The Basel framework has produced complex definitions of “adequate” capital, expressed in terms of book (accounting) ratios. However, solvency actually depends not on accounting ratios but on private investors' valuation of the firm's assets' and liabilities' market values. At large banking...

Recent theory papers by Diamond and Rajan (2000, 2001) and others suggest that banks with higher capital ratios may create less liquidity because capital diminishes financial fragility and/or “crowds out” deposits. Other contributions suggest the opposite outcome: banks with higher capital...

Recent theory papers by Diamond and Rajan (2000, 2001) and others suggest that banks with higher capital ratios may create less liquidity because capital diminishes financial fragility and/or “crowds out” deposits. Other contributions suggest the opposite outcome: banks with higher capital...