Why Bank Separation Must Complement the Leverage Ratio
The authors’ empirical evidence is used to show that there is no reasonable capital rule that can protect the financial system in the face of events like 2007–2008: large interconnected banks would need 4 times the amount of capital to avoid default without government aid. They argue that separating deposit-guaranteed banks from investment banking, while maintaining a leverage ratio, is the policy mix supported by empirical evidence. They suggest the best threshold for separation should be derivatives exposure (with no netting) at or above 10%. They compare their own legal separation proposal to the Volcker rule, the UK Vickers rule and to those European proposals that were quietly dropped to please banks. They rebut 5 criticisms of separation proposals and review the 2017 Mnuchin Treasury modification of the Volcker Rule.
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