start by explaining why banks have capital. banks play a critical role in the economy by connecting those seeking to borrow with those seeking to save. 2 a bank lends to its customers, including individuals and businesses, based on its assessment of the customer ’ s creditworthiness. a bank ’ s depositors benefit from having bank accounts that allow them to easily make payments to others and to maintain a balance of money in a safe and liquid form. a healthy banking sector is central to a healthy economy. the nature of banking, however, along with the interconnectedness of the financial system, can pose vulnerabilities. even if a bank is fundamentally sound, it can suddenly be threatened with failure if its customers lose confidence and withdraw deposits. 3 this inherent vulnerability can pose risks to the entire economy. in the 19th and early 20th centuries, before the creation of the federal reserve and the federal deposit insurance corporation ( fdic ), banking panics were frequent and costly to the economy. 4 based on this experience — and similar experiences around the globe — many countries employ deposit insurance and other forms of a safety net to kashyap, rajan and stein ( 2002 ) describe the dual role that banks play in the economy, providing liquidity to both households and businesses. fama ( 1985 ) notes that banks are special on both the asset and liability side of the bank ’ s balance sheet. see the bank run literature developed by diamond and dybvig ( 1983 ) and others. jalil ( 2015 ) concludes that “ major banking panics either caused or amplified nearly half of all business cycle downturns between 1825 and 1914. ” bernanke ( 1983 ) shows that bank failures did economic harm during the great depression. - 3protect depositors and banks. 5 but offering this protection, shielding depositors and banks from risk, can have the perverse effect of encouraging risk - taking, creating what is called “ moral hazard. ” supervision and regulation — including capital regulation — provides a critical counterbalance, to ensure that banks, not the taxpayers, internalize the costs to society of that risk - taking. the impact of inadequate supervision and regulation was starkly revealed in the global financial crisis, as banks and their functional substitutes in the nonbank sector borrowed too much to fund their operations. 6 while nearly all were “ adequately capitalized ” in theory, many were undercapitalized in practice, since their capital levels did not reflect future losses that would

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