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09 Jul 2020Working Paper Summaries

How Should US Bank Regulators Respond to the COVID-19 Crisis?

by Michael Blank, Samuel G. Hanson, Jeremy C. Stein, and Adi Sunderam

Instead of the "watchful waiting" approach taken by US bank regulators to the pandemic crisis, they should use their prudential authorities to encourage banks to increase their equity capital. This is effectively a way of buying low-cost insurance against adverse scenarios that have become more likely.

Author Abstract

Drawing on lessons from the 2007–2009 Global Financial Crisis (GFC) and a simple conceptual framework, we examine the response of US bank regulators to the COVID-19 pandemic. We argue that the current regulatory strategy of “watchful waiting”—the same strategy that was used during the early stages of the GFC—poses unnecessary risks to the financial system and broader US economy. Instead, promoting an early recapitalization of the banking system, by stopping dividends and by encouraging new equity issues, would be a more prudent way to manage the vulnerabilities the pandemic has created. We close by suggesting additional measures that we believe regulators should take in both the short and long run.