Banking Regulatory Frameworks, between the 1973 collapse of Bretton Woods and the introduction of the Basel Accords in 1988?

Question

Does anyone know of any work on banking system behaviour, and in particular the governing regulatory frameworks that applied between the 1973 collapse of the gold standard based Bretton Woods system and the introduction of the Basel Accords and capital regulation beginning in 1988?

Answer 1

I found two of two papers discussing this period, the second at length.

Throughout the 1970s, the capital position of many banking institutions declined significantly. To address this decline, in December 1981, the bank regulators issued explicit minimum capital standards for banks and bank holding companies. These standards required banks to hold capital at least equal in amount to a fixed percentage of their assets. While these standards have been given credit for increasing bank capital ratios, the 1980s saw an increase in both the number and cost of bank failures. A weakness of the minimum capital standards is that they failed to take into account the risk in a bank's portfolio of assets; high-risk assets required the same amount of capital as low-risk assets.

Risk-based capital, portfolio risk, and bank capital: A simultaneous equations approach by K Jacques and P Nigro (1997)

In 1972 the Fed capital standard was revised again. Asset risk was separated into “credit risk” and “market risk” components. In addition, banks were required to maintain a higher capital ratio to meet the test of capital sufficiency. Further, the Fed reintroduced both the capital to total asset and capital to total deposit ratios. This time, however, the former ratio was based on total assets less cash plus U.S. government securities, a rough “risk asset” adjustment. In practice, bankers and analysts used the FDIC and Fed standards more than those of the OCC.

None of the agencies established a firm minimum capital ratio. Instead, the capital positions of banking institutions were evaluated on an individual bank basis. Particular attention was directed toward smaller banks whose loan portfolios were not as diversified and whose shareholders were fewer in number than those of larger institutions. It was reasoned that small or “community banks” might have a hard time raising capital in times of difficulty and therefore should be more highly capitalized at the start than larger institutions. Table 1 shows the banking industry’s capital-asset ratios from 1960 to 1980. The table shows that there was a steady downward drift in the ratio, which can be explained by a number of factors. Chief among these would be the attractiveness of increased leverage in banking and reliance on other techniques to manage balance sheets, e.g., liability management.

In late 1981 the three Federal bank regulatory agencies announced a new coordinated policy related to bank capital. The policy established a new definition of bank capital and set guidelines to be used in evaluating capital adequacy. The new definition of bank capital included two components: primary and secondary capital.

Primary capital consisted of common stock, perpetual preferred stock, surplus, undivided profits, mandatory convertible instruments (debt that must be convertible into stock or repaid with proceeds from the sale of equity), reserves for loan losses, and other capital reserves. These items were treated as permanent forms of capital because they were not subject to redemption or retirement. Secondary capital consisted of nonpermanent forms of equity such as limited-life or redeemable preferred stock and bank subordinated debt. These items were deemed nonpermanent since they were subject to redemption or retirement.

In addition to the new definition of capital, the agencies also set a minimum acceptable level for primary capital and established three zones for classifying institutions according to the adequacy of their total capital.

International risk-based capital standard: History and explanation by MC Alfriend (1988)

In the United States it isn't just Basel that is changing. FDICIA act of 1991 is also an important regulatory change for regulatory capital standards. My understanding is that Basel I only worried about credit risk but FDICIA introduced capital requirements for interest rate risk as well, perhaps in response to the contemporaneous savings and loan crisis where many thrifts failed as a result of losses from interest rate exposures.