Why Higher Capital Standards Are Needed

At one level, the pursuit of higher and more robust capital requirements for banks is not going well. The United States Treasury insisted, throughout the yearlong financial reform debate, that capital should be the focus -- increasing the loss-absorbing buffers that banks must carry -- and that it (and other regulators) needed to negotiate this is through the Basel Committee process.

But Basel has come under great pressure from the banking lobby, which argues that any increase in capital requirements would limit lending and slow global growth, an issue discussed by Douglas Elliott in this useful paper. The Institute of International Finance, a lobbying group for big banks, issued an influential argument along these lines, and the European stress-test results strongly suggest that European politicians do not want to press more capital into their financial system -- just enough would be fine with them.

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