Therefore, capital is a required structure of finance for risk taking.

And therefore, capital is a constraint on risk taking.

Almost all lending is a form of risk taking (e.g. lending to fiat currency issuers excluded, although even lending to a fiat currency issuer might include some interest rate risk which in turn requires capital, depending on the pricing structure of the deal).

So capital is a constraint on lending, not because it is lending per se, but because it is a form of risk taking.

At first, banks impose their own standards for capitalization. Then the regulators get involved, and their standards become superimposed.

The fact is that some banks, given regulatory constraints, then proceed to self-impose standards that are even more rigorous than regulatory minimums. E.g. this was the case through the crisis for all major Canadian banks.

Capital constraints translate in terms of both the quantum and pricing of risk, and the quantum and pricing of capital. These things must match up properly in order for banks to actually take on risk that they are considering in the proposal stage.

You point out very correctly (more or less) that the concept of “hurdle” is critical in the decision to take on risk.

So the constraint works there at the level of allocation of available capital. By definition, available capital is excess capital until it is deployed to take risk, whereupon it becomes utilized capital.

In addition to the constraint in terms of meeting the hurdle to utilize available capital, there is also the constraint in terms of the availability of excess capital per se – i.e. whether an individual bank in a position where it has the excess capital to even make the allocation choice for new projects.

Finally, the word “constraint” can apply in the aspect of a bank’s ability to generate new capital internally or externally.

The last two usages of the constraint idea were particularly impinging during the financial crisis.

So “constraint” is a multi-nuanced word when used to characterize bank capital.

However, I see little value in distinguishing the meaning of capital constraint in any truly fundamental way as it applies to the banking system versus an individual bank. And this is where it gets very interesting from an MMT perspective – because the appropriate and very meaningful distinction between systemic and specific dimensions when talking constraints is in the aspect of bank reserves rather than bank capital. The economics profession for the most part is apparently cursed by a failure to understand the difference in these two distinctions – i.e. the importance of the fallacy of composition in understanding the reserve system, versus its lesser role in understanding the nature of bank capital constraints, in my view.

(also submitted at winterspeak’s)

http://alephblog.com/2009/01/10/a-new-goal-for-tarp-money-create-mutual-banks/

Breaking up the big banks is not an unreasonable “second best” idea but I’m not as convinced as he is that this will really solve the problem of homogeneity amongst banks. Maybe some sort of punitive taxation based on size could level the playing field.

Anyway, this post is just one small point in a broader theme I’m increasingly convinced about – that all our macroeconomic policy is being stymied by real micro blockages and problems with the underlying incentive/competitive structure in the economy, esp. in the banking sector.