Back to Basics: A Better Alternative to Basel Capital Rules | Thomas M. Hoenig

FDIC Director Thomas Hoenig calls for a simple capital ratio of Tangible Equity/Tangible Assets instead of the complex measures proposed by Basel III. Using Tier 1 capital measured according to Basel III standards overstates tangible equity capital by about 40 percent and using risk-weighted assets makes capital adequacy ratios even more subjective.

Prior to the founding of the Federal Reserve System in 1913 and the Federal Deposit Insurance Corporation in 1933, bank equity levels were primarily market driven. In this period the U.S. banking industry’s ratio of tangible equity to assets ranged between 13 and 16 percent, regardless of bank size……..

[Basel capital standards] led to a systematic decline in bank capital levels. Between 1999 and 2007, for example, the industry’s tangible equity to tangible asset ratio declined from 5.2 percent to 3.8 percent, and for the 10 largest banking firms it was only 2.8 percent in 2007. More incredible still is the fact that these 10 largest firms’ total risk-based capital ratio remained relatively high at around 11 percent, achieved by shrinking assets using ever more favorable risk weights to adjust the regulatory balance sheet.

via FDIC: Speeches & Testimony – 9/14/2012.

Hat tip to Barry Ritholz.