The debate on banking regulation has been dominated by flawed and misleading claims.
The title of our book The Bankers New Clothes: What’s Wrong with Banking and What to Do
about It (Princeton University Press, 2013, see bankersnewclothes.com) refers to flawed claims
about banking and banking regulation, and the book discusses and debunks many of them.
Flawed claims are still made in the policy debate, particularly in the context of proposals
that banks be funded with more equity and rely less on borrowing than current or new
regulations would allow. Those who make the flawed claims do so without addressing our
arguments, even when they comment on the book or on our earlier writings. Because the
financial system continues to be dangerous and distorted, however, flawed claims must not win
the policy debate.1
This document provides a brief account of claims that we have come across since the
book was published in February, 2013. We provide brief responses, with references to more
detailed discussions in the book and elsewhere.2 References to chapter numbers refer to our
book. Nothing that we heard or read changes our conclusions or our strong policy
recommendations.
We first provide a list of the flawed claims that the rest of this document takes on.
List of Flawed Claims
Claim 1: Capital is money that banks hold or set aside as a reserve, like a rainy day fund.
Claim 2: Requiring banks to hold reserves equal to 15% of their assets does not make them safe.
Therefore, a capital requirement of 15% is useless.
Claim 3: The argument for requiring banks to have substantially more equity is only based on
the so-called Modigliani-Miller theorem, which does not apply in the real world because its
assumptions are unrealistic.
Claim 4: The key insights from corporate finance about the economics of funding, including
those of Modigliani and Miller, are not relevant for banks because banks are different from other
companies.
Claim 5: Banks are special because they produce (or create) money.
Claim 6: Increasing equity requirements would reduce the ability of banks to provide people
with deposits and other short-term claims that are liquid and can be used like money.
Claim 7: Increasing equity requirements is undesirable because the funding costs of banks
would increase.
Claim 8: Increased equity requirements would lower the banks’ return on equity (ROE) and
therefore harm shareholders and make investors unwilling to invest in banks’ stocks.
Claim 9: Increased equity requirements would force banks to make fewer loans.
Claim 10: Increased equity requirements would induce banks to lend less, and this would be
harmful for the economy.
Claim 11: Higher equity requirements are undesirable because they would prevent banks from
taking advantage of government subsidies and would force them to charge higher interest on
loans.
Claim 12: Banks cannot raise equity and will have to shrink if equity requirements are
increased; this will be bad for the economy.
Claim 13: Increasing equity requirements would harm economic growth.
Claim 14: Basel III is already tough, doubling or tripling previous requirements. Banks have
much more capital [equity] now than they had earlier and they are safe enough.
Claim 15: Basel III is based on careful scientific analysis of the cost and benefits of different
levels of capital requirements, whereas the rough numbers of those who advocate much higher
requirements cannot guide policy because they are not supported by scientific calibration.
Claim 16: Because capital requirements should be adjusted to risk, it is essential to rely
primarily on requirements that are based on assigning risk weights to assets.
Claim 17: Instead of issuing more equity, banks should be required to issue debt that converts to
equity when a trigger is hit, so-called “contingent capital” or co-cos.
Claim 18: The Dodd-Frank Act in the US has done away with the need to bail out banks; if a
bank gets into trouble, the FDIC will be able to resolve it without cost to the taxpayer
Claim 19: If capital requirements are increased, banks will increase their “risk appetite,” which
may make the system more dangerous.
Claim 20: If capital requirements are increased, bank managers will be less disciplined.
Claim 21: Tighter regulation is undesirable because it would cause activities to move to the
unregulated shadow banking system.
Claim 22: Since banking is a global business, banking regulation must be coordinated and
harmonized between regulators worldwide. It is important to maintain a “level playing field” in
global competition.
Claim 23: Stricter regulation is would harm “our” banks; instead we should be supporting them
in global competition.
Flawed Claims Debunked…
