Ryan Avent summarizes a new BOE paper at The Economist. As captioned, the paper makes it rather clear that the arguments against increased equity by the TBTF (Too Big to Fail) banks just don’t hold water.
Mr Jenkins concludes by asking the obvious question and providing some possible answers:
If these are in fact myths, why do bankers propagate them? Are they not working for their shareholders? Do they not have a paramount interest in financial stability? Do they not want their respective financial centres to be strong and confidence inspiring? Surely they would never dream of putting their personal interests ahead of those of society and their owners? I let you be the judge. But I can think of a few possible explanations. First, it is conceivable that many bankers simply do not understand the basics. Have you met a single senior banker who understands his cost of capital? I have not – though I should probably get out more. Second, many do not understand fully the notion of risk-adjusted returns – witness their recent quest gone wrong of chasing returns without adequate understanding of risk. Third, many managements remain transfixed by the notion of RoE as the primary measure of profitability. They have promised it to their boards and to their shareholders. The targets were written into their remuneration plans. Results fed their bonuses. And there is no doubt about it, all else being equal, higher equity reduces the measure of short term RoE. Never mind that it is the wrong measure and therefore the wrong target. Finally, it is possible that some bankers and boards actually wish they had more capital – but dare not admit it without putting their jobs at risk. This is partly because many have insisted throughout that they were “well capitalized” and partly because they demonstrably failed to tap the market for equity each time it could have been had more cheaply.