By Simon Johnson. An edited version of this short post appeared today on the NYT.com’s Room for Debate: “Are Global Banking Rules Anti-American?”
Jamie Dimon claims that the new rules on bank capital “anti-American” because they somehow discriminate against American banks and American bankers. This framing of the issues is misleading at best.
The term “bank capital” is often poorly explained in the debate on this issue. It is just a synonym for equity – meaning the amount of a bank’s activities that are financed with shareholder equity, rather than debt. The advantage of equity is that it is “loss absorbing,” meaning that it takes losses and must be wiped out in full before any losses fall on creditors.
More capital means that a bank is safer, both from the perspective of shareholders and for creditors. Bankruptcy has become less likely.
But the real need for capital requirements arises from the social costs that a banking crisis can impose. Switzerland has moved to 20 percent capital requirements because they have two large banks which, if they fail, would cause major damage to the economy. The British are discussing moving in the same direction – the recent Vickers Commission report regards the Basel capital rules as insufficient for safeguarding public interests.
Bankers get lots of guarantees from the government – some explicit, like deposit insurance; and some implicit, like being Too Big To Fail. This is downside protection – but only for bank executives and some employees; everyone else in society still suffers when big banks blow themselves up.
If the evidence from our recent deep recession and slow recovery is not enough, look at Europe today. Big banks have huge debts relative to their equity – Deutsche Bank, for example, has a leverage ratio (assets divided by shareholder equity) around 35 times. Even small losses on sovereign debt in Europe could wipe out shareholder equity – the capital – of those banks.
Requiring higher capital – more equity relative to debt – in US banks is good for everyone. If some bankers complain and work hard to overturn these rules, they are the ones being anti-American.
For more reading on what really is bank capital and why we need higher capital requirements, I strongly recommend this paper by Anat Admati of Stanford University and her colleagues: http://www.gsb.stanford.edu/news/research/Admati.etal.html. Send the link to anyone you think may be misusing or misunderstanding the terminology.