Financial Update (July-September 1998)

Masthead

Cover Story

Choice of Capital Instruments

New Look for Financial Update

Check Growth

Bank Consolidation and Lending

Technology in Banking

DEPARTMENTS

Year 2000

Did You Know?

Data Bank

The Docket

Regulations Limit Banks' Choice
of Capital Instruments

N ow that mergers of very large banking organizations are commonplace, it's become more important than ever that bank regulations protect taxpayers and the financial system from the risk of bank failures without imposing unnecessary costs on banks.

An article in the Atlanta Fed's Economic Review (Second Quarter 1998) focuses on whether existing capital regulations, one of the primary regulatory tools of bank supervisors, are imposing unnecessary costs on banks. Authors Larry D. Wall and Pamela P. Peterson question, in particular, whether the capital requirements may be causing banks to issue equity when it would be less costly for them to issue subordinated debt.

A number of studies have indicated, they note, that "maintaining higher equity capital levels at the cost of reduced debt levels is costly — for example, in reducing the tax shield associated with corporate interest payments."


The analysis of the regulatory implications of allowing banks to substitute debt for equity in the capital structure suggests that properly structured debt is as good as, or better than, equity in addressing most regulatory concerns.

To obtain evidence on the costs generated by equity issues, Wall and Peterson examine the type of capital U.S. banks issued in response to the capital guidelines of the 1980s, which included a type of debt in capital. Their model takes into account regulatory and market factors that, at least in theory, influence banks' decisions about issuing capital.

Their results, like those of previous studies, suggest that allowing banks to issue debt rather than equity could reduce their costs of complying with the capital standards. But, they note, not all banks would benefit equally from expanding the definition of capital; large banks and banks with low market values would benefit the most.

"The analysis of the regulatory implications of allowing banks to substitute debt for equity in the capital structure suggests that properly structured debt is as good as, or better than, equity in addressing most regulatory concerns," including concerns about bank failures, Wall and Peterson conclude.