Calibrating Capital: When Will Banks Have Enough?
19 Pages Posted: 21 Dec 2017 Last revised: 1 Feb 2018
Date Written: January 31, 2018
Capital is controversial. Banks complain that regulators demand too much. Critics complain that banks have too little. A few lone voices contend that banks have just about enough, thanks to the regulatory reform measures taken over the past decade in the wake of the financial crisis. Who’s right?
To determine the answer, we need a standard against which to measure the responses. We suggest that be the risk of deposits, for deposits are the linchpin to the bank’s being able to perform its critical economic function of making and receiving payments.
There are two aspects to the risk of deposits: the possibility that the depositor (or the deposit guarantee scheme) may suffer a loss of principal, and second, the possibility that access to that principal might be suspended. This paper argues that current regulation minimises the first possibility. Provided the authorities initiate resolution in a timely manner, requirements that banks maintain a minimum total loss absorbing capacity (TLAC) – together with depositor preference – make deposits practically immune from loss of principal.
However, this will not make deposits also exempt from suspension. To avoid suspension, resolution reform needs completion. Two areas are vital: valuation, so that the authorities avoid forbearance and intervene promptly; and liquidity, so that the recapitalised bank in resolution can meet demands for withdrawal when it reopens for business. Together these steps can make deposits not only immune from loss, but also exempt from suspension. If deposits meet that standard, the bank surely has enough capital.
Keywords: banks, capital, resolution, valuation, liquidity, emegency liquidity assistance, supervision, stress testing
JEL Classification: G21, G28
Suggested Citation: Suggested Citation