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Matt Levine

Capital Rules Get Less Stressful

Also coronavirus hedges, Jefferies bonuses, fund names and little guys from Kentucky.

The first rule of bank capital is that banks need to be solvent. Traditionally banks make a living by borrowing a lot of short-term money (deposits, etc.) and investing it in long-term assets (loans, etc.). If the bank owes depositors $100 and only has $95 worth of assets, that is bad, in a fairly straightforward way. You do not want that to happen.

But the long-term assets can lose value: If you have a bank with $100 of assets and $99 of liabilities, and the assets lose 2% of their value, then the bank becomes insolvent. The way to prevent this is to require that banks have a certain amount of equity capital: You write a rule like “a bank with $100 of assets can only have $92 of liabilities,” requiring the rest of the assets to be funded with equity. Then if the assets lose 8% of their value, the bank will still be solvent; it will still have enough assets ($92) to pay off its depositors.