Read The Planet Money Article Ask A Banker Capital

Read The Planet Money Article Ask A Banker Capital Capital By Mat

Read the Planet Money article "Ask a Banker: Capital, Capital!" by Matt Levine and answer the following questions. 1. List all the things that a bank can do to change the amount of shareholder capital on its balance sheet. 2. Explain the "psychologico-regulatory" advantage of capital compared to debt, in terms of freaking out. Consider the statement "more capital makes banks safer." 3. Why does the author say that the statement is somewhat "nonsensical?" 4. Why does the author say that he is "lying" when he says that the statement is "nonsensical?" The previously proposed Brown-Vitter bill attempted to solve the Too-Big-To-Fail problem with a much lower leverage limit. How does this affect banks? Assume banks must maintain at least 10% of total assets in shareholder capital. A bank with $100 million in total assets has just enough shareholder capital to meet the 10% requirement and then the bank has a loss of $5 million. 5. What is the amount of shareholder capital after the loss? 6. What is the amount of total assets after the loss? 7. After the loss, if the bank chose meet the 10% capital requirement by increasing shareholder capital through selling additional shares, what dollar amount would it have to sell to get back to the 10% of total assets in shareholder capital? 8. If the bank chose meet the 10% capital requirement by selling assets, what dollar amount would it have to sell to get back to the 10% of total assets in shareholder capital? Consider the statement "more capital makes risks clearer." 9. Explain the advantage of clearer risks. 10. Explain the disadvantage of clearer risks.

Paper For Above instruction

The article "Ask a Banker: Capital, Capital!" by Matt Levine offers a nuanced exploration of how banks can adjust their capital structures, the perceptions surrounding capital adequacy, and the implications of regulatory policies such as the Brown-Vitter bill. This analysis aims to address twelve specific questions related to banking capitalization, risk understanding, and regulatory impacts, providing a comprehensive understanding of financial safety mechanisms within banking institutions.

1. Methods for Banks to Adjust Shareholder Capital

Banks can modify their shareholder capital through several strategic actions. First, they can issue new equity shares, thereby directly increasing the amount of shareholder capital on their balance sheet. This process involves selling additional shares to investors, which raises cash and, consequently, shareholder equity. Second, banks can retain earnings rather than distributing dividends, thereby automatically increasing shareholder capital over time as profits accumulate. Third, banks can buy back their shares, which decreases shareholder equity; thus, to increase capital, they would avoid share repurchases or actively issue new shares. Additionally, banks can convert other forms of capital, such as hybrid securities, into common equity if permissible under regulatory guidelines. These maneuvers directly influence the size of shareholder capital, which forms a bedrock of the bank's financial stability and regulatory capital ratios.

2. The "Psychologico-Regulatory" Advantage of Capital

The term "psychologico-regulatory" highlights how high levels of regulatory capital can provide a psychological comfort to both regulators and market participants, in contrast to debt. Capital, being a buffer that absorbs losses without defaulting, reassures stakeholders that the bank can withstand financial shocks. When a bank has ample capital, there is less need to rely on external creditors, reducing the risk of a panic or bank run precipitated by fears of insolvency. In terms of "freaking out," or panic, higher capital levels lessen the likelihood of damaging market reactions since the bank's financial health appears more robust. This psychological comfort means regulators and investors are less alarmed by potential failures and are less inclined to impose draconian measures, thus stabilizing the bank's presence in the financial system.

3. Why the Statement "More Capital Makes Banks Safer" Is "Nonsensical"

Levine argues that saying "more capital makes banks safer" is somewhat "nonsensical" because safety is not solely determined by a simple increase in capital. Instead, safety depends on how banks manage risk, the nature of their assets, and their operational frameworks. Merely increasing capital does not eliminate risk; it merely buffers against losses. A bank can hold high levels of capital but still engage in risky behaviors that could jeopardize safety. Conversely, a bank with less capital but conservative risk management could be safer in practice. Therefore, the statement oversimplifies complex risk dynamics, reducing safety to a superficial metric of capital quantities rather than actual risk mitigation.

4. Levine's Use of "Lying" About the Safety Statement

Levine humorously suggests that he is "lying" when he states that "more capital makes banks safer" because, in a strict sense, more capital alone does not guarantee safety. While higher capital reduces the probability of insolvency, it does not address the root causes of risk and operational failures. Such a candid admission underscores that safety is a multifaceted concept, involving risk management practices, business models, market conditions, and regulatory oversight. The "lie" is a rhetorical device to highlight the misleading simplicity of equating more capital with absolute safety.

5-8. Analysis of a $100 Million Bank Experiencing a $5 Million Loss

5. Shareholder Capital After Loss

Initially, the bank has a total of $100 million in assets and at least 10% shareholder capital, which amounts to $10 million. After a $5 million loss, the bank's equity reduces by that amount, resulting in shareholder capital of $5 million, assuming no new capital is raised or additional shares are issued.

6. Total Assets After Loss

The total assets decrease by the amount of loss if the loss is recognized as a reduction in asset value, leading to total assets of $95 million, given the original total assets of $100 million. This assumes no asset sales or new capital infusion occurs at this stage; the loss directly reduces both assets and equity proportionally.

7. Increasing Capital Through Share Sale

If the bank chooses to restore the 10% capital requirement by issuing new shares after experiencing a $5 million loss, it must determine how much shareholder equity needs to be added. Since total assets after the loss are $95 million and the bank needs $9.5 million of capital, but currently has only $5 million, it must raise an additional $4.5 million. Selling shares worth $4.5 million at an appropriate valuation will accomplish this, restoring the capital to 10% of assets.

8. Increasing Capital Through Asset Sales

Alternatively, if the bank seeks to maintain the same amount of shareholder capital and adjust its total assets to restore the 10% ratio, it needs to sell assets worth enough to decrease total assets so that shareholder capital remains at 10%. Selling $5 million worth of assets reduces total assets from $100 million to $95 million, aligning with the remaining shareholder capital of $5 million. This action elevates the capital ratio to 10%, assuming no change in shareholder equity.

9. Advantages of Clearer Risks

Making risks more transparent—i.e., "clearer risks"—allows both regulators and investors to better assess the safety and stability of banks. Transparency enhances market discipline, as stakeholders can identify potential vulnerabilities before they materialize into crises. It also improves risk management practices within banks, prompting them to allocate resources more prudently and avoid hidden dangers that could threaten their solvency. Furthermore, clear risk signals help regulators craft more effective policies, reducing the likelihood of catastrophic failures, and fostering a more resilient banking system.

10. Disadvantages of Clearer Risks

Conversely, increased transparency can lead to heightened anxiety among market participants and trigger panic during periods of instability, especially if risks are perceived to be systemic or unmanageable. Excessive focus on risk signals might cause banks to become overly conservative, restricting credit availability or leading to asset fire sales that can depress prices and destabilize markets further. Additionally, revealing detailed risk information could give competitors strategic advantages or expose sensitive operational data, potentially impairing a bank's competitive position. Therefore, transparency must be balanced carefully to prevent unintended negative consequences, including market volatility and strategic disadvantages.

References

• Basel Committee on Banking Supervision. (2011). Basel III: A global regulatory framework for more resilient banks and banking systems. Bank for International Settlements.
• Levine, M. (2014). Ask a Banker: Capital, Capital! Planet Money. NPR. https://www.npr.org/sections/money/
• Adrian, T., & Shin, H. S. (2010). The changing nature of financial intermediation and the financial crisis. In R. G. Hubbard (Ed.), Financial Markets and Financial Crises (pp. 1-34). University of Chicago Press.
• Brunnermeier, M. K., & Oetinger, N. (2014). How.