Pew Finds Increasing Bank Capital Requirements May Help Stabilize Financial Markets Without Substantially Impacting Lending

Higher capital requirements on the U.S. banking industry likely have less of an impact on bank lending than has been asserted, according to the findings of a new study released by Pew's Financial Reform Project.

Bank capital is the cushion of extra assets that a bank must hold to protect against loans that go bad or investments that fail. There is a strong consensus among financial experts and policymakers that the banking system needs considerably more capital than the four percent to eight percent of total assets they typically have now.

The new report, “Quantifying the Effects on Lending of Increased Capital Requirements,” shows that higher bank capital requirements would likely have much less effect on lending than many analysts have predicted. For example, if capital requirements rose on average from six percent to ten percent, loan rates on a typical bank loan might rise by only 0.2 percentage points, assuming modest tightening of loan terms or by 0.25 percentage points, assuming no changes in the terms.

“This is an important new insight. This study shows that the U.S. banking industry could potentially accommodate significantly higher capital requirements with very limited adjustments,” said Charles Taylor, director of the Pew Financial Reform Project.

“These results suggest that tougher capital requirements can powerfully aid the stability of the system without doing significant damage to lending or the economy,” said Douglas J. Elliott, a fellow at the Brookings Institution and author of the report.

Inadequate capital requirements are widely believed to be a contributing factor to the onset, spread and severity of the recent financial crisis.  New international standards for stronger, higher capital requirements for banking firms are an important aspect of the Obama Administration and congressional reform proposals and are expected to be a leading topic of discussion at the upcoming G-20 meeting in Pittsburgh.

The Financial Reform Project, an initiative of Pew's Economic Policy Group, is working to create a fair, competitive and stable financial system for the 21st century. The Task Force on Financial Reform, a group of eminent scholars of disparate views, is focused on building consensus on the major issues of reform in order to provide Congress with a powerful objective basis for selecting the best policy options.

Pew is no longer active in this line of work, but for more information, visit the main Pew Financial Reform page.

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