A Capital Conflict
Thomas M. Hoenig
Vice Chairman
Federal Deposit Insurance Corporation
Presented to the National Association for Business Economics (NABE) and
the Organization for Economic Cooperation and Development (OECD)
Global Economic Symposium
Paris, France
May 23, 2016
Thomas M. Hoenig
Vice Chairman
Federal Deposit Insurance Corporation
Presented to the National Association for Business Economics (NABE) and
the Organization for Economic Cooperation and Development (OECD)
Global Economic Symposium
Paris, France
May 23, 2016
The market no longer determines what is adequate capital for the banking industry. Following
generations of taxpayer support and ever-expanding government involvement, politicians,
regulators, and lobbyists have supplanted the role of the market in determining what counts as
capital, how it is calculated, and how much is enough. An artificial capital framework has thus
developed, which has resulted in steadily lower levels of capital and declining quality—even
blurring the distinction between debt and equity. Unfortunately, recent experience has shown
that when the marketplace does finally realize it cannot trust such a framework, the
consequences for the banking industry and the global economy can be dire.
Even so, the market remains on the sidelines as regulators and lobbyist renew the conflict over
what constitutes adequate capital. And I would add, the conflict is not really about risk-based
versus leverage ratios, nor about complex versus simple calculations. Fundamentally, the
conflict is about whether more or less equity capital best assures that banking firms are sound
and that economies enjoy strong, sustained growth. Seen in this light, it is apparent why the
demand for bank capital ebbs and flows as crises come and go, and why this conflict intensifies
as economies stabilize.
In my remarks today, I will provide a brief historical perspective on bank equity capital, its long-
term and recent trends, and its effect on economic stability and growth. I will cite research that
shows the banking industry and the economy do better in the long run with more—not less—
equity capital. And I will describe ongoing attempts globally to backtrack from recent successes
in strengthening equity capital mandates, and my concern that such efforts would prove
counterproductive.
A Brief History of Equity Capital in Banking
Equity capital is the most stable funding source for the banking industry. It is ownership-funded,
and unlike debt it cannot run in crisis. Equity absorbs losses before creditors are affected, and a
bank does not default on its stock if it misses a dividend payment. Thus, equity has long played
a key role in assuring financial and economic stability. However, over time, as bank creditors
have come to experience and now to expect governments to protect them from loss, they rely far
less on a bank’s equity position as a source of confidence. As a result, equity’s relative place on
the industry’s balance sheet has systematically declined.
generations of taxpayer support and ever-expanding government involvement, politicians,
regulators, and lobbyists have supplanted the role of the market in determining what counts as
capital, how it is calculated, and how much is enough. An artificial capital framework has thus
developed, which has resulted in steadily lower levels of capital and declining quality—even
blurring the distinction between debt and equity. Unfortunately, recent experience has shown
that when the marketplace does finally realize it cannot trust such a framework, the
consequences for the banking industry and the global economy can be dire.
Even so, the market remains on the sidelines as regulators and lobbyist renew the conflict over
what constitutes adequate capital. And I would add, the conflict is not really about risk-based
versus leverage ratios, nor about complex versus simple calculations. Fundamentally, the
conflict is about whether more or less equity capital best assures that banking firms are sound
and that economies enjoy strong, sustained growth. Seen in this light, it is apparent why the
demand for bank capital ebbs and flows as crises come and go, and why this conflict intensifies
as economies stabilize.
In my remarks today, I will provide a brief historical perspective on bank equity capital, its long-
term and recent trends, and its effect on economic stability and growth. I will cite research that
shows the banking industry and the economy do better in the long run with more—not less—
equity capital. And I will describe ongoing attempts globally to backtrack from recent successes
in strengthening equity capital mandates, and my concern that such efforts would prove
counterproductive.
A Brief History of Equity Capital in Banking
Equity capital is the most stable funding source for the banking industry. It is ownership-funded,
and unlike debt it cannot run in crisis. Equity absorbs losses before creditors are affected, and a
bank does not default on its stock if it misses a dividend payment. Thus, equity has long played
a key role in assuring financial and economic stability. However, over time, as bank creditors
have come to experience and now to expect governments to protect them from loss, they rely far
less on a bank’s equity position as a source of confidence. As a result, equity’s relative place on
the industry’s balance sheet has systematically declined.