Three Cs of Bank Capital: Convergence, Conundrums and Contrariness

Saturday, January 1st, 1994 at 12:00 am by Stuart D. Root
Stuart D. Root, Three Cs of Bank Capital: Convergence, Conundrums and Contrariness, 1994 Colum. Bus. L. Rev. 135

Of all the benefits that banks derive from capital, perhaps the most important to the economy are the ability to add value to a borrower’s credit (e.g., by making loans or giving guarantees), and the ability to reward savers for their participation in the capital formation process.

The function of adding value should distinguish banks from mutual funds which do not accumulate capital. Unfortunately, over the past few years, even healthy banks have evidenced a ‘pathology‘ of not adding value to support economic growth. Further, the exigent need for greater domestic capital formation through personal savings is currently frustrated by the systematic elimination of institutions formed to serve savers.

This article argues that policy makers have been so preoccupied with the convergence of capital standards that they have lost sight of how individuals, as both savers and borrowers, have been forced to assume the burdens of inflation induced volatility exposure while still being underpaid on their savings. The result of this preoccupation is that while in the 1970s, the Federal government created (or suffered to be created) inflation at rates unprecedented in the Twentieth Century, the Federal Government now reacts by penalizing individual savers and borrowers in the name of capital convergence and homogeneity for all depository institutions.

There is a better way to prepare for the Twenty-first Century – one that requires a more patient approach to institutional crises and a better return for savers.

Part II briefly reviews the regulatory policy that favored convergence of capital standards despite legislation that allowed for differences in regulatory treatment. It also briefly discusses how this convergence policy rode roughshod over investors who invested capital to help the Federal government manage a collapse in real estate values – this policy ignored investors’ assertions of impaired contractual rights and often destroyed the institutions in which investments had been made. Part II also examines the growing annoyance of regulators and their constituents with the different drummer to which the thrift institutions were marching, and the regulators’ consequent silencing of the drummer.

Part III looks at some of the intractable problems in developing a regulatory capital structure that is consistent with the banking function of adding value to the creditworthiness of its customers, paying special attention to the issue of mark-to- market accounting. The principal area for discussion is whether the concept of ‘market‘ is viable when actions by the Federal government, an 800 pound gorilla with little memory capacity, can wreak economic violence.

Part IV questions whether many of the current regulatory pursuits are, in effect, contrary to an economic recovery from a collapse of real estate values, contrary to a banking system which adds value to borrowers, and hostile to an economy which depends on, or should promote savings for, capital formation and increasing net private investment to foster growth. Part IV also advocates a new approach to regulating institutions that ‘serve those who save.‘

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practices law in Bronxville, NY