Higher capital requirements on the U.S. banking industry could have less of an impact on bank lending than has been widely expected, according to a new study from Pew’s Financial Reform Project. The U.S. administration and other regulators abroad have been pushing to increase bank capital as a bigger cushion against loans that go bad or investments that fail. They would like to see requirements increased from the 4 to 8 percent of total assets now. However, banks and businesses have objected that increasing capital now will further restrict lending. The new Pew study, “Quantifying the Effects on Lending of Increased Capital Requirements,” suggests that this may not be the case. If capital requirements rose on average from 6 percent to 10 percent, loan rates on a typical bank loan might rise by only 0.2 percentage points, assuming modest tightening of

loan terms, or by 0.25 percentage points, assuming no changes in the terms, the study found. “This is an important new insight,” said Charles Taylor, director of the Pew Financial Reform Project. “This study shows that the U.S. banking industry could potentially accommodate significantly higher capital requirements with very limited adjustments.” Inadequate capital requirements are widely believed to be a contributing factor to the onset, spread and severity of the recent financial crisis. New international standards for stronger, higher capital requirements for banking firms were among the measures agreed to at the recent Group of 20 Summit in Pittsburgh. “These results suggest that tougher capital requirements can powerfully aid the stability of the system without doing significant damage to lending or the economy,” said Douglas Elliott, a fellow at the Brookings Institution and author of the report. Elliott cited three reasons why this is so. First, banks are highly leveraged institutions. The bulk of the funding for a loan comes from deposits and debt, so that common equity accounts for less than a fifth of the cost of a typical loan. Second, if banks have higher levels of equity, the reduced risk could enable them to obtain both debt and equity from investors at a lower rate. Third, reasonable actions by the banks — such as turning down risky loans or tightening terms on loans — can restore returns on equity to levels that are attractive to investors.