Admati: Banks need much more capital

Stanford professor Anat R. Admati argues in a Bloomberg column today for much higher capital requirements for banks and urges regulators to disregard “empty” threats from bankers that higher capital requirements will restrict credit and hurt the recovery.

She notes that the Federal Reserve may soon let banks increase dividends to shreholders. Instead, this money should be retained to build up a deeper capital cushion, Admati writes.

Confusing language often obscures the discussion of capital regulation and makes it more difficult to evaluate such threats. Banks often are said to “hold in reserve” or “set aside” capital; capital is described as a “rainy day” fund, and we are told “a dollar in capital is a dollar not put into the economy.” These descriptions portray capital as a pile of money sitting idle and not being used productively. This is nonsense.

Capital is simply equity, the value of shareholders’ ownership claims in banks; and it represents a way for banks to fund their investments without undertaking debt commitments that they might not be able to meet and which add to systemic risk. Bankers are fiercely resisting the suggestion that they use more equity and less debt in funding, even though this would reduce their dangerous degree of leverage.

Admati warns that the current strategies to avoid another financial crisis, for example by raising bank capital requirements, are inadequate.

The muddled debate on capital regulation has left us with only minor tweaks to flawed regulations, even after banks’ catastrophic failure in the crisis and the lasting consequences for the economy. The proposed solutions that regulators in the U.S. are focused on, such as resolution mechanisms, bail-ins, contingent capital and living wills, are based on false hopes. They can’t be relied on to prevent a crisis. Increasing equity funding is simpler and better than these pie-in-the-sky ideas.

Until they build up much greater capital, banks should retain their earnings rather than make payouts to equity. Bank boards, helped by regulators, should make sure that “excess capital” isn’t wasted or cause banks — as JPMorgan Chief Executive Officer Jamie Dimon said — to do “stupid things.” And empty, self-interested threats shouldn’t win another round of implicit subsidies if we are to prevent another crisis.