Top-Down Bank Capital Regulation

Résumé du livre

The rules that govern bank capital are often referred to as “minimum” capital ratios. Institutions that comply with these ratios are not necessarily safe or unlikely to fail in a crisis given that the rules still allow extremely high levels of debt. Experience suggests that minimum capital ratios are a lagging indicator of a bank's financial stability. During the Financial Crisis, banks that failed or required government support appeared adequately capitalized under the then current rules. The firm-specific supervisory process is meant to correct the deficiencies of one-size-fits-all rules by requiring some banks to hold higher levels of capital. For large banks, this case-by-case determination is made through Federal Reserve's annual Comprehensive Capital Analysis and Review (CCAR) process and for small institutions these decisions are made through formal and informal administrative enforcement proceedings. While the imposition of higher capital ratios through these supervisory mechanisms sounds promising, this system is actually at odds with the concept of “prudential” regulation in that the supervisory process builds only incrementally upon weak minimum rules. Our combined rulemaking and supervisory system would be more effective if capital rules applicable to all banks were set high -- high enough so that the risk of serious undercapitalization, distress or insolvency is very small. This would make capital rules consistent with a precautionary approach, erring on the side of more capital. Conceptually, capital rules would be guided by what is prudent as opposed to what is minimally tolerable. This article explores how moving to a system of prudent capital rules could interact with firm-specific supervision to achieve a safer banking system.