Alan Greenspan, the former chairman of the U.S. Federal Reserve, who argued in a July 27 article in the Financial Times that compelling banks to use more equity funding is misconceived, was criticized by a group of prominent economists in today’s issue of the newspaper.
In a letter signed by, among others, Anat Admati of Stanford University, Charles Goodhart of the London School of Economics and David Miles of Imperial College London, it’s argued that tougher capital requirements don’t constrain how banks invest their funds but merely require them to use less debt and more equity funding for investments.
Changing the funding mix “imposes few, if any, costs on the economy,” while offering better incentives to manage risk and fewer refinancing difficulties because of overhanging debt, the economists said.
In the 19th century, banks funded their assets with as much as 40 percent equity, and today banks often require borrowers to contribute equity of more than 25 percent, according to the letter.
The signatories conclude that “low equity requirements and manipulable risk-weighting systems,” rather than excessive equity, permit systemic risk to develop.
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