Bank capital is funding, but can't always be lent
Time and again, various academic publications explain to us that bank capital is actually cash funding, and therefore higher capital requirements do not constrain lending, in fact they help banks lend more.
This underlying opinion, barely disguised behind a cynical tone, is that bankers do not understand capital is funding. I am afraid the issue is more that most non-bankers do not seem to realise that raising capital requirements and raising capital are not the same thing, but opposing factors which cancel each other out. I will demonstrate that with a simple example below. The conclusion is that capital raised because of increasing capital requirements is funding which can't be used for more lending.
Let's start with a bank which has 100 in loans, and a capital requirement of 10%. So its liabilities are 10 in capital and 90 in client balances. Now the authorities raise capital requirements to 15%. Suppose the bank goes out and raises that extra 5 in capital. Now its liabilities are 90 client balances, and 15 in capital. And its assets are 100 in loans and 5 in cash. Can it now go and lend the extra 5? No, it can't. Because the 100 in existing loans requires exactly the 15 capital it has. If it lends the 5, that means another 15% or 0.75 in capital is required. So the bank faces a choice of either leaving the cash in the central bank or shortdated govvies at negative interest, or (economically the better option) reduce client balances. Neither option leads to the new lending that is supposed to be possible. If the bank is leverage constrained, even holding the cash is impossible.
As always, when confronted with facts, people with an opinion get irritated. The heated statements about banks needing more capital have nothing to do with this: that is either true or not, but in neither case does the outcome lead to more lending. By the same token, explaining that investors have it all wrong when they look for 10% roe's is nice as an opinion, but a company raising money pays that market price, whether politician and journalists like it or not.
It is also interesting how we pay professors to think about complex matters and help us get the right answers, yet they often fail to properly think about simple matters like this one and then come up with wrong answers.
This underlying opinion, barely disguised behind a cynical tone, is that bankers do not understand capital is funding. I am afraid the issue is more that most non-bankers do not seem to realise that raising capital requirements and raising capital are not the same thing, but opposing factors which cancel each other out. I will demonstrate that with a simple example below. The conclusion is that capital raised because of increasing capital requirements is funding which can't be used for more lending.
Let's start with a bank which has 100 in loans, and a capital requirement of 10%. So its liabilities are 10 in capital and 90 in client balances. Now the authorities raise capital requirements to 15%. Suppose the bank goes out and raises that extra 5 in capital. Now its liabilities are 90 client balances, and 15 in capital. And its assets are 100 in loans and 5 in cash. Can it now go and lend the extra 5? No, it can't. Because the 100 in existing loans requires exactly the 15 capital it has. If it lends the 5, that means another 15% or 0.75 in capital is required. So the bank faces a choice of either leaving the cash in the central bank or shortdated govvies at negative interest, or (economically the better option) reduce client balances. Neither option leads to the new lending that is supposed to be possible. If the bank is leverage constrained, even holding the cash is impossible.
As always, when confronted with facts, people with an opinion get irritated. The heated statements about banks needing more capital have nothing to do with this: that is either true or not, but in neither case does the outcome lead to more lending. By the same token, explaining that investors have it all wrong when they look for 10% roe's is nice as an opinion, but a company raising money pays that market price, whether politician and journalists like it or not.
It is also interesting how we pay professors to think about complex matters and help us get the right answers, yet they often fail to properly think about simple matters like this one and then come up with wrong answers.
Wrong. Capital regulation does not tell banks what to do with their funds or what they should hold. Your argument simply places 'capital' - 'bank capital', 'equity' - on the wrong side of the balance sheet. Capital (equity) is not an asset but a way of funding the assets of a bank, which include 'loans to businesses or households'. Capital / equity is placed on the right-hand side of the balance sheet and not on the left-hand or assets side. There is therefore not competition between loans on the one hand and capital on the other as two competing alternatives for spending funds (they don't compete since capital constitutes funds for lending, and is not a way of allocating/spending those funds).
BeantwoordenVerwijderenCapital regulation only tells banks what portion of the funds they use must be unborrowed. The confusion is insidious because it biases the debate, suggesting costs and trade-offs that do not actually exist.
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