Establishing capital requirements that are sufficient to support the banking system through a crisis is critical to preserving financial stability. In this paper we use the experience of the recent financial crisis which peaked in 2008 to analyze and measure the potential risk to capital at large U.S. financial institutions during a period of severe stress. Specifically, we perform a historically based analysis of the extent to which losses from financial institutions’ risk exposures would have eroded their capital ratios under certain assumed constraints. We analyze financial data from 26 large financial institutions in the United States over the period from 2007:Q1 to 2012:Q2 to estimate the erosion of capital during each institution’s most stressful period. We consider only large financial institutions, as critical levels of capital impairment at these institutions are more likely to have implications for the broader financial system.

Our study indicates that the capital depletion during the recent financial crisis at large U.S. financial institutions was extensive and often rapid. Specifically, of the 26 large institutions examined in this study, half had losses that would deplete capital ratios by at least 200 basis points. Of that number, 12 institutions had capital ratio erosion in excess of 300 basis points and eight institutions had capital ratio erosion in excess of 450 basis points. When our estimates of capital depletion at large U.S. firms are compared to the adopted and proposed Basel III capital standards for the largest U.S. firms, capital requirements do not appear excessive as some observers have alleged.

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