Goldman Sachs: Equity Versus Leverage

Researchers are looking into ways that banks can be regulated in a more positive and socially beneficial manner.  The article below states that equity requirements can keep the financial system healthy.  If equity is used with flexibility it can become a tool to avoid financial crises.  Regulators can ban dividends for equity holders during a crisis;  when banks are able to pay dividends then they should be able to lend.

Control of payouts and equity issued mandates can maintain stability and health in the financial system.  The more leverage in a bank the worse the risk.  Leverage should not be subsidized but equity should be encouraged.  The topic discussed below is equity versus debt in regulating the financial system.

Why Bank Equity Is Not Expensive
By Bill Snyder - Stanford

(This paper has sparked discussion. View other material related to this topic)

Since the 2008 market crash, banking interests and economists have clashed over how much of their operations banks should fund with equity as opposed to debt. Bankers and others often say that, "equity is expensive." By contrast, a recent paper, coauthored by three faculty of the Stanford Graduate School of Business, argues that this conventional wisdom is incorrect, and that, "Quite simply, bank equity is not expensive from a social perspective, and high leverage is not required in order for banks to perform all their socially valuable functions." 

STANFORD GRADUATE SCHOOL OF BUSINESS—When the financial markets crashed two years ago, Americans discovered that all too many banks and financial institutions became distressed because of their high degree of leverage. Since then, regulators, economists, and the banking industry have jousted over the question of how much equity capital banks should hold.

The prevailing argument by the industry and its allies is that raising equity requirements will weaken banks and raise the cost of borrowing for everyone because "equity is expensive." But is that really the case?

In a new, and likely to be controversial, research paper, Anat Admati, of the Stanford Graduate School of Business, and her colleagues argue that this is not the case. "Quite simply, bank equity is not expensive from a social perspective, and high leverage is not required in order for banks to perform all their socially valuable functions, including lending, taking deposits, and issuing money-like securities," they wrote.

What's more, the researchers argue, raising capital requirements would produce widespread social benefits as well: "Our analysis leads us to conclude that, starting from current capital requirements, the social benefits associated with significantly increased equity requirements are large, while the social costs, if any, are small."

Read the entire piece here 
See the videos with Anat Admati here