Thursday, 26 November 2015

10% bank capital ratio is the same as 100%.

If bank regulators think that some level of bank capital, say 10%, means that the chance of a bank failing is vanishingly small, then it follows that the remaining 90% of bank funders (i.e. debt holders) run no risk, even if there’s no deposit insurance. But if those 90% were converted to shareholders, they’d also run no risk. Thus those shareholders wouldn’t charge any more for funding the bank than the latter debt holders. Ergo, once a bank has enough capital to make failure near impossible (e.g. the latter 10%) the capital ratio might as well be raised to 100%. Doing that won’t make any difference to the cost of funding the bank.

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