Journalism in the Public Interest

In Debate Over Bank Capital Regulation, a Trans-Atlantic Gulf

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The United States and Britain are two countries separated by a common financial crisis.

Since the crisis, Anat Admati and her colleagues have been arguing for higher bank capital standards to make the financial system safer. In this country, Professor Admati, who teaches economics and finance at the Stanford business school, has been a voice in the wilderness. In London, she finds a more receptive audience. "The U.S. is so much friendlier to the banks than the U.K.," she says. "You just try to get a word in -- well, the level of the debate is not the same."

Over there, major government figures speak openly about requiring substantially higher bank capital. The governor of the Bank of England, the head of the Financial Services Authority (the equivalent of the Securities and Exchange Commission) and even the conservative chancellor of the Exchequer have backed a bigger crackdown on the banking sector. While the international banking rules, called Basel III, settled on 7 percent as the minimum standard for a certain kind of capital, it's acceptable in Britain to talk about having significantly higher standards. A recent Bank of England paper contemplated capital on the order of 15 to 20 percent.

Here, that thought is restricted to cranks and university professors. Though the big three -- Ben S. Bernanke, the Federal Reserve chairman; Treasury Secretary Timothy F. Geithner; and Mary L. Schapiro, the Securities and Exchange Commission chairwoman -- have made supportive noises about higher capital, they have not come close to advocating something that radical and substantial. Here, when the Federal Reserve Bank of New York writes a paper on capital requirements, the economists focus on the costs and exclude any examination of the benefits.

The difference in attitudes between the Americans and the British reflects the difference in severity between our crisis and theirs. Ours was serious; theirs was an utter calamity. The British have an even more concentrated banking system than we do, and a greater dependence on the financial sector, which meant a more severe crisis.

The American debate over bank capital isn't supposed to be over. Later this year, under the Dodd-Frank rules, regulators have to decide what the capital requirements will be for "systemically important financial institutions" and how they should be weighted for risky assets. Giant, enmeshed firms will be required to hold more capital than smaller banks with fewer ties to other entities in the financial system.

But on March 18, the banks threw a knock-down punch against the proponents of substantially higher capital standards. This was the result of Round 2 of the central bank's stress tests, which amounted largely to a self-graded exam. The Fed, the main regulator for the nation's largest banks, gave most of the big banks a green light to start paying dividends to shareholders. Curtailing dividend payments would have been the fastest, cheapest way for banks to build up capital.

Since all but a few of the biggest financial firms are being allowed to pay dividends, any argument that they should have significantly higher capital requirements is untenable.

The Federal Reserve wasn't a total pushover. Citigroup didn't even try to request permission to pay a meaningful dividend. Bank of America was told no. That was an embarrassment for Brian Moynihan, the chief executive for just over a year. In January, Mr. Moynihan told investors to expect a payout later this year. But the Fed held the line, presumably concerned about, among other things, Bank of America's exposure to bad mortgages and other problems inherited in its purchase of Countrywide.

Still, other banks sailed through, including SunTrust and KeyCorp, two regional banks that investors still view as fragile. Both were able to borrow money to repay the government's Troubled Asset Relief Program investment. Few banks have replaced the government's money with equity capital on a dollar-for-dollar basis, but SunTrust and KeyCorp are being allowed to raise relatively little equity to pay off the Feds.

The banks decry any contemplation of an increase in capital standards as a death knell for economic growth. Professor Admati is struck by the similarities the debate has to the one over stock option expensing that raged through the 1990s. The technology industry denounced such proposals as sure job killers, and politicians like Sen. Joseph I. Lieberman of Connecticut defended the accounting treatment. Finally, expensing regulations were put in place and the world failed to end. Indeed, Silicon Valley baristas, at last report, were frothing up a new tech frenzy, options expensing be damned.

This time around, the banks argue that they need extra leverage or they won't be able to lend freely. This is flawed logic. Clearly, not all lending is good lending. We just emerged from an era of spectacularly reckless lending.

Professor Admati argues that the economy will be better off with better capitalized banks. "There isn't a real economic reason, as we are figuring out how to have safe and healthy system, why money should go out of the banks."

Obviously, higher capital cushions are not in the immediate interests of the equity holders -- including top bank executives -- for whom leverage creates higher returns.

Many of the differences between the United States and Britain are superficial: one banker's elevator is another's lift. But the intertwined nature of the world's capital markets makes it likely that American compromises will eventually erode British insistence on higher capital standards.

The result may add up to more than a matter of semantics.


Good article.  Thank you for passing it along.  A related subject is the “stink” that some financial institutions are making over the requirement that they hold on to 5% of a loan if less than a 20% downpayment accompanied the loan.  How soon we forget.

I applaud your calling attention to the failure to insist on sensible amounts of capital in US banks. Euroland is even worse than the US in terms of tolerating leverage and being “big-bank-friendly”. Don’t drop the subject.

A serious discussion of this issue, however, should not avoid mentioning the main distortionary element of applicable rules, i.e. the risk-weighting system that is the core of the Basle framework. This allows banks to manipulate the base for calculating minimum capital requirements. So long as banks can arbitrage this base down to pretty much whatever they like the minimum regulatory ratio, whether 7% or the BOE’s 15-20% will not matter much. I’d encourage more focus on risk-weight arbitrage.

Now that the big banks have convinced themselves and the government that they have bought and paid for that they are too big to fail, they are too big to fail.

Jesse Eisinger

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In this column, co-published with New York Times' DealBook, I monitor the financial markets to hold companies, executives and government officials accountable for their actions. Tips? Praise? Contact me at .(JavaScript must be enabled to view this email address)