01 September 2020

SUERF: Are bank capital requirements optimally set? Evidence from researchers’ views

In spite of sweeping regulatory reforms in banking after the Global Financial Crisis of 2007-2009, many key questions, including the optimal level of bank capital, are still debated in the literature

In spite of sweeping regulatory reforms in banking after the Global Financial Crisis of 2007-2009, many key questions, including the optimal level of bank capital, are still debated in the literature.2 Moreover, there have been a number of notable initiatives from researchers to fundamentally change bank capital regulation (see e.g. Admati and Helwig 2013) but it is unclear how commonly these views are shared within the academic community. At this juncture, it is important to ask what have we learned from recent research regarding the current state of bank capital regulation? Which issues in bank capital regulation enjoy relatively strong consensus vis-à-vis those subject to considerable disagreement? How should these research results translate into actual regulation?

In a recent study we have surveyed leading academic researchers in banking and finance and macro-finance worldwide on their views on bank capital regulations to address these questions (Ambrocio et al. 2020). Although surveys of the literature have been recently conducted (cf. Dagher et al., 2016; BCBS, 2019a), this is the first time to the best of our knowledge that academic experts exclusively have been directly surveyed on bank regulation. We invited 1,383 academic experts to participate in the survey in the first quarter of 2019, of which 149 responded, translating to a response rate of approximately 11%, which is comparable with many methodologically similar studies.3

The respondents support the current overall regulatory design but are much stricter regarding the level of banks’ minimum capital requirements, particularly the non-risk-weighted equity-to-assets ratio (i.e., the “leverage ratio” requirement), which the initial Basel III recommendation sets at 3% (see Figure 1). According to the average response, banks should have approximately a minimum of 15% of common equity in relation to their total assets at all times. The median response is somewhat lower, 10%. A considerable number of respondents prefer even much higher levels of bank capital.

Interestingly, there is a significant difference between North-American respondents who on average prefer an 18% minimum equity-to-assets ratio and Europeans who on average prefer 13%. The response distribution concerning the risk-weighted minimum capital requirement is broadly similar, and the average response is remarkably close to that for the leverage ratio requirement (see Figure 1).

Figure 1. Distributions of the preferred minimum capital requirements; common equity to risk-weighted assets (left panel) and common equity to total assets, i.e., the leverage ratio requirement (right panel)

Respondents were asked to answer the following questions, part a) referring to the leverage ratio requirement and part b) to the risk-weighted requirement: “What approximate values of the following capital ratios (in terms of book value equity and in percent) is closest to your view of the level of capital that all banks should have as a minimum at all times: a) common equity to total assets b) common equity to risk-weighted assets? Possible values for the responses were limited to the range from 0% to 50% in 5 percentage point increments (e.g. 0%, 5%, 10%, 15%, etc.). The highest possible response value of 50% means 50% or higher. Mean responses in the figures are rounded to the closest integer.

The average view regarding the desirable level of bank minimum capital is not likely to be significantly affected by potential sample selection biases such as respondents’ age (the sample is quite balanced in this regard) or the strictness of their views regarding bank regulation relative to peers (there is a slight skew towards stricter respondents). A respondent’s view on the effect of capital requirements on the cost of bank lending is the most robust predictor of her preferred level of minimum capital requirements.

The majority of respondents approves of the new elements in banking regulation introduced in the Basel III reform after the Global Financial Crisis. In addition to the leverage ratio requirement, a clear majority approves of an extra capital charge on the largest, systemically important banks, a counter-cyclical component to capital requirements, and additional liquidity requirements. Somewhat weaker approval was given also to the eligibility of hybrid and bail-inable securities in fulfilling the minimum capital requirements. Notably, most respondents would favor an additional market-based capital requirement to complement the current book value-based capital requirements on banks.

In the rest of this note, we first discuss the motivation of the survey and then discuss further results that might help understand respondents’ preferences concerning the level of minimum capital requirements.

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