Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity is Not Expensive

We examine the pervasive view that “equity is expensive,” which leads to claims that high capital requirements are costly and would affect credit markets adversely. We find that arguments made to support this view are either fallacious, irrelevant, or very weak. For example, the return on equity contains a risk premium that must go down if banks have more equity. It is thus incorrect to assume that the required return on equity remains fixed as capital requirements increase. It is also incorrect to translate higher taxes paid by banks to a social cost. Policies that subsidize debt and indirectly penalize equity through taxes and implicit guarantees are distortive. Any desirable public subsidies to banks’ activities should be given directly and not in ways that encourage leverage. Finally, suggestions that high leverage serves a necessary disciplining role are based on inadequate theory lacking empirical support. We conclude that bank equity is not socially expensive, and that high leverage is not necessary for banks to perform all their socially valuable functions, including lending, taking deposits and issuing money-like securities. To the contrary, better capitalized banks suffer fewer distortions in lending decisions and would perform better. The fact that banks choose high leverage does not imply that this is socially optimal, and, viewed from an ex ante perspective, high leverage may not even be privately optimal for banks. Setting equity requirements significantly higher than the levels currently proposed would entail large social benefits and minimal, if any, social costs. Approaches based on equity dominate alternatives, including contingent capital. To achieve better capitalization quickly and efficiently and prevent disruption to lending, regulators must actively control equity payouts and issuance. If remaining challenges are addressed, capital regulation can be a powerful tool for enhancing the role of banks in the economy.capital regulation, financial institutions, capital structure, too big to fail, systemic risk, bank equity, contingent capital, Basel.

Fallacies, irrelevant facts, and myths in the discussion of capital regulation: Why bank equity is not expensive

We examine the pervasive view that equity is expensive which leads to claims that high capital requirements are costly and would affect credit markets adversely. We find that arguments made to support this view are either fallacious, irrelevant, or very weak. For example, the return on equity contains a risk premium that must go down if banks have more equity. It is thus incorrect to assume that the required return on equity remains fixed as capital requirements increase. It is also incorrect to translate higher taxes paid by banks to a social cost. Policies that subsidize debt and indirectly penalize equity through taxes and implicit guarantees are distortive. Any desirable public subsidies to banks' activities should be given directly and not in ways that encourage leverage. Finally, suggestions that high leverage serves a necessary disciplining role are based on inadequate theory lacking empirical support. We conclude that bank equity is not socially expensive, and that high leverage is not necessary for banks to perform all their socially valuable functions, including lending, taking deposits and issuing money-like securities. To the contrary, better capitalized banks suffer fewer distortions in lending decisions and would perform better. The fact that banks choose high leverage does not imply that this is socially optimal, and, viewed from an ex ante perspective, high leverage may not even be privately optimal for banks. Setting equity requirements significantly higher than the levels currently proposed would entail large social benefits and minimal, if any, social costs. Approaches based on equity dominate alternatives, including contingent capital. To achieve better capitalization quickly and efficiently and prevent disruption to lending, regulators must actively control equity payouts and issuance. If remaining challenges are addressed, capital regulation can be a powerful tool for enhancing the role of banks in the economy

Fallacies, irrelevant facts, and myths in the discussion of capital regulation: Why bank equity is not socially expensive

We examine the pervasive view that 'equity is expensive' which leads to claims that high capital requirements are costly for society and would affect credit markets adversely. We find that arguments made to support this view are fallacious, irrelevant to the policy debate by confusing private and social costs, or very weak. For example, the return on equity contains a risk premium that must go down if banks have more equity. It is thus incorrect to assume that the required return on equity remains fixed as capital requirements increase. It is also incorrect to translate higher taxes paid by banks to a social cost. Policies that subsidize debt and indirectly penalize equity through taxes and implicit guarantees are distortive. And while debt´s informational insensitivity may provide valuable liquidity, increased capital (and reduced leverage) can enhance this benefit. Finally, suggestions that high leverage serves a necessary disciplining role are based on inadequate theory lacking empirical support. We conclude that bank equity is not socially expensive, and that high leverage at the levels allowed, for example, by the Basel III agreement is not necessary for banks to perform all their socially valuable functions and likely makes banking inefficient. Better capitalized banks suffer fewer distortions in lending decisions and would perform better. The fact that banks choose high leverage does not imply that this is socially optimal. Except for government subsidies and viewed from an ex ante perspective, high leverage may not even be privately optimal for banks. Setting equity requirements significantly higher than the levels currently proposed would entail large social benefits and minimal, if any, social costs. Approaches based on equity dominate alternatives, including contingent capital. To achieve better capitalization quickly and efficiently and prevent disruption to lending, regulators must actively control equity payouts and issuance. If remaining challenges are addressed, capital regulation can be a powerful tool for enhancing the role of banks in the economy

Debt overhang and capital regulation

We analyze shareholders' incentives to change the leverage of a firm that has already borrowed substantially. As a result of debt overhang, shareholders have incentives to resist reductions in leverage that make the remaining debt safer. This resistance is present even without any government subsidies of debt, but it is exacerbated by such subsidies. Our analysis is relevant to the debate on bank capital regulation, and complements Admati et al. (2010). In that paper we argued that subsidies that favor debt over equity are the key reason that banks funding costs would be lower if they economize on equity. Subsidies come from public funds, and reducing them does not represent a social cost. It is thus irrelevant for assessing regulation. Other arguments made to support claims that equity is expensive are flawed. Like reduction in subsidies, the effects of leverage reduction on bank managers or shareholders do not represent a social cost. In fact, we show that debt overhang creates inefficiency, since shareholders would resist recapitalization even when this would increase the combined value of the firm to shareholders and creditors. Moreover, debt overhang creates an addiction to leverage through a ratchet effect. In the presence of government guarantees, the inefficiencies of excessive leverage are not fully reflected in banks' borrowing costs. Since banks' high leverage is a source of systemic risks and imposes costs on the public, resistance to leverage reduction leads to social inefficiencies. The main beneficiaries from high leverage may be bank managers. The majority of the banks' shareholders, who hold diversified portfolios and who are part of the public, are likely to be net losers. Our analysis highlights the critical importance of effective capital regulation and high equity requirements, especially for large and systemic financial institutions. We analyze shareholders' preferences when choosing among various ways leverage can be reduced. We show that, with homogeneous assets, if the firm's security and asset trades have zero NPV, and the firm has a single class of debt outstanding, then shareholders find it equally undesirable to deleverage through asset sales, pure recapitalization, or asset expansion with new equity. When these conditions are not met, shareholders can have strong preferences for one approach over another. For example, if the firm can buy back junior debt, asset sales are the preferred way to reduce leverage. This preference for asset sales, or deleveraging can persist even if such sales are inefficient and reduce the total value of the firm

Why High Leverage is Optimal for Banks

Abstract Liquidity production is a central role of banks. High leverage is optimal for banks in a capital structure model in which there is a market premium for (socially valuable) liquid financial claims and no deviations fro

ENIGMA-anxiety working group : Rationale for and organization of large-scale neuroimaging studies of anxiety disorders

Altres ajuts: Anxiety Disorders Research Network European College of Neuropsychopharmacology; Claude Leon Postdoctoral Fellowship; Deutsche Forschungsgemeinschaft (DFG, German Research Foundation, 44541416-TRR58); EU7th Frame Work Marie Curie Actions International Staff Exchange Scheme grant 'European and South African Research Network in Anxiety Disorders' (EUSARNAD); Geestkracht programme of the Netherlands Organization for Health Research and Development (ZonMw, 10-000-1002); Intramural Research Training Award (IRTA) program within the National Institute of Mental Health under the Intramural Research Program (NIMH-IRP, MH002781); National Institute of Mental Health under the Intramural Research Program (NIMH-IRP, ZIA-MH-002782); SA Medical Research Council; U.S. National Institutes of Health grants (P01 AG026572, P01 AG055367, P41 EB015922, R01 AG060610, R56 AG058854, RF1 AG051710, U54 EB020403).Anxiety disorders are highly prevalent and disabling but seem particularly tractable to investigation with translational neuroscience methodologies. Neuroimaging has informed our understanding of the neurobiology of anxiety disorders, but research has been limited by small sample sizes and low statistical power, as well as heterogenous imaging methodology. The ENIGMA-Anxiety Working Group has brought together researchers from around the world, in a harmonized and coordinated effort to address these challenges and generate more robust and reproducible findings. This paper elaborates on the concepts and methods informing the work of the working group to date, and describes the initial approach of the four subgroups studying generalized anxiety disorder, panic disorder, social anxiety disorder, and specific phobia. At present, the ENIGMA-Anxiety database contains information about more than 100 unique samples, from 16 countries and 59 institutes. Future directions include examining additional imaging modalities, integrating imaging and genetic data, and collaborating with other ENIGMA working groups. The ENIGMA consortium creates synergy at the intersection of global mental health and clinical neuroscience, and the ENIGMA-Anxiety Working Group extends the promise of this approach to neuroimaging research on anxiety disorders

Chameleons: The misuse of theoretical models in finance and economics

En este ensayo muestro que los modelos teóricos en finanzas y economía se usan de un modo que los vuelven “camaleones”, y que los camaleones devalúan la moneda intelectual y enturbian los debates de política. Un modelo se convierte en camaleón cuando se basa en supuestos con conexiones dudosas con el mundo real pero sus conclusiones se aplican acríticamente (o sin suficiente crítica) para entender la economía. Muestro que los camaleones son creados y alimentados por la idea errónea de que un modelo no se debe juzgar por sus supuestos, por el argumento infundado de que los modelos deben estar en pie de igualdad hasta que se hagan pruebas empíricas definitivas, por apelaciones improcedentes a argumentos “como si”, a la elegancia matemática, a la sutileza, por referencias a supuestos “estándar en la literatura”, y por la necesidad de manejabilidad.In this essay I discuss how theoretical models in finance and economics are used in ways that make them “chameleons” and that chameleons devalue intellectual currency and obscure policy debates. A model becomes a chameleon when it is based on assumptions with dubious connections with the real world but draws conclusions that are uncritically (or not critically enough) applied to understand our economy. I discuss how chameleons are created and nurtured by the mistaken notion that a model should not be judged by its assumptions, by the unfounded argument that models should have equal standing until definitive empirical tests are conducted; and by misplaced appeals to “as-if ” arguments, by mathematical elegance, by subtlety, by references to assumptions that are “standard in the literature,” and by the need for manageabilit