Regulating Banks by Regulating Capital

Abstract

Last decade’s Dodd–Frank banking reform was a very costly and questionably effective effort to strengthen the U.S. banking system. A much simpler reform would be far more effective: require banks to hold much more shareholder equity against their liabilities. Banks would likely balk at this, claiming the equity would be better used to make loans. However, much larger equity reserves would reduce the need for costly regulation. The proposed Financial Choice Act is a step in this direction, but it must set an adequate equity ratio.

Keywords: Dodd-Frank Act, banking reform, Financial Choice Act, equity ratio, shareholder equity

JEL Classification: E44, G28, G21