MNI INTERVIEW: U.S. Urged to Require Banks To Recapitalize

The authors of a widely circulated study that found an additional 186 U.S. banks at risk of meeting the same fate as that of Silicon Valley Bank are urging regulators to require banks to promptly raise hundreds of billions of dollars in equity capital to soothe solvency concerns.

Erica Jiang of the University of Southern California and Tomasz Piskorski of Columbia University, along with researchers at Stanford University and Northwestern University, have presented a proposal to Treasury, FDIC and OCC officials that would restrict equity payouts indefinitely, require an increase in equity in order to access government lending facilities, and tie all additional support and regulatory forbearance to an increase in capital requirements for the most affected banks.

They estimate that an infusion of private capital in the range of USD190 billion to USD400 billion is needed to get banks to between a 0% and 5% liabilities coverage ratio.

"The U.S. banking system is certainly not safe. There's a lot of inherent hidden fragility," Piskorski said in an interview. "This is a market-based proposal. We're suggesting that regulators sit down with banks and say, look, we need you to raise capital. This is maybe a better time to do it now than doing it in an abrupt manner. It will, in some ways, restore the calm in the short run."

WIPED OUT

Dramatically higher interest rates have slashed the market value of assets in the U.S. banking system by about USD2.2 trillion, or an average of 10% across all banks, the researchers found. That's several times higher than the FDIC's estimate as they take into account the market value of assets labeled as held-to-maturity securities.

Should spooked investors again withdraw their deposits in a hurry, nearly half of U.S. banks could be in trouble because the market value of their assets are less than the face value of their liabilities, Piskorski said.

"The banks are very thinly capitalized -- typically 10% equity financed and 90% debt financed. So using this crude metric, it looked like almost all the capitalization of banks were wiped out," Piskorski said.

That reduced equity position can trigger a credit crunch in the near term, while the moral hazard of backstopping uninsured deposits could lead to imprudent lending as in the 1980s savings-and-loan crisis over the long run, the researchers said.

RAISE CAPITAL REQUIREMENTS

Nonbank lenders such as Quicken Loans generally have twice as much capital buffer as traditional banks, "which tells you when the private market operates without insurance and subsidies, they actually force lending institutions to be much safer and more capitalized. That could potentially guide what should be the increase in capital regulation for regional banks," Piskorski said.

"If the regional banks were as well capitalized as nonbanks, we wouldn't be having this conversation, because they will have capitalization rates of more than 20% of assets, which will give them enough cash to sustain an average decline of 10% to 15% of asset value."

The USD190 billion minimum estimate needed to improve banks' capital positions is not a large number relative to the available supply of risk capital, the researchers noted, and is much smaller than the roughly USD2 trillion hit to investors should the FDIC be forced to seize those troubled banks and sell off their assets.