A new study from the International Monetary Fund (IMF) finds that banks can hold too much capital, hampering economic growth.
The IMF’s new study examines the extent to which safer financial structures lead to good economic growth outcomes. It founds that higher capital ratios within banks are associated with better results for the economy. But, beyond a certain point, large capital accumulations may actually start to be a drag on growth.
It also notes that there’s no single financial structure that works best under all circumstances. “What is good for China may not be good for Germany, and what works in Japan may not work in the United States,” it says.
Additionally, it notes that while cross border connections among banks are beneficial most of the time, during a crisis, they may contribute to the spread of instability.
Ultimately, the IMF says that better regulation and more intrusive supervision is needed to adapt to changing circumstances. Its recommends that banks be required to have a sufficient quantity and quality of capital, and adequate liquidity, but that the requirements should not be so high that they inhibit banks’ lending role to help economic growth.
It also calls for effective management and supervision of foreign banks to support healthy financial activity across borders, and suggests that there need to be strong frameworks to deal with failed banks that lend across borders to ensure that financial flows between countries are less volatile.
“Our analysis reinforces the lesson from the crisis that high quality regulation and supervision should be at the forefront of reform efforts,” said Laura Kodres, chief of global stability analysis in the IMF’s Monetary and Capital Markets Department.