How Would You Know If A Bank Has Enough Capital?

In its discussion of bank capital adequacy, the American Banker raised the questions that can only be answered by banks disclosing current asset-level data to all market participants:

• How much is enough capital; and

• By what measure.

If current asset-level data was disclosed, credit and equity market analysts and competitors could independently

• Determine if a financial institution is solvent [where solvency is a measured by asking if the market value of the financial institution's assets exceeds its liabilities] and therefore has enough capital;

• Adjust the price charged for funds, both debt and equity, so that it is related to the risk of the financial institution.  

If market participants do not know what is currently on the balance sheet of a financial institution they cannot assess its solvency and capital adequacy so long as it uses leverage.

The definitive observation confirming this statement is on page 373 in the Financial Crisis Inquiry Commission report during its discussion of why the credit markets froze up [emphasis added]

The key concern for markets and regulators was that they weren’t sure they understood the extent of toxic assets on the balance sheets of financial institutions—so they couldn’t be sure which banks were really solvent.

As shown in the American Banker article, bankers prefer arguing that they are more than adequately capitalized rather than providing the current asset-level data needed to confirm the fact.  [emphasis added]

An awful lot of capital. Capital on top of capital. 

These were just some of the phrases used last month by Jamie Dimon, the chairman and chief executive of JPMorgan Chase & Co., in describing the company's cushion for absorbing future losses. 

Citigroup Inc. executives sounded equally confident, telling investors on a recent conference call that the company is "one of the best capitalized large banks in the world." 

There is little question that banks are in a better position than they were just a few short years ago. 

But is more capital, or even an awful lot of capital, enough capital? And if so, what basis of measurement would one use to prove it?

The basis of measurement to prove that more capital or even an awful lot of capital is enough capital would be if the banks disclosed their current asset-level data.  Then the market could decide.  Absent disclosure of current asset-level data, there is no way to prove it.