WASHINGTON – OCTOBER 14: The words “In God We Trust” are seen on U.S. currency October 14, 2004 in … [+]
What should the interest rate be? The very question insults reason simply because economies are comprised of individuals, businesses and governments with wildly divergent pasts, presents and futures. An interest rate is a singular concept, not a number that a central planner can divine.
What’s true about interest rates is similarly true about bank capital requirements. What should they be? What an odd question, and what an arrogant conceit from Basel, the Fed, or any other entity for presuming to place a requirement on banks. Which helps explain the pushback from banks and their associated trade assocations against the Fed, Basel and others so pregnant with conceit.
The crucial point is that central banks or planners can’t credibly decree a bank capital requirement any more than they can decree an interest rate. Both are market driven as reflections of individual borrowing or the bank banking. Which should be a statement of the obvious.
Different types of loans have different types of risk. Think about it. A loan made to Taylor Swift would logically bring with it a much lower interest rate than the rate placed on a loan to Phoebe Bridgers, one of the performers who opened up for Swift on her recent tour. From this it’s no insight to suggest that market forces would require quite a bit more liquid capital on hand for a portfolio of loans made to individuals with Bridgers’s past, present and future earnings profile than they would loans made to individuals with economics resembling that of Swift.
What’s true for individuals is true for businesses and governments. If Bank A’s loan portfolio is heavily weighted toward Container Store, and Bank B’s to Berkshire Hathaway, it’s no stretch to say that capital requirements would be higher for Bank A not due to regulations, but market realities. Applied to governments, no capital requirement would be high enough as liquidity against a book of loans made to Haiti, but if a bank could solely claim U.S. Treasuries on its books, capital requirements would likely be zero, or something close.
Which hopefully vivifies the oddity of the Fed’s actions vis-à-vis banks right now. Particularly since 2008, banks have had foisted on them all manner of capital requirements care of the Fed. Again, very odd. The Fed’s requirements have a superfluous quality to them simply because the markets will most certainly tell you when you don’t have enough liquid capital on hand, and the severity of the message will be rooted in just how much risk individual banks can lay claim to.
Fed regulators presuming the imposition of broad capital requirements are acting in as conceited a fashion as FOMC members setting a rate of interest. In each instance they ignore that bank capital requirements are as numerous as banks themselves, much as there are as many interest rates as there are people, businesses, and governments.
We’re all different. That we are hopefully once again helps explain the pushback from banks and bank trade groups against the Federal Reserve. Rising capital requirements to ensure bank safety are damning evidence of regulators substituting their limited knowledge for that of the marketplace. To expect bank-enhancing results from this kind of substitution insults reason as much as the conceit about bank capital requirements themselves.
