By Steven K. Beckner
Levine also suggests that strengthened capital regulations are not
the guarantor of financial stability than many perceive them to be.
“Tightening capital regulations will not necessarily improve the
asset allocation decisions of banks and promote economic growth,” he
writes. “While many analysts look to capital regulations as a sort of
policy panacea for all that ails banks, research suggests that the
impact of increasing capital requirements will differ across countries
with different nonbanks and securities markets and across banks with
different ownership and corporate governance structures.”
In fact, Levine says tighter capital standards could do real
damage.
“Although the direct effect of more capital is the creation of a
larger ‘cushion’ against adverse shocks, an indirect effect could induce
insiders to increase overall bank risk,” he writes. “Since more
stringent capital regulations hurts insiders by reducing profits, they
might respond by increasing bank risk to compensate for this policy
change.”
Capital regulations could also hurt growth, Levine warns. “To the
extent that more stringent capital regulations induce banks to shift out
of making investments in new and growing corporations and into
government securities, and no other sources of capital substitute for
this reallocation, these regulations will have clear implications for
the emergence of new firms and expansion of old ones.”
Banks may alter the alter the composition of their assets in
response to more stringent capital regulations with disruptive effects,
Levine also cautions.
He explains that banks tend to “choose a particular risk profile
based on the comparative power of equity holders, equity-compensated
managers, salaried managers, and debt holders within the corporate
governance structure of the bank — which reflect legal and regulatory
institutions.”
But “an increase in capital stringency will upset this balance,” he
goes on. “While the direct effect of more capital is the creation of a
larger ‘cushion’ that reduces the riskiness of the bank, an indirect
effect could induce bank decision makers to increase the riskiness of
other assets such that overall riskiness could rise.”
“More stringent capital regulations tend to hurt equity claimants
by reducing their profits,” he continues. “Consequently, more stringent
capital regulations can incentivize equity claimants to push the bank to
increase risk taking as compensation for this adverse change.”
Private capital investment could suffer as a result, Levine warns.
“If banks simply change their portfolios by switching some of their
risky assets into government bonds and if they do not raise more capital
and if they do not alter the allocation of their risk assets, this will
reduce bank financing of corporate investment.”
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** Market News International **
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