Keep it simple

I think that's Thomas Hoenig's mantra.  Hoenig, former head of the KC Fed and now a director of FDIC, thinks we should apply it when trying to set capital standards for banks.  Yes, an international consortium of bankers and others have promulgated another version (Basel III) of a global regulatory standard on bank capital adequacy,stress testing and market liquidity.   

The problem is that, while Basel III tries to improve over Basel II (which was in effect when the Great Recession began), it "does so using highly complex modeling tools that rely on a set of subjective, simplifying assumptions to align a firm’s capital and risk profiles. This promises precision far beyond what can be achieved for a system as complex and varied as that of U.S. banking. It relies on central planners’ determination of risks, which creates its own adverse incentives for banks making asset choices."  The rules are dependent on formulas which few can decipher.

Simple rules will make things more understandable and, hence, enforceable.  Hoenig is advocating that we use the ratio of tangible equity to tangible assets ratio, emphasizing "tangible" (i.e., drop such items as good will, minority interests, deferred taxes, etc.).

Before the world began using sophisticated banking rules, banks relied on the market to establish equity ratios.  In those simpler days, the ratio was in the range of 13 - 16%.  Basel III accepts a ratio of 3.25%, which is much too low in the real world. 

Hoenig has two more suggestions: rely on periodic examinations more than stress tests for the largest banks, restore Glass-Steagall.