The Agenda

Charles Calomiris on Bank Capital Ratio Requirements

My Economics 21 colleagues sponsor the Shadow Open Market Committee, a group of experts on monetary policy who gather to discuss Federal Reserve policy. You can find papers and related materials at their website. At today’s session, Thomas Hoenig of the Kansas City Federal Reserve Bank, will address the assembled guests. 

Charles Calomiris of Columbia University has written a paper on bank capital requirement reform, which he is presenting at the meeting:

In this paper, I will address three questions about the reform of MCRR [minimum bank capital ratio requirements]: (1) What size and structure of MCRR should we be moving toward? (2) How should we manage the transitional issues of raising capital requirements, in light of the potentially huge adverse consequences for credit supply that can result from higher MCRR? (3) How should so-called “macro-prudential” capital regulation be managed, together with monetary policy, so that capital requirements can add productively to the policy makers’ toolkit of mitigating business cycles?  

Calomiris’s conclusion is sobering:

Capital requirements should rise for US and European banks. More importantly, they must be credibly linked to bank risk ex ante, and must credibly recognize losses on a timely basis ex post. A mix of a higher equity requirement and a large CoCo requirement based on a market trigger would provide a more effective MCRR regime than the current book-equity capital standard. A combination of equity and CoCos would also be a more cost-effective means of raising capital ratios. 

Increases in capital ratios are not costless, privately to bank stockholders, or socially, given the substantial reactions of bank credit supply to increases in MCRR. A combination of book equity requirements and CoCos mitigates the costliness of higher MCRR, but the costs of meaningfully higher MCRR are still significant.   

In light of these costs, Calomiris suggests that a gradual phase-in of the new requirements might be the most feasible approach. 

Reihan Salam — Reihan Salam is executive editor of National Review and a National Review Institute policy fellow.

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