The Future of Regulatory Capital: General Principles and Specific Proposals

There is a risk of an increasing disconnect between regulatory capital and what banks and other financial institutions do. The last few decades have brought tremendous changes in the nature of financial firms, their activities, and their approaches to risk management. In such an environment, past regulatory achievements provide no guarantee of future success. This paper argues for increased reliance on informed supervision of compliance with sound practices. Mechanical formulas may play a role in regulation, but they are in general incapable of providing a solution to the question of how much capital a bank should have. The paper concludes by applying these general principles to examine a series of specific new approaches to regulatory capital that are currently being discussed.