Magazine article American Banker

Rx for Setting Capital Standards: Work from Banks' Own Models

Magazine article American Banker

Rx for Setting Capital Standards: Work from Banks' Own Models

Article excerpt

Policymakers are pushing past the increasingly complex calculations of capital to find new and better ways to measure a bank's health.

One suggestion comes from Arturo Estrella, vice president of financial markets and institutions at the Federal Reserve Bank of New York.

In the July issue of Economic Policy Review, Mr. Estrella advocates simplifying minimum capital standards while allowing banks to use internal risk-management models to determine how much capital they should hold.

Mr. Estrella joins scores of commentators offering ways for regulators to adapt capital standards to a changing financial services environment.

Institutions hold capital to reduce taxpayers' exposure to bank failures, and to improve their credit ratings. Regulators currently require banks to hold at least 4% capital. Most banks hold at least 6%.

While regulators want well-capitalized banks, they are concerned that banks are holding too much capital to ensure they are comfortably above the minimum standards. Besides being an inefficient use of capital, it depresses profits and constrains lending.

The current trend to make capital standards more complex will only exacerbate this problem, according to Mr. Estrella. For example, the Fed in June proposed adding interest rate risk to risk-based capital standards, which would make it even tougher to calculate a bank's ratios.

Mr. Estrella's solution: Keep it simple. Regulators should focus on the internal models banks use to identify their ideal capital levels and make the minimal capital requirement a simple ratio that can identify sick banks. This would preserve the dual system currently in place, he said.

Mr. Estrella said his long-term plan could produce the same safety and soundness benefits at a lower compliance cost and without constant regulatory oversight.

Under his plan, the bank's internal capital calculation would become binding. …

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