One capital ratio tops others in foreshadowing distress—and it’s not the one that’s traditionally been regulated.
In response to the global banking crisis, regulators and policy makers worldwide have united behind efforts to increase financial institutions’ minimum capital requirements and to limit leverage, hoping to reduce the likelihood of future bank distress.1 As of this writing, the debate over proper capital requirements continues, with major implications for the industry and the economy—yet there have been few specifics on which ratios should be targeted or at what levels.
To shed some light on the discussions, we analyzed the global banking crisis of 2007 through 20092 to identify relationships that different types of capital and capital ratios have to bank distress.
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