Bank capital regulation is a form of government accounting. Bank capital is regulated, or at least, is advertised to be regulated, in order to promote stability in the banking system.
Banking crises threaten the public purse, as well as the overall economy, so our government sets up capital requirements to try to make sure that banks are adequately capitalized, and stable enough to survive a crisis.
That’s the theory, anyway. Trouble is, in 2007-2009, we went into one of the worst financial crises in US history. Bank capital was regulated before the crisis. So why was the banking system so fragile?
A good case can be made that the banking system was sorely undercapitalized because bank capital is regulated. The regulators, well, to make a longer story short, made a big mess of things.
Have they learned their lessons, after the 2007-2009 crisis?
While banks are holding more of their own capital relative to assets, things are only marginally changed in that regard.
One of the ways bank capital is regulated is via “stress tests.” Bank regulators set up hypothetical events and simulate the effect of those events on bank capital.
Last week, the Federal Reserve announced the results of its latest round of “stress tests.”
Then, late in the week, a real, not fake test, arrived, with the Brexit and its impact on banking market confidence.
So far, we haven’t seen a banking system implosion like late 2008 -- far from it, at least in the US.
So far.
Some cautionary notes from Anat Admati might be worth considering. In a new working paper chock-full of worthy observations, Admati (professor at Stanford) cautions that:
"The measures of financial health used by regulators are unreliable and can lull regulators and the public into a false sense of safety just as happened prior to the Crisis. They still count on problematic accounting rules, credit ratings, and complex “risk weights” that give the pretense of science while in fact being distortive, political and counterproductive."