At RealClearMarkets finance prof Sanjai Bhagat, noting that despite Dodd-Frank many large banks are still simultaneously vulnerable and too big to be allowed to fail, advises:
Our bank capital proposal has two components. First, bank capital should be calibrated to the ratio of tangible common equity to total assets (i.e., to total assets independent of risk) not the risk-weighted capital approach that is at the core of Basel. Second, bank capital should be at least 20% of total assets. Also, total assets should include both on-balance sheet and off-balance sheet items; this would mitigate concerns regarding business lending spilling over to the shadow banking sector.
Greater equity financing of banks coupled with the aforementioned compensation structure for bank managers and directors will drastically diminish the likelihood of a bank falling into financial distress; this will effectively address the too-big-to-fail problem. Our market-based solution (greater bank equity, and reforming bank executive and director incentive compensation) will accomplish Dodd-Frank’s worthy objectives without the need for much of the pursuant regulations. Our bank capital reform is also consistent with the essence of the CHOICE Act regarding bank equity capital.
Back in the early days of the financial crisis, I suggested that our problem was that everyone was pursuing the incentives they had. As long as you keep the incentives in place, you’ve changed nothing. All of the same incentives are still in place.
Total vs risk adjusted assets sounds like a meat ax approach. 20% sounds like it came from a random number generator. And including off balance sheet items falls under the heading “duh.”
Your final paragraph still encapsulates it all. And until bank capital providers run the risk of losing it all they won’t police their boards and senior managers.