In taking up issues of bank capital requirements and the [Modigliani & Miller] M&M Propositions, I am actually returning to a subject treated in a paper on the regulation of bank holding companies that Fischer Black, Richard Posner and I wrote back in 1978. We start there with the proposition that if the government is indeed insuring bankd eposits either explicitly, or implicitly via the too-big-to-fail doctrine, then it effectively stands as a creditor visa vis the bank’s owners; and its regulations, to be socially efficient, should resemble the measures adopted by freely-contracting private lenders in similar circumstances. And, at least in a broad-brush way, they really do. Both, for example, maintain surveillance against changes in the debtor’s business activities that might jeopardize the safety of the loan; both impose equity capital requirements; and both monitor any dividend diversions to the shareholders that might pull the capital ratio below the agreed-upon levels. So close is the mimicry in fact, that I can’t help smiling at complaints from bankers about their capital requirements, knowing that they have always imposed even stronger requirements on people in debt to them.
Journal of Banking & Finance, vol. 19, pp. 483-489