Fifteen Eighty Four

Banks rely on two main sources to fund their lending and investment activities: debt and equity capital. Over the past two centuries, banks have increasingly operated with less equity capital, yet maintaining sufficient capital remains essential for financial stability. The new book Capital in Banking explores a fundamental question: why are modern banks more leveraged than those in the 19th century?

Bank capital is one of the most regulated aspects of the financial system. Nearly every country imposes minimum capital requirements. Despite ongoing debates among regulators, policymakers, and economists about capital adequacy, surprisingly little research has taken a long-term historical perspective. Capital in Banking fills this gap, offering one of the first in-depth historical assessments of how capital regulation has evolved over time.

Tracing the Evolution of Bank Capital: 19th Century to Today

The book examines the role of capital in the banking systems of the United States, the United Kingdom, and Switzerland from the 19th century to the present. Given the broad historical scope, it focuses on key moments that shaped capital regulation. In the 19th century, capital adequacy was often determined by rules of thumb. By the 1940s, extensive war-related financing led to the development of the risk-weighted assets approach, a concept that remains central to banking regulation today. The financial crises of the 1930s and 1970s prompted the introduction of new capital regulations, eventually leading to the first Basel Accord in 1988, which aimed to standardize global banking regulations. The Great Financial Crisis of 2007-2008 then triggered a renewed emphasis on unweighted capital ratios, as regulators sought to address the weaknesses of existing frameworks.

Beyond these regulatory shifts, the book presents new historical data on undisclosed reserves, shareholder liability, and hybrid forms of capital such as subordinated debt—elements that have played a significant yet often overlooked role in banking stability.

Why Capital Matters: The Two Key Functions

While banking systems have changed dramatically over the past two centuries, the fundamental role of equity capital has remained the same. It serves two key functions. First, it absorbs unexpected losses, theoretically reducing the risk of insolvency and helping banks survive financial shocks. Second, it reassures customers and investors, fostering trust and lowering the likelihood of bank runs. However, capital is not the only means of ensuring confidence in the banking system. Government guarantees, deposit insurance, strict regulation, and cautious bank management have also played a crucial role in maintaining stability. What has changed over time is not the purpose of bank capital but the way these functions are configured and balanced within different banking systems.

The rich history of banking in the United States, the United Kingdom, and Switzerland offers numerous examples, from stable banks with low capital levels to unstable banks with high capital, suggesting that there is no single formula for banking stability.

A Fresh Perspective on an Ongoing Debate

One of the book’s key insights is that capital regulation has often been shaped by past experiences rather than forward-looking considerations. Instead of fundamentally rethinking banking stability, regulators have frequently relied on existing frameworks, modifying them to address weaknesses revealed by past crises. This has led to an increasingly complex regulatory landscape.

As debates over financial regulation continue, Capital in Banking offers a fresh perspective by placing discussions on capital adequacy within a broader historical context. The book raises important questions about whether current capital regulations are truly making banks safer, whether the complexity of modern banking rules is justified, and whether past financial crises provide the right lessons for future stability.