From The Financial Times (h/t Yves Smith) :
The average non-financial listed company in the US funds itself with 70 per cent equity. Many successful businesses, including Apple, Gap and Yahoo, are essentially 100 per cent equity financed. Given their intermediation function, banks cannot be funded entirely with equity. But there is no compelling reason for them to rely on it so little. Our financial system would work better if banks funded 15 per cent or even 30 per cent of their assets with equity. The Basel III reforms agreed last year set minimum bank equity between 4.5 per cent and 7 per cent of “risk-weighted assets”, which are significantly smaller than total assets for most banks. Triple A-rated assets require little or no equity capital. The system of risk weights established by Basel II, which distorts banks’ investments towards favourably treated assets, was mostly maintained. Under Basel III, the ratio of equity to total assets can be as low as 3 per cent. These equity requirements are dangerously low. Significantly increasing banks’ equity funding would provide many benefits to the economy, at little social cost ... The US should strive to lead the world in setting prudent standards for banks. The easiest and quickest path to better capitalisation is to require that banks temporarily withhold equity payouts. Even taking Basel III as the benchmark requirements, delaying adherence by allowing dividends now makes no sense. The tax advantage of debt is one reason banks choose high leverage ... The corrupting subsidies associated with “too big to fail” guarantees are best handled by high equity requirements, which force banks to face the full consequences of their decisions. Alternatives such as bail-in procedures, which involve regulators converting debt to equity ahead of taxpayers’ support, are unlikely to work as well. Regulators are required by this mechanism first to determine exactly when large banks, with illiquid assets around the world and complex structures on and off balance sheets, would be insolvent without debt conversion. Then they must be politically able to pull triggers, telling some creditors that their debt is converted to equity. Ahead of such a situation, market participants, including governments, are likely to exert pressure on regulators. Equity requirements are simpler and more reliable.
(Link to Complete Article Here)
(Image: COTO Report)