A Reassessment Of Regulated Bank Capital On Profitability And Risk

Abstract

Banks must maintain minimum capital levels, but a regulated balance sheet implies profit suboptimization. Moreover, the presumptive role of minimum capital in reducing insolvency risk may be misplaced. Evidence is presented that suggests a bank’s level of capital may not accurately presage the risk of loan default. Regulators must exercise restraint in further increasing bank capital levels, as unintended consequences may make matters worse.