Money, Banking and Financial Markets

Primers

Primers

 
 
Posts tagged Capital requirements
Understanding Bank Capital: A Primer

Over the past 40 years, U.S. capital markets have grown much faster than banks, so that banks’ share of credit to the private nonfinancial sector has dropped from 55% to 34% (see BIS statistics here).  Nevertheless, banks remain a critical part of the financial system. They operate the payments system, supply credit, and serve as agents and catalysts for a wide range of other financial transactions. As a result, their well-being remains a key concern. A resilient banking system is, above all, one that has sufficient capital to weather the loan defaults and declines in asset values that will inevitably come.

In this primer, we explain the nature of bank capital, highlighting its role as a form of self-insurance providing both a buffer against unforeseen losses and an incentive to manage risk-taking. We describe some of the challenges in measuring capital and briefly discuss a range of approaches for setting capital requirements. While we do not know the optimal level of capital that banks (or other intermediaries) should be required to hold, we suggest a practical approach for setting requirements that would promote the safety of the financial system without diminishing its efficiency....

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Steve Cecchetti and Kim SchoenholtzAssets, Liabilities, Net worth, Capital, Capital adequacy, Capital requirements, Loss-absorbing capacity, Exposure, Leverage ratio, Debt-equity ratio, Self-insurance, Incentives, Solvency, Liquidity, Risk-weighted assets, Derivatives, Balance sheet, Off-balance sheet, Debt overhang, Gamble for redemption, Skin in the game, Too big to fail, Time consistency, Adverse selection, Goodwill, Intangible capital, Deferred tax assets, Credit conversion factor, US GAAP, IFRS, Hypothetical portfolio exercise, Modigliani-Miller theorem, Minneapolis Plan, Narrow banking, De factor bank, Credit supply, De facto bank, Primer
Time Consistency: A Primer

The problem of time consistency is one of the most profound in social science. With applications in areas ranging from economic policy to counterterrorism, it arises whenever the effectiveness of a policy today depends on the credibility of the commitment to implement that policy in the future.

For simplicity, we will define a time consistent policy as one where a future policymaker lacks the opportunity or the incentive to renege. Conversely, a policy lacks time consistency when a future policymaker has both the means and the motivation to break the commitment.

In this post, we describe the conceptual origins of time consistency. To emphasize its broad importance, we provide three economic examples—in monetary policy, prudential regulation, and tax policy—where the impact of the idea is especially notable....

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Steve Cecchetti and Kim SchoenholtzPrimer, Time consistency, Dynamic inconsistency, Strategy, Policy commitment, Credibility, Rules vs. discretion, Constrained discretion, Institutional design, Policy framework, Transparency, Communications, Monetary policy, Central bank independence, Inflation targeting, Inflation, Inflation expectations, Too big to fail, TBTF, Bailout, Capital requirements, Resolution, Stress test, Taxation, Capital, Tax treaty, Fiscal sustainability, Investment treaty