Do We Need Regulation of Bank Capital? Some Evidence from the UK
18 Pages Posted: 20 May 2013
Date Written: March 27, 2013
Banks need to keep both capital and liquidity against unforeseen events.
During the early-mid nineteenth century, there were a number of banking crises. Banks responded by holding higher levels of capital.
An analysis of bank capital shows that they adjusted their capital ratios according to the risks that they were taking and that they were well capitalised in comparison with the standards set by regulators under the Basel I and Basel II approaches.
Indeed, when bank capital levels became very thin after the Second World War, banks were prevented by the Bank of England from raising more capital, despite their appeals to the Bank.
During this long period of prudent management of the banking sector, there was no clear expectation that the state would have stepped in to save an insolvent bank in Britain.
Capital regulation is relatively recent and led to banks trying to game the rules contributing to the complexity that was created in the banking system.
An analysis of history demonstrates that capital regulation is not necessary if banks are not underwritten by the state.
The principle of many of the reforms to banking law and regulation currently being proposed or implemented is correct. That principle, which should be at the heart of regulatory reform, is that banks should be wound up in an orderly way if they fail.
The whole apparatus of bank capital regulation which has done so much to make the banking system more opaque should be abandoned. Attempts by the British government to require large banks to hold very high levels of capital are misguided.
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