Recapitalization Through Profits

When your banking sector is undercapitalized, there are two things regulators can do. One is to force the banks to raise additional capital, diluting the value of existing shareholders’ existing shares. If necessary, the funds can be put up by the government. Some may call it a “bailout” but the banks’ owners will lose money and the taxpayers will earn a profit if the bank benefits. The other options is to just gives the banks a thumbs up and let them recapitalize themselves through profits.


As it turns out, the US banking sector is about $60 billion short of capital relative to the new Basel III standards. Guess which path regulators are picking to bring banks into compliance?

Fed officials said that most banks should be able to reach the new levels by retaining earnings during the next few years rather than by raising capital in the market.

The Fed’s proposals, which will be phased in from next year, are part of a larger package implementing the Basel III accords in the US. Banking regulators want lenders to hold more high-quality capital, and they are taking a more stringent approach when judging the relative riskiness of banks’ assets.

All fine if it works out, but what if something goes wrong during “the next few years” while we’re in transition? Why not simply insist that the banks get the capital they need as quickly as possible, even if that means diluting shareholders?