Regulators should stick to the risk-based capital system for banks, rather than return to a simplistic capital-to-lending ratio, ABA Chief Economist James Chessen argued in an American Banker op-ed.
The risk-based approach “remains a better way of gauging and guarding against the true risks associated with a bank than the one-dimensional leverage ratio to which some policymakers want to return,” he wrote.
“The concept behind risk-based capital is simple and fair: Make capital commensurate with underlying risk. It's true that putting this into practice has not been simple.”
Chessen emphasized that leverage ratios -- to which some in Congress seem to want to return -- did not distinguish banks that failed post-2008 and those that remained healthy. “Once economic conditions deteriorated, losses overwhelmed capital and led to failures. . . . [T]he losses were so great that no reasonable level of capital would have been enough to absorb them.”
Chessen noted the importance of not confusing “more capital” with “you can’t have too much capital,” warning: “Capital comes at a cost -- both to banks and the economy at large -- in the form of foregone lending as institutions shrink to meet extreme capital-to-asset ratios.”
Read the op-ed.