Large banks across the globe routinely compete head-to-head.  As an example, we have recently shown how large banks in the U.S. compete directly with large European banks to provide underwriting and derivative services to large U.S. corporations.  The ability to compete in the global market for banking services depends importantly on costs:  a bank with lower costs can offer its services at lower prices and win business.  For banks, capital is a significant cost driver.  A bank that is required to issue more equity to build capital will incur higher costs since equity financing is expensive.  More specifically, these days a bank pays depositors around one to two percent per year in interest on a deposit account but generally pays equity investors a rate of return closer to ten percent per year. 

In this post, we review the differences between required capital levels for U.S. and European banks and discuss the implications for competitive equality. 

The amount of capital that a large, internationally active bank is required to maintain is determined according to the formula,

$ Capital = $ RWA X % Capital Requirment.

The term $ RWA is the value of risk-weighted assets held by the bank and reflects the risk-adjusted size of the bank’s balance sheet.  The term % Capital Requirement refers to the amount of capital that is required to support each dollar of risk-weighted assets.  As we will show, both $ RWA  and % Capital Requirement are higher for large U.S. banks than for large European banks.