Do the M&M Propositions Apply to Banks?

Do the M&M Propositions Apply to Banks?

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.

Merton H. Miller

Journal of Banking & Finance, vol. 19, pp. 483-489

June 1995

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By |2018-01-01T00:00:00-08:00January 1st, 2018|Financial Regulation, Political Economy, Reference, Reforms|