A Prolegomenon to Future Capital Requirements
Bank supervisors have made significant strides since 1980 in the area of capital requirements, and they are currently pursuing further refinements. This article looks beyond such developments at longer term supervisory goals. Abstracting to some extent from the current regulatory framework, the author attempts to delineate a set of fundamental principles for future work on capital requirements. He distinguishes minimum capital—an objective standard imposed by regulators across firms—from optimum capital—a subjective standard adopted by individual firms to cover their own risks—and shows how the two concepts can form the basis for a general supervisory approach to capital.
or Supervision? Remarks
on the Future of Regulatory Capital
This paper focuses on the relative emphasis that the structure of regulatory capital places on formulas and on supervision. The two are not viewed as mutually exclusive, but as elements to which capital policy implicitly assigns relative weights. We will see that in U.S. regulatory practice, these weights have shifted over time, not always in the same direction. Furthermore, we will explore the relationships among regulatory formulas, supervisory appraisals, and the prevailing business practices in the banking industry. We then ask, what is the appropriate mix of formulas and supervision?
Ratios as Predictors of Bank Failure
The current review of the 1988 Basel Capital Accord has put the spotlight on the ratios used to assess banks’ capital adequacy. This article examines the effectiveness of three capital ratios—the first based on leverage, the second on gross revenues, and the third on risk-weighted assets—in forecasting bank failure over different time frames. Using 1988-93 data on U.S. banks, the authors find that the simple leverage and gross revenue ratios perform as well as the more complex risk-weighted ratio over one- or two-year horizons. Although the risk-weighted measures prove more accurate in predicting bank failure over longer horizons, the simple ratios are less costly to implement and could function as useful supplementary indicators of capital adequacy.