Benefits and Costs of Higher Capital Requirements for Banks
Cline provides new estimates of the likely economic losses from banking crises and the economic cost of increasing bank capital requirements. He applies previous official estimates of the impact of higher capital on the probability of banking crises to derive a benefits curve for additional capital. The benefit and cost curves are examined to identify the socially optimal level of bank capital. This optimum is estimated at about 7 percent of total assets, with a more cautious alternative at about 8 percent, corresponding to about 12 and 14 percent of risk-weighted assets (RWA), respectively. On this basis, the Basel III benchmarks are below optimal capital requirements, at only 7 percent of RWA (9.5 percent for global systemically important banks). Further international banking reform could usefully consider phasing in capital requirements on the order of one-fourth to one-half higher than the Basel III requirements.
Data disclosure: The data underlying this analysis are available here [zip].