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Federal Reserve Board Gov. Daniel Tarullo said Friday that he was still concerned about ongoing risks from banks' potential overreliance on short-term wholesale funding, but suggested one possible remedy: higher capital requirements.
May 3 -
The best way to prevent the repo market from freezing up in a future crisis is to require broker-dealers to use Treasury securities as collateral.
September 9 -
Today's investors realize how little they understand banks' risk exposures and are skittish about providing risk capital. The solution is to create transparent bank reports that present information in a clear, accessible manner, according to Vincent Papa of the CFA Institute.
August 1 -
As Treasury Secretary Jacob Lew defended the legacy of the 2010 reform law, in another part of the capital a banker and Republican lawmakers pleaded for legislative changes.
July 8
Customers judge their banks by the quality and variety of services they provide not by size. Legislators, on the other hand, frequently mistake banks' size as the most important indicator of their stability. In fact, bank stability depends not on size but on the riskiness of a bank's assets, as well as which of the bank's sources of funding bear that risk. Market discipline provides one way to control these risks.
Asset risks and funding risks are inherently bound up with one another. Yale University professor Gary Gorton discusses how risky secrets lurking on the asset side of banks historically triggered bank runs once they became public knowledge in his book
But bank stability can also be maintained if banks fund a significant amount of their investments with long-term bonds and equity such as common stock. Since long-term bonds are liabilities, while equity measures the bank's net worth of total assets minus total liabilities, long-term bonds and equity would serve as the bank's capital, as Professors Anat Admati and Martin Hellwig made clear in their book
Former finance professor and Goldman Sachs partner Fischer Black
The market discipline in Black's proposal arises from his recommendation that we measure a bank's equity at market value, rather than book value computed by the bank's accountants. Using market value of equity instills market discipline because it can fluctuate quite a bit, in accordance with equity investors' perceptions of the risk lurking on bank balance sheets. Unpleasant surprises mean the stock price and market value of the bank's equity fall as investors sell. This market discipline puts the corporate finance side of the bank in conflict with the bank's asset managers and loan officers, who now have to check their own risk-taking so the bank does not have to find new investors.
Finally, since a firm's risk of default rises with its debt-equity ratio, banks that rely more on equity would be safer especially since the slightest hint of those secrets will cause equity investors to sell their assets. In Black's world, size depends on the collective decisions of the bond and equity investors, as well as depositors. If anything, a bigger bank means a better bank, just as a rise in Apple's market share for phones and computers indicates that customers think Apple sells a superior product.
But that's not the world we live in today. In this world, our
For example, the
All told, our current legal and regulatory framework invites bank failure even five years after the passage of Dodd-Frank. Legislation focused on size does not address the problem, since it does nothing to reestablish the market discipline missing in the United States since before the Great Depression. Measuring equity at market value would restore that much-needed discipline.
