Myron Scholes, a Nobel prize-winning quantitative analyst, warns that requiring banks to hold too much capital will result in more volatile financial markets.
“If you restrict or require more capital of banks, what will happen is that they have to wait until the deviations [in price] get larger before they intermediate, because they have to make a return on the capital they are employing. As intermediary services stop, markets then become more chaotic.”
Scholes also said that models should take better account of the constraints of market participants—including bank capital requirements—and their effect on capital flows. Setting capital requirements that are too onerous would mean banks would need too high a return for intermediating in the markets, and that as a result their “correcting influence” would be absent.
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