With 'The Bankers' New Clothes,' Can Banks Be Too Safe?

The Bankers’ New Clothes, published on Feb. 24, is wowing critics of fragile banks with a simple and attractive message: Force banks to have much thicker cushions of capital and you can make them safer without paying any cost in terms of higher interest rates, less lending, or lower economic growth. At a Feb. 11 prepublication event with authors Anat Admati and Martin Hellwig at the Peterson Institute for International Economics, senior fellow Morris Goldstein called the book “the most important contribution to the analysis of banking regulation in the past 25 years … beautifully written and forcefully argued.”

The thicker a bank’s buffer of capital is—that is, the less it relies on borrowing to fund its operations—the lower the chance it will require a taxpayer bailout. Also, the easier it will be for the bank to keep lending and sustaining growth in a financial crisis. The extra margin of safety provided by more capital is a free lunch, argue Admati, a professor of economics and finance at Stanford business school, and Hellwig, an economist and director of the Max Planck Institute for Research on Collective Goods in Bonn, Germany. Says Admati in an interview: “What we are told—that you have to choose between growth and safety of banks—is just a false trade-off.”