In response to the global banking crisis, regulators and policy makers worldwide have united behind efforts to increase financial institutions’ minimum capital requirements and to limit leverage, hoping to reduce the likelihood of future bank distress.¹ As of this writing, the debate over proper capital requirements continues, with major implications for the industry and the economy—yet there have been few specifics on which ratios should be targeted or at what levels.

To shed some light on the discussions, we analyzed the global banking crisis of 2007 through 2009² to identify relationships that different types of capital and capital ratios have to bank distress.³ Our analysis is observational, based on historical data, and not a real-world experiment, which would have required randomly selected financial institutions to hold different capital levels to gauge their effects. As a result, the findings do not definitively establish how institutions might perform in the future if minimum capital ratios were changed, but we believe that the evidence we provide is a valuable input for current policy discussions.