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In this post researchers from the Bank of Finland reveal that academics responding to the Bank’s survey prefer a minimum of 15% of common equity in relation to banks’ total assets at all times, considerably higher than the current regulatory minimum requirement that aims to constrain bank leverage.
Following the global financial crisis of 2007–2009, banking regulation has undergone significant reforms. In conjunction, the academic literature on banking regulation has made a great deal of progress in identifying key issues and tackling many of these in turn.1 The optimal amount of capital banks should have remains a central question.
In order to facilitate an overview of the current state and future of banking regulation, with a focus on bank capital requirements, we have conducted a survey addressed to leading academic experts worldwide, particularly in the fields of banking and finance and macro-finance.2 To the best of our knowledge, this is the first time that international academic experts have been surveyed on their views on bank capital regulation (see also our earlier Vox poston further motivation for running the survey).
The survey focused on two key aspects: first, how much capital banks should have; and second, how, in broad terms, the regulatory requirements enforcing this should be designed.
The description of the responses to each survey question can be found here. Here we will provide a brief summary of the preliminary findings.
On average, the academic experts surveyed prefer banks to have a minimum of 15% of common equity in relation to their total assets at all times. The median response was 10%. These numbers are considerably higher than the current regulatory minimum requirement that aims to constrain bank leverage (see Figure 1, panel a).
The corresponding numbers for the minimum common equity requirement in relation to risk-weighted assets at all times are 17% (the average response) and 15% (the median response), respectively (see Figure 1, panel b).3
Figure 1 Survey responses concerning a) the leverage ratio requirement and b) the risk-weighted capital requirement
Notes: Distribution of survey responses to the following questions: 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 (left panel, “Leverage ratio”), b) common equity to risk-weighted assets (right panel, “Risk-weighted capital ratio”)? Possible values for the responses were limited to the range from 0% to 50% in 5 percent increments (e.g., 0, 5, 10, 15...50) where the highest possible response value of 50 means 50% and more.
The majority of the surveyed experts approve of the new elements of bank regulation introduced in the Basel III reform after the global financial crisis.4 In addition to the leverage ratio requirement, clear approval was given, for example, to the counter-cyclical capital requirement, and the extra capital requirement on the largest, systemically important banks. Support for the use of hybrid instruments in meeting part of the capital requirements was somewhat weaker.
Interestingly, about 70% of the respondents favour an additional market-based capital requirement to complement the current book value-based capital requirements on banks.
Regarding the elements of the central trade-off in setting optimal capital requirements, the respondents generally believe that higher capital requirements would likely decrease both the likelihood and the social cost of banking crises while causing minimal to no change in economic activity.
The survey was conducted anonymously and has purely academic aims. While the results may be helpful in guiding future policy discussions on banking regulation, the survey is not directed at supporting any specific policy initiative.
The survey was launched online on 14 February 2019 and was successfully concluded on 10 March 2019. A total of 1,383 experts were sent invitations and 149 responses were received.5 The experts were chosen based on their publication records and academic credentials, including their standing in the field. The selection of respondents is intended to provide a representative, although non-exhaustive, sample of experts from academia. A clear majority of respondents came from Europe and North America, in approximately equal proportions.
For further information, please contact Gene Ambrocio or Esa Jokivuolle ([email protected], +358 09 1831).
Admati, A and M Hellwig (2013), The Banker’s New Clothes: What’s Wrong with Banking and What to Do about It, 1st ed, Princeton University Press.
Basel Committee on Banking Supervision (2018), "Survey on the interaction of regulatory instruments: results and analysis", Working Paper 33.
Boissay, F., C. Cantú, S. Claessens, A. Villegas (2019), "Impact of financial regulations: insights from an online repository of studies", BIS Quarterly Review, March.
Freixas, X, L Laeven and J-L Peydro (2015), Systemic Risk, Crises, and Macroprudential Regulation, MIT Press.
Haldane, A, D Aikman, M Hinterschweiger and S Kapadia (2018), “Rethinking financial stability”, Bank of England Staff Working Paper No. 712.
Kashyap, A, J Stein and S Hanson (2011), “A Macroprudential Approach to Financial Regulation”, Journal of Economic Perspectives 25(11): 3–28.
[1] See for instance the review by Haldane et al. (2018), and Freixas et al. (2015), Admati and Hellwig (2013), Boissay et al. (2019), and Kashyap et al. (2011).
[2] The survey was designed under the guidance of an Advisory Board comprising the following members: Mark Flannery, Thomas Gehrig, Seppo Honkapohja, William Kerr, Philip Molyneux, Steven Ongena, George Pennacchi, and Tuomas Välimäki. The survey questionnaire was pre-tested several times on a select group of intended recipients and the resulting questionnaire consisted of 18 question groups which could be completed in about 5–15 minutes. Any remaining errors and deficiencies are solely the responsibility of the survey research team.
[3] In these questions concerning the leverage ratio requirement and the risk-weighted capital requirement the response options given were 0%, 5%, 10%… up until 50%, which restrict the median responses to the same numbers. The precise question asked was: “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?”.
[4] Cf. Basel Committee on Banking Supervision (2018).
[5] 1,045 experts were invited to participate in the Survey on 14 February 2019. Reminders were sent on 25 February and 8 March. An additional 338 experts were invited on 25 February and were also sent a reminder on 8 March.
