FRB-Minneapolis President Kashkari today released his TBTF cure, doing so in concert with an election that has reopened key provisions of the Dodd-Frank Act to critics who, like him, believe TBTF remains at least as much of a problem as it did in 2008. Mr. Kashkari’s plan relies in good part on a new capital requirement for large banks that would set their risk-based capital (measured only by CET1) at 23.5 percent along with a leverage ratio of 15 percent; these would rise far higher if Treasury deemed the bank still TBTF. This capital requirement is premised on a model that tells Mr. Kashkari that financial crises are correlated with bank regulatory capital. A good deal of data is presented in his plan to substantiate this point, but our read leads us to conclude that more capital may well reduce the probability of a crisis as he measures it, but only because he starts with the assumption that crisis risk is strongly correlated with bank capital. If financial crises are caused by factors with no clear link to bank regulatory capital – arguably true prior to 2008 in the U.S. and increasingly likely given financial-structure changes – then all this capital would not in fact reduce crisis probability.
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