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When More Financial Regulation Is Not Better

Recently proposed rule changes to increase large banks' capital requirements may do more harm than good. While we do not want banks to be so thinly capitalized that small losses and accidents can precipitate panics, we also must recognize how more capital can facilitate mismanagement.

CHICAGO – Partly in response to the banking failures of March 2023, US regulators now want to impose higher capital requirements on banks with over $100 billion in assets. But this is a puzzling choice, considering that some of the most egregious risk-taking recently has been found among smaller banks.

Some of the proposed changes – such as a requirement that banks include unrealized gains and losses from certain securities in their capital ratios – are overdue. By and large, however, CEOs of large banks are not pleased. Jamie Dimon of JPMorgan Chase, for example, has blasted the proposal for stricter capital rules, warning that it could prompt lenders to pull back and thereby stymie economic growth. Before we dismiss such outbursts as self-serving “bankerspeak,” we should ponder the role that bank capital serves, and whether regulators are moving in the right direction.

Long-term “patient” financing, such as equity, counts as bank capital. Unlike demand deposits, it does not have to be paid back in the short run. If banks can be brought down by uninsured depositors rushing for the exit, isn’t it obvious that more capital means fewer runs, and thus a more stable banking system?