by Joe Peek and Eric S. Rosengren
September/October 1997

The wave of bank and savings and loan failures in the 1980s and early 1990s, and the resulting losses to deposit insurance funds, served to highlight the need for banks to hold sufficient capital to survive difficult times. In addition, many argued that deposit insurance reduces the market discipline that depositors might otherwise provide. Consequently, recent bank regulatory initiatives increasingly have emphasized the role of bank capital as a cushion to allow banks to absorb adverse shocks without experiencing insolvency.

While regulations are being designed to reward banks that are deemed to be well capitalized and restrict those that are not, no clear consensus has been reached in the academic literature on just how much capital is necessary. This article examines whether institutions satisfying the "well-capitalized" criteria before and during the recent banking crisis in New England had sufficient capital to weather the storm. The authors find that many of the institutions that either failed or required substantial supervisory intervention were well capitalized prior to the emergence of banking problems in New England. Problems of the magnitude recently experienced in New England would require greater capital cushions than the minimum "well-capitalized" prompt corrective action threshold, if widespread bank insolvencies were to be avoided.

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