Calibrating Capital: When Will Banks Have Enough?

19 Pages Posted: 21 Dec 2017 Last revised: 1 Feb 2018

See all articles by Thomas Huertas

Thomas Huertas

Goethe University Frankfurt - Institute of Law and Finance; Center for Financial Studies

Date Written: January 31, 2018

Abstract

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

Huertas, Thomas, Calibrating Capital: When Will Banks Have Enough? (January 31, 2018). Available at SSRN: https://ssrn.com/abstract=3036925 or http://dx.doi.org/10.2139/ssrn.3036925

Thomas Huertas (Contact Author)

Goethe University Frankfurt - Institute of Law and Finance ( email )

Campus Westend - Grüneburgplatz 1
Frankfurt, 60323
Germany

Center for Financial Studies ( email )

Grüneburgplatz 1
Goethe University
Frankfurt am Main, 60323
Germany

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