Appropriate Capital Ratio in Major Swedish Banks – An Economic Analysis

Abstract

Extensive work is now in progress around the world to create a more stable financial system. An important part of this work is to tighten the requirements on the banks’ capital adequacy. There is abundant research on optimal capital levels from the micro perspective, but few studies try to estimate an appropriate capital ratio from a societal perspective. This report seeks to fill this gap by using several different approaches to calculate the socially appropriate capital ratio for Swedish banks. The approach is based on weighing the benefits of higher capital ratios against the costs. The calculations of costs and benefits are based on methods and models from the relevant literature that have been adjusted to Swedish conditions as far as possible.

However, estimating appropriate capital ratios is very complex and requires a number of assumptions regarding the advantages and disadvantages of higher capital ratios. Rather than resulting in a single figure, the calculations indicate that the socially-appropriate capital ratio for the Swedish banks is somewhere in the interval of 10 to 17 per cent of risk-weighted assets. One conclusion is that the higher capital adequacy requirements of the international Basel III Accord appear too low for the Swedish banks. According to Basel III, the lowest permitted capital ratio is seven per cent of risk-weighted assets. This is much lower than the 10 to 17 per cent concluded from the calculations in this report.

Keywords: capital adequacy, banking crises, banking regulation, Basel III

JEL Classification: G01, G21, G28, G32, E22