Capital in banking : an analysis of the role of capital in British and Swiss banking, 1830-1990

Abstract

Capital in banking is a central pillar of financial regulation. In the wake of the last financial crisis, the low levels of capital have become a widely discussed topic. Historically, most of the decline of capital/assets ratios occurred already before the end of the First World War. The capital/assets ratio fell rapidly again during the Second World War, followed by a much slower decrease during the second half of the 20th century. Focusing on the United Kingdom and Switzerland, the thesis critically assesses the evolution of capital ratios and the validity of the numbers used by the existing literature for the period from 1830 to 1990. It shows that undisclosed (hidden) reserves, shareholders’ liability, and hybrid forms of capital (e.g. subordinated debt) must be considered when assessing capital adequacy. All three factors substantially alter published capital/assets ratios. Based on archival material from regulators, supervisors, and banks, the thesis sheds light on three vital drivers of capital/assets ratios in the long run: ideas, wars, and regulation. I argue that the capital policies of banks in the 19th century were guided by informal conventions: The managers of the first joint-stock banks already had well-established ideas about the role of capital and its relationship with risk. These ideas on capital adequacy and how to manage banks and their risks became more nuanced over time. The two World Wars, however, fundamentally changed the perception of capital ratios in banking. Rapidly increasing government debt, of which banks held a substantial part, coupled with inflation and the absence of capital issuances during the wars, led to a sharp decline in capital/assets ratios. Finally, I assess how bank capital was regulated over time, showing that banks were highly involved in the evolution of capital regulation, both in the United Kingdom and Switzerland, and therefore shaped their regulatory environments.