Higher Capital Ratios: It’s the Market, Stupid

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JPMorgan Chase Chairman Jamie Dimon.

Since the financial crisis, the U.S. banking system has made material steps to increase the quality and quantity of capital which it uses to fund its business. As a result, the financial system is much sounder because banks have far more tangible common equity to absorb any losses.

All the same, many banks and commentators have argued that more capital is a bad thing that raises a bank’s cost of capital. As a result, they blame regulators for making life more difficult for banks. In turn, anemic lending is blamed on regulators. The problem with this argument is that banks are already meeting targets that aren’t required of them until 2019. Clearly,there’s something else at play.

In my view, it’s the market, not regulators, that has forced the largest banks to increase capital ratios years ahead of regulatory deadlines, shoring up their balance sheets.

After all, a key marketing message of JPMorgan CEO Jamie Dimon during the past few years has been his bank’s “fortress” balance sheet. Investors have been happy to hear the news that banks are actively making themselves more secure and sound.

If banks are indeed responding to market pressures to make their balance sheets more secure, complaints that regulators are stifling loan growth with these new rules appears unwarranted. Regulators may be taking the blame for something that investors are demanding.

For that matter, investors are right to want banks to increase capital ratios. Risks to the financial system remain high, and U.S. banks are exposed to the Eurozone crisis. For instance, at the end of March, JPMorgan had a total sovereign and non-sovereign credit exposure of $12.5 billion to the crisis countries (Spain, Italy, Greece, Ireland and Portugal), or 9.7 percent of tangible common equity.

I’m pleased that tangible equity now represents 10.2 percent of risk-weighted assets, more than the 6.3 percent that JPMorgan had when Lehman Brothers failed.

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