Thoughtful look at the implications of more stringent capital requirements on banks

A few days ago on Economix, I ran into some fascinating arguments about the capital requirements of banks.  This paper, which was mentioned in the post, is thought provoking because it really fleshes out the idea of banks as utilities is not only a good idea, but not a terrible thing from the perspective of bank shareholders.  I could just be putting up a straw man, but I think there is a tacit acceptance of the big bank argument that higher capital requirements are bad for shareholders/America/capitalism.  It seems to fit with the narrative du jour that Obama has no business experience and is destroying the capitalist fabric of America with his boneheaded policies.  While I doubt most people want to read a 60 page paper on the subject of capital requirements, luckily one of the authors happens to be a JPM shareholder, and wrote an open letter that provides a more cursory rundown of the paper's arguments.  It is also in reference to JPM stock, so the arguments can easily be applied to bank stocks in general.

The letter can be found here.  A brief excerpt of the letter that should whet the appetite for some grounded-in-logic argumentation:

A flaw in Mr. Dimon's argument concerns the "market-demanded return on capital" that he claims banks must earn. In a well-functioning financial market, investments in Treasury bills "demand" a lower return than investments in risky mortgages. The required return on capital depends on the risk to which it is exposed. When funding with a mix of debt and equity, the lower the leverage, the lower the riskiness of equity per dollar invested, and therefore the lower the return investors require as compensation for bearing the equity risk. ...Mr. Dimon's letter displays JPM's return on equity (ROE). ROE does not measure shareholder value because it is affected, through the market, by leverage and risk.   Reaching a target ROE can be helped by leverage and risk without benefiting shareholders. Thus, if increased capital requirements lead to lower average ROE, this need not mean lower value, because it reflects the reduced riskiness of equity.

The rub with Admati's argument might be that in order to achieve the necessary capital levels, dilution of current shareholders would have to occur.  Given time to respond to capital requirements though, banks are entirely capable of earning their way to that level in a pretty short time frame.  Especially in the current interest rate environment in the US, the mega banks are making a bunch of money preprovision pretax, so they are replenishing their capital base a reasonable clip.  If the risk premium demanded decreases in response to deleveraged balance sheets, will this prove to be a wash for share prices?

Give Andrew your opinion on capital requirement's effect on shareholders