Systemic risk? Measure the subsidy and not the capital

in Announcements, In the News
July 15th, 2013

From the Financial Times.

Sir, Your editorial paean to bank leverage ratios (July 11) is undermined by your report on the same day describing how US banks intend to shuffle assets around to avoid the new rules.

We should have learnt by now that capital ratios, whether risk-weighted or leverage, are not the cure for systemic risk.

The market knows that it’s not by measuring capital that we determine the systemic riskiness of a company – it’s by measuring the subsidy the company receives for being so risky that it has to be underwritten by the government.

The answer to the too big to fail problem is not to pin the tail on the capital donkey but, rather, to acknowledge and measure the subsidy and then to let the markets speak. At this time, the US General Accountability Office is in the thick of a study quantifying the subsidy.

To be sure, capital has its place in the regulator’s toolbox. But as a means for stemming systemic risk that tool is woefully inadequate as has been demonstrated repeatedly over the years. We do not have to live between the Scylla of economic stagnation caused by banks with bloated capital levels and the Charybdis of financial meltdowns of our largest institutions.

Cornelius K Hurley, Director, Boston University Center for Finance, Law & Policy, Boston, MA, US