Benefits and Costs of Higher Capital Requirements for Banks

William Cline

No WP16-6, Working Paper Series from Peterson Institute for International Economics

Abstract: This study provides new estimates of the likely economic losses from banking crises. It also provides new estimates of the economic cost of increasing bank capital requirements, based on the author's earlier estimate (Cline 2015) of the empirical magnitude of the Modigliani-Miller effect in which higher capital reduces unit cost of equity capital. The study applies previous official estimates (BCBS 2010a) of the impact of higher capital on the probability of banking crises to derive a benefits curve for additional capital, which is highly nonlinear. The benefit and cost curves are examined to identify the socially optimal level of bank capital. This optimum is estimated at about 7 percent of total assets, with a more cautious alternative (75th percentile) at about 8 percent, corresponding to about 12 and 14 percent of riskweighted assets, respectively. These levels are, respectively, about one-fourth to one-half higher than the Basel III capital requirements for the large global systemically important banks (G-SIBs).

Keywords: Financial Regulation; Bank Capital Requirements; Capital Structure (search for similar items in EconPapers)
JEL-codes: E44 G21 G28 G32 (search for similar items in EconPapers)
Date: 2016-03
New Economics Papers: this item is included in nep-cba, nep-mac and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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