To the editor:
In a Nov. 1 BankThink piece, (
Banks are not overcapitalized. The largest on average fund themselves with only about a 7% to 8% equity-to-total-asset "leverage ratio." Smaller banks fund with about 10%. A ratio
The key capital ratio under the Basel regulatory framework is the Tier 1 risk-weighted ratio. The average Tier 1 ratios for all banks equal 13%, which only looks high. That's because the adjusted asset measure is lower than actual total assets, not because actual equity capital is higher. Basel ratios measure regulatory capital, which is then divided by bank assets adjusted for expected losses based on historical data. But capital requirements are meant for future, unexpected losses.
The Basel framework, adopted by U.S. regulators in 1988, arose after the 1982 Latin American Debt Crisis. In exchange for helping distressed governments make debt payments on bonds held by U.S. banks, Congress called on regulators to increase equity capital for U.S. banks (which had average leverage ratios then of about 6%) and abroad through the
Risk-weighting reflects a compromise to get other countries like France and Japan, whose banks were then funded with even less equity, to sign on. Special interests have since successfully lobbied to lower the risk-weight on the asset classes they represent (mortgages, mortgage-backed securities, municipal bonds, etc.).
Mr. Puwalski also incorrectly depicts our view about unrealized losses. Yes, these arise on the asset side of a bank's balance sheet and are not capital. However, when an unexpected shock occurs on that side, it must be reflected on the liabilities (plus equity) side.
That's what happened when market equity values for poorly performing SVB, Signature, First Republic and Silvergate tanked between Q1 2022 and Q4 2022 in-line with unrealized losses — even as their Tier 1 ratios hardly moved. In the most absurd case, Silvergate's ratio was above 50% when it closed. SVB had nearly 75% of its funding from uninsured deposits, triggering a run.
If these banks had more equity then, they might still be here. Each time we revise Basel capital rules, we discover new reasons why the regulatory code hasn't accounted for some unexpected event.