One possible way to make big banks safer — in addition to downsizing them and/or restructuring them to eliminate government’s TBTF subsidy — is by making them fund their loans with more unborrowed money — equity capital. Banks may only have 1% to 3% equity capital relative to the overall assets. Some economists think 20% or 30% might be what’s needed.
Bankers tend to not like this idea at all. They argue holding more equity capital would increase funding costs, lower return on equity, and force them to cut back on lending. Not so, argue Anat Admati and Martin Hellwig in The Bankers’ New Clothes: What’s Wrong With Banking and What to Do About It out later this month. The above table outlines Admati and Hellwig’s responses to typical banker objections.