); i.e. it’s not risk-weighted at all, and
- “the [Federal Deposit Insurance] Corporation, the [Federal Reserve] Board, and the Comptroller [of the Currency] shall be prohibited from any further implementation of [Basel III].”
This feels like it may not be intended all that seriously, but whatever, let’s do the math and see what it gets us. Roughly speaking, it gets us the following:
That totals to about $1.2 trillion in additional capital. If you make the magical assumption that equity costs banks 10% a year – and, I mean, that’s on you – then this proposal would cost the six biggest banks $120 billion a year. You’ll notice that that’s bigger than even some quite extravagant claims about the size of the too-big-to-fail subsidy given to those banks.
Anyway, we’ll see! I’m not holding my breath for this to become law as is. You can tell it’s a little bit of a joke from that last bullet point up above. It’s actually easy to both (1) do what this bill wants (10%/15% total capital requirements, not risk-weighted) and (2) comply with Basel III and keep getting invited to cool-banking-regulator parties. Just say banks need to meet both Basel III and these rules. Since these rules will pretty much always be higher, that doesn’t really add much burden, compared to these rules alone.2
If it did become law … I mean, good times for capital markets bankers? Or something? Lotta equity to raise. I for one will not be subscribing to take my share of that $1.2 trillion but I suppose there are other patriots who might.
It would, though, be sort of interesting to live in a world where a lot of big banks (in Europe) have a very risk-weighted-assets focus, where the goal is to squeeze the most return out of regulatorily blessed “safe” assets, and where other big banks (in the U.S.) have a purely total-assets focus, where the goal is to buy the highest-yielding stuff you can get away with using 15% equity. There’s a lot of evidence that dumb leverage ratios are better predictors of risk than smart risk-weighted-asset ratios, though that evidence doesn’t really come from a world where the two systems are in competition. I’d be interested in what that world looks like, though I don’t think we’ll be seeing it any time all that soon.
Senators to Propose Higher Capital for Banks Over $400 Billion [Bloomberg]
New bill would end Basel III and hike bank capital requirements to 10% [Qz]
Imaginary bank capital requirements [Google Docs]
2. Also the bill allows banking regulators to add additional risk-weighted capital rules. Just not Basel-y ones. The rejection of Basel seems to be anti-internationalist, not anti-risk-weighting.