March 21, 2016

Keep Banks' Capital Requirements High to Protect against Financial Crises

Stephen Matteo Miller

Senior Research Fellow
Summary

Higher capital requirements might have prevented the Latin American debt crisis. Simpler capital requirements without risk weights might have prevented the recent crisis. In the future, if we’re going to regulate capital, let’s have simpler, higher capital requirements and put an end to this cycle.

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While writing a recent public interest comment concerning the Federal Reserve’s new “total loss-absorbing capacity” rule to raise capital requirements on the largest bank holding companies, it struck me that we have come full circle. After the 1982 Latin American debt crisis, Congress pushed regulators to raise capital requirements. Regulatory capital requirements were then effectively lowered, we had another crisis and now Congress and bank regulators want to raise capital requirements again. How did we get here?

The 1982 debt crisis reflected insolvency risk facing large banks after Mexico declared interest payments would not be forthcoming. The Senate banking committee announced taxpayer-funded bank bailouts would not happen, though taxpayers did fund the U.S. government’s assistance packages to Mexico. The legislative “price” for international assistance to Mexico was the International Lending Supervision Act of 1983.

Among other things, the legislation called for U.S. bank regulators to find a multilateral way to raise capital requirements that did not disadvantage American banks vis-a-vis their foreign competition. Foreign competition at the time meant French and especially Japanese banks, which had become the largest in the world. 

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