Enforcement of Risk‐Based Capital Rules

Abstract

AbstractThis chapter examines the role of enforcement for capital adequacy regulation in US banking and securities markets. Very little is known about how enforcement works: What broken rules are being enforced? By whom? How serious are the violations? How effective is enforcement, which presumably should discourage others from breaking important capital rules? The data are from enforcement actions over the last 6 to 10 years by US regulators, who are unique in publishing them. Even though the capital adequacy rules differ for banks and securities firms, the approaches to enforcing them overlap enough to allow rough comparison. This chapter finds a very low number of formal enforcement actions. Most target the small firms or individuals, not the big firms. Formal actions are particularly rare against the largest banks and securities firms, those that pose the greatest threat to the financial system. All but one of the capital adequacy violations resulted from fraud, theft, or other forms of operational risk. Only one resulted from credit risk. The chapter examines possible explanations of the findings, such as the relatively strong economy during much of the period and the possibility that very effective supervision catches almost all firms before their capital falls too low. Evidence from case studies of failed banks suggests that supervisors need to do a better job relating a bank's apparently adequate capital to its risk exposure, and to force banks to implement proposals regulators make to remedy deficiencies. Perhaps the very limited enforcement against large firms reflects a regulatory bias in their favor rather than their underlying strength and adequate capital.