Banks often oppose higher equity asset ratios, because equity capital is more expensive than debt capital. But this is precisely because of the lemon effect.

That, in turn, avoids triggering requirements of more bank capital.

But how much public capital should be used, and on what terms? Private capital, of course, is preferable, but, given the risk that it will be wiped out by future public intervention, investors will be wary.

Exposure to Mexican debt alone represented some 90 of the capitalization of major US banks.

At a time when bank capital is scarce, that impediment carries significant economic costs.

The next challenge will be to push for a restoration of bank capital, so that commercial banks can once again lend for longer term investments.

In the face of high systemic risk, private capital is leaving banks and the sovereign debt markets, causing governments borrowing costs to rise and bank capitalization to fall.

As they struggle to raise new capital, European banks and insurers are likely to be forced to sell overseas assets.

Indeed, if, as some believe, only a fraction of the banks equity is at risk, the potential debt equity swaps would be minuscule.

But in bad times, when it is important to keep banks lending, bank capital would automatically be increased by the debt to equity conversion.

Much has already been done to advance regulatory reform, notably the recent agreement to strengthen bank capital (Basel III).

There is more to come. As they struggle to raise new capital, European banks and insurers are likely to be forced to sell overseas assets.

The government has established a new agency, Central Hujin Investment Company, to manage and re capitalize big state owned banks before they are sold.

The Federal Reserve s bailout of the financial system is unlikely to stand up unless banks find fresh capital, and lots of it. Ultra rich sovereign wealth funds have the cash to rescue US banks.

Monetary policy was undermined by the banking crisis, and any reduction of interest rates to boost economic activities would encourage further flight of capital and stop capital inflows.

But doesn t the banks ability to raise new equity capital indicate that, regardless of whether the stress tests are reliable, investors believe that their assets value does significantly exceed their liabilities?

And bank bailouts, involving the direct use of public money to recapitalize failing institutions, are even more costly and politically unpopular.

Government subsidies for private bad banks, or public bad banks to clean up private banks toxic assets, are a bad way for taxpayers to transfer money to troubled banks compared to normal capital injections.

Anat Admati, a professor at Stanford s Graduate School of Business, focuses on bank capital specifically, the incentives that banks have to fund their activities with very high leverage little equity and a great deal of debt.

The old NPL problem was resolved, primarily by establishing asset management companies to take over doubtful assets, and injecting new capital into the commercial banks.

First, while broad financial stability has been restored, and bank capital has been boosted significantly as a result of last year's stress tests, there are still important pockets of weakness.

If the economy were to weaken, the need for additional bank capital could be significant.

On the contrary, compared to their likely future losses, European banks have raised relatively little capital recently and much of this has been creative accounting, rather than truly loss absorbing shareholder equity.

If the International Monetary Fund were calling the shots in Europe, they would be arguing forcefully for tough stress tests and bank recapitalization throughout the eurozone.

The Fed s commitment to buy shares of the mutual fund at a preset price would have caused investors to put new capital into the stronger banks to take advantage of the central bank s price support.

There is a credit crunch, as banks with insufficient capital do not want to lend to risky borrowers, while slow growth and high levels of household debt have also depressed credit demand.

As their capital declines, so, too, do their future loans.

The second report finds that a one percentage point increase in bank capital ratios, if introduced gradually over four years, would lower GDP by about 0.2 .

As they absorb their losses on US treasury and agency securities, capital flows toward the US will diminish.

Over the past three years, 52 billion in capital has fled the country.

Consider the seemingly heated debate over how much capital banks should hold.

Third, commercial banks also lost heavily in these dealings, wiping out much of their capital.

Neither the Cypriot government nor European taxpayers will put any additional funds into these banks.

One estimate suggests that a 50 reduction in the value of peripheral countries sovereign debt (reasonable for Greece, but high for the others) would cause about 3 trillion in losses, overwhelming the capital of European banks.

Bank shares in particular are rebounding, and some banks have even succeeded in repaying at least part of their government provided capital.

Concerned about the excessive volatility of speculative short term capital flows and the contagion effects in financial markets in times of crisis,

More than half of the Southern countries' debts are in the form of private capital deposited in tax havens controlled by the banks of the North.

If faced with such losses, banks might choose to protect their reputations by using official funds for repayment, transferring the risk onto their balance sheets.

Moreover, there must be greater balance between capital intensive and labor intensive activities.

That led to the next step Foreign firms wishing to invest in China were allowed to tap those deposits by issuing renminbi denominated bonds, and eligible offshore financial institutions were permitted to invest renminbi funds in China s interbank bond market.

If so, then the unavoidable conclusion must be that things would not have been so bad if the government had refused to implement an expansionary fiscal policy, recapitalize banks, nationalize troubled institutions, and buy financial assets in non standard ways.

It helps banks immediately, and it creates the right incentives for future behavior, as banks will know that the government will not prevent private equity capital from being destroyed in a crisis.

Alfred Mann has set up this foundation to advance this research because he saw there's no way venture capital would come in for something like this.

The banks, having been recapitalized only to the extent necessary to keep them afloat, still have weak balance sheets.

But, unfortunately, the most obvious way for banks to increase their capital ratios is to curtail their lending.