Anat Admati and Martin Hellwig’s The Bankers’ New Clothes: What’s Wrong with Banking and What to Do about It is an argument, written for non-specialists by two financial economists, that banks are far more fragile than they need to be because they fund themselves almost entirely with borrowed money, and that the reasons bankers give for keeping it that way do not survive scrutiny. Princeton University Press published it in 2013 and brought out a new and expanded edition, dated 2024, after the bank failures of 2023. The book takes the claims that dominate debates about bank capital (that capital is money set aside, that equity is expensive, that safer banks would lend less, that strict rules would handicap a country’s banks against their rivals) and answers each in plain language, before proposing that banks be required to hold equity of 20 to 30 percent of their total assets, several times what the rules require. For an internal auditor at a bank it is not a policy tract to agree or disagree with; it is a training in how to read capital: what the ratios in a board pack measure and what they leave out, why a bank can look solvent in its accounts while its assets are worth less than its debts, and why incentives tied to return on equity push in one direction. This guide summarises the book without reproducing it, sets out its claims and answers, brings the regulatory story up to October 2026 from the regulators’ own documents, maps the argument to the audit of capital management and board reporting, and ends with a worked example of a regional bank’s audit function applying it in its 2027 plan.
In this guide
- The book in one page
- Who Admati and Hellwig are, and how the book came about
- The structure: an opening chapter, four parts and seventeen chapters
- The bankers’ new clothes: the claims and the answers
- Leverage, equity and the subsidy
- The 2024 edition: still too fragile
- Where the rules stand in October 2026
- The nine ideas worth keeping
- The vocabulary: fourteen terms defined for practitioners
- What it means for internal audit: auditing capital and its reporting
- The criticisms, and what the book leaves to the auditor
- Editions, reading time and how to read it
- A one-hour discussion guide for an audit team
- Worked example: Lakeshore Bancorp audits its capital story
- Frequently asked questions
- Related guides
The book in one page
| Question | The answer, in our words |
|---|---|
| What is the thesis? | That banking is fragile by choice rather than necessity: banks borrow far more, relative to their assets, than other kinds of company, the fragility benefits bankers while the public bears the risk, and a much safer system is available at little or no cost to society. |
| What is the central confusion? | That “capital” means money held in reserve. In banking, capital means equity, the part of a bank’s funding that comes from its owners rather than its lenders; capital rules limit how much a bank borrows, not how much it can lend. |
| What do the authors propose? | Equity of 20 to 30 percent of total assets, measured without risk weights; during the transition, no dividends or other payouts, and new equity issued. |
| Why do banks not choose it? | Because debt is cheap for banks: creditors expect governments to protect them and charge less than the risk warrants, interest is tax-deductible where dividends are not, and pay tied to return on equity rewards borrowing. |
| What does the 2024 edition add? | A new preface and a fourth part of four chapters, written after the failures of 2023, on the shortcomings of current policy and on how banking’s dominance threatens democracy and the rule of law. |
| How is it written? | Plainly, for readers with no background in finance; the opening chapter says the book assumes no prior expertise, and the notes and references serve specialists. |
| Why read it as an auditor? | Because the claims it examines turn up in capital plans and board papers, and because the questions it teaches (what is the equity measured against, at what values, and who bears the loss) are the questions an audit of capital management should ask. |
| Reading time | The main text can be read in a few evenings; the notes are for checking the argument rather than following it. |
Who Admati and Hellwig are, and how the book came about
Anat Admati is the George G.C. Parker Professor of Finance and Economics at Stanford Graduate School of Business and faculty director of its Corporations and Society Initiative. She studied at the Hebrew University of Jerusalem and at Yale, where she completed her doctorate in 1983, and she has served on the FDIC’s Systemic Resolution Advisory Committee; Princeton’s author note records that she has been named among Time’s hundred most influential people and Foreign Policy’s leading global thinkers. Martin Hellwig, who holds a doctorate in economics from MIT, is director emeritus of the Max Planck Institute for Research on Collective Goods in Bonn. He has chaired Germany’s Monopolies Commission and was the first chair of the Advisory Scientific Committee of the European Systemic Risk Board, and he shared the Max Planck Research Award in 2012 for work on international financial regulation. Both are academic economists, and the book is their attempt to take an argument from the journals to the general public.
The book grew out of an argument. In the spring of 2010, by Admati’s account in a Stanford interview published as the first edition appeared, she read a banking textbook that contradicted what she taught in basic finance about the cost of equity. That summer she, Hellwig, Peter DeMarzo and Paul Pfleiderer wrote a long paper arguing that bank equity is not expensive: higher equity requirements would raise banks’ funding costs only by reducing the subsidies they enjoy. Finding many politicians and regulators unwilling to engage with the argument, and much of the policy debate conducted behind closed doors, Admati and Hellwig concluded that only a book for a general audience could develop it fully. Admati has taken part in regulatory debates internationally since 2010, and the authors have kept the argument current in working papers, including a running catalogue of what they regard as flawed claims, the latest version of which, from January 2024, lists forty-four. The new and expanded edition followed a decade after the first.
The structure: an opening chapter, four parts and seventeen chapters
The new and expanded edition opens with a preface to the 2024 edition and the original preface, then a single introductory chapter that sets out the thesis and the central analogy before the parts begin. The opening chapter and the first three parts are the 2013 book, with the parts covering the mechanics of borrowing and risk, which the opening chapter says the book treats in general before turning to banks; the case for more equity; and the politics of reform. The fourth part, added in the new edition, carries the argument past 2013. The chapter titles in the table are from Princeton’s contents page; the middle column says what each title promises and the right-hand column is the guide’s view.
| Part and chapter, as listed | What the title promises | Why an auditor should read it (our view) |
|---|---|---|
| 1. The Emperors of Banking Have No Clothes | The thesis and the central analogy, before the parts begin | The list of claims the rest of the book answers |
| Part I, Borrowing, Banking, and Risk. 2. How Borrowing Magnifies Risk | How debt amplifies the owner’s gains and losses | The arithmetic every capital audit rests on |
| 3. The Dark Side of Borrowing | The costs of heavy borrowing beyond larger swings in returns | Why a heavily indebted firm behaves differently |
| 4. Is It Really “A Wonderful Life”? | Whether a familiar, reassuring image of banking holds up | A check on the assumptions behind a bank’s own account of itself |
| 5. Banking Dominos | How one bank’s failure spreads to others | Contagion and interconnection in the risk assessment |
| Part II, The Case for More Bank Equity. 6. What Can Be Done? | The remedy | The proposal itself |
| 7. Is Equity Expensive? | Whether equity costs banks more than debt | The claim most often made in capital papers |
| 8. Paid to Gamble | How incentives reward risk-taking | Pay and return-on-equity targets |
| 9. Sweet Subsidies | The support banks receive from the state | Why bank debt is cheaper than the risk warrants |
| 10. Must Banks Borrow So Much? | Whether banks’ borrowing is necessary | The question behind every leverage target |
| Part III, Moving Forward. 11. If Not Now, When? | The case for acting | Timing arguments against raising capital |
| 12. The Politics of Banking | Why reform stalls | Lobbying and the governance of regulatory engagement |
| 13. Other People’s Money | Whose money banks put at risk | Who bears the losses |
| Part IV, Undermining Democracy and the Rule of Law (new in the expanded edition). 14. Too Fragile Still | That the system remains fragile after the post-crisis reforms | The 2023 failures read through the book’s argument |
| 15. Bailouts and Central Banks | The part central banks play in supporting banks | Liquidity support and its limits |
| 16. Bailouts Forever | That bailouts have continued despite promises | The credibility of resolution arrangements |
| 17. Above the Law? | Whether banks escape legal accountability | Conduct, enforcement and accountability |
The bankers’ new clothes: the claims and the answers
The opening chapter starts from an exchange at the World Economic Forum in Davos in 2011, when JPMorgan Chase’s chief executive, Jamie Dimon, said that complaints about bankers were unproductive and the French president, Nicolas Sarkozy, replied that the public was angry with institutions that had abandoned common sense. The authors then borrow Hans Christian Andersen’s story of the emperor whose new clothes do not exist. In their account bankers and their supporters make claims with the confidence of specialists; critics hesitate to challenge them for fear of looking ignorant; and so arguments that do not hold up go unchallenged and shape policy. The book’s purpose is to say, as the child in the story does, that the clothes are not there, and to make the subject accessible enough that more people can see it for themselves. The table sets out the claims the opening chapter lists, the authors’ answers in our words, and the question each gives an auditor.
| The claim (in our words) | The authors’ answer | What an auditor can ask |
|---|---|---|
| The crisis was a rare event, so much tighter rules are not needed | Bankers concede mistakes but treat the crisis as a fluke; the authors argue that the fragility behind it remains, because banks still borrow so heavily | Do the bank’s capital stress scenarios include losses as large as those of the crises it has lived through? |
| Tougher rules will have unintended consequences for the economy | A bugbear: a warning used to alarm policymakers that does not engage with the problem the rules address | When management argues against a stricter internal limit, does it say which consequence it expects and how large? |
| Society must choose between growth and stability | A false choice: the crisis itself destroyed output, and lending fell because banks were overindebted, not because they held too much equity | Does the board paper treat capital as a brake on growth, or as what lets lending continue in a downturn? |
| Capital requirements make banks hold idle money | Capital is equity, a source of funding, not a reserve; capital rules limit borrowing, not lending | Do board papers describe capital as money “held” or “set aside”? |
| Equity is expensive | Other companies use far more equity; bank debt looks cheap because implicit guarantees move part of its cost to taxpayers | What cost of equity does the capital plan assume, and does it allow for the bank becoming safer? |
| Strict national rules handicap banks against foreign competitors | Success built on subsidies or excessive risk is no benefit to society; the level playing field does not justify fragility | Is comparison with peers the only basis on which the capital target was set? |
The chapter supports the claims with comparisons the rest of the book develops. Most American non-financial companies, the authors note, borrow less than half the value of their assets; banks routinely borrow more than 90 percent, some European banks more than 97 percent, and the post-crisis rules would still allow debt to fund 97 percent of a bank’s assets. They recall Lehman Brothers’ bankruptcy in September 2008 and the rescues that kept Hypo Real Estate, Dexia and UBS out of bankruptcy, and the cases of Ireland and Iceland, where the size of the banking system turned bank failure into national economic collapse. And they set out the prescription in outline: greatly reduce banks’ reliance on borrowing, which they argue is the most direct and cost-effective way to reduce risk; recognise that the reforms after 2008, the Volcker rule among them, had been weakened in the writing; and deal with banks that are too big to fail through better arrangements for resolving them as well as through limits on borrowing. The Too Big to Fail summary covers the 2008 events from the inside.
Leverage, equity and the subsidy
The argument rests on arithmetic that applies to any borrower, which the book works through in general terms before turning to banks. To take a household example of our own: a family that buys a house with a small deposit and a large mortgage gains more, as a share of its own money, when prices rise, and loses more when they fall; if prices fall by more than the deposit, the family’s equity is gone and the lender bears the rest. A bank is the same, except that its deposit is a few percent of its assets and its lenders include depositors, other banks and, implicitly, the government. The table is our illustration, not the authors’ figures: a bank with 100 of assets, earning 4 percent on them and paying 3 percent on whatever it borrows, funded with three different amounts of equity.
| Equity as a share of assets | Return on equity in a normal year | Equity left after assets lose 4 percent of their value | What happens to the lenders |
|---|---|---|---|
| 3 percent (debt funds 97 percent, the Basel III leverage minimum) | About 36 percent | Minus 1: the bank is insolvent | They bear the loss beyond the equity, unless a guarantor steps in |
| 10 percent | 13 percent | 6: equity has fallen by 40 percent | Protected, but the bank must rebuild equity, often by cutting lending |
| 25 percent (within the authors’ range) | 7 percent | 21: equity has fallen by 16 percent | Protected; the bank absorbs the loss and carries on |
The table shows why bankers resist: return on equity falls as equity rises. The authors’ answer, which they first set out in the 2010 paper, is that the fall in return on equity is not, by itself, a cost. Equity in a safer bank carries less risk, so shareholders should require a lower return on it; a lower return for a lower risk is not a loss to society. What does change is the subsidy. With little equity, much of a bank’s downside falls on its creditors, and because creditors expect governments to protect them, they do not charge the bank for it. The tax system adds a further advantage, since interest is deductible and dividends are not. More equity reduces both advantages, which is a private cost to the bank’s shareholders and managers and, in the authors’ view, a saving to everyone else. Pay tied to return on equity completes the picture: an executive rewarded for a high return on equity is, among other things, rewarded for borrowing.
The proposal follows: equity of 20 to 30 percent of total assets, without risk weights, against the 3 percent minimum of the Basel III leverage ratio. A reviewer in the Journal of Financial Innovation notes that the authors support the range by intuition and by history, since equity of around a quarter of assets was common for banks in the nineteenth and early twentieth centuries. For the transition, they would stop dividends and other payouts and require banks to issue new equity. Higher equity, they argue, does not reduce lending: banks cut lending in a crisis because they have too little equity, not too much. The proposal uses total assets rather than risk-weighted assets, and the difference matters to an auditor reading a board pack. A risk-weighted ratio depends on estimates of risk that can be wrong, and the bank or its regulator chooses them; a ratio of equity to total assets depends on no model at all. The credit risk guide covers credit risk measurement and capital, and the SR 11-7 guide covers the governance of the models behind risk-based figures.
The 2024 edition: still too fragile
The expanded edition’s fourth part was written after the failures of spring 2023, which Princeton presents as showing that little had changed since the global financial crisis. The publisher describes the four new chapters as an examination of the shortcomings of current policy and of how banking’s dominance threatens the rule of law and democracy. Around the launch the authors argued, in an article in The Banker, that the most striking fact about Silicon Valley Bank was neither the speed of the run nor the part played by social media, but that its supervisors had failed to recognise, months earlier, what the authors call the bank’s technical insolvency. They also argued that bailouts had continued despite the promises made after 2008, in the Dodd-Frank Act of 2010, in the European Union’s bank resolution framework of 2014 and by Mark Carney in 2014, and Admati has argued that persistent regulatory failure and bailouts erode democracy and undermine the rule of law. The table sets out the events of 2023 from the regulators’ own accounts.
| Date | Event | What the authorities’ own documents say |
|---|---|---|
| 10 March 2023 | Silicon Valley Bank closed by the California Department of Financial Protection and Innovation; the FDIC appointed receiver | About $209.0 billion of assets and $175.4 billion of deposits at the end of 2022 (FDIC). The bank lost over $40 billion of deposits on 9 March and expected to lose more than $100 billion more the next day; about 94 percent of its deposits were uninsured at the end of 2022 (Federal Reserve review) |
| 12 March 2023 | Signature Bank closed by its state chartering authority; systemic risk exception for both banks | All depositors of both banks protected; shareholders and certain unsecured debtholders not protected; any loss to the Deposit Insurance Fund to be recovered through a special assessment on banks (joint statement of the Treasury, Federal Reserve and FDIC) |
| 19 March 2023 | FINMA approves the takeover of Credit Suisse by UBS | Government support triggered a complete write-down of Credit Suisse’s additional tier 1 debt, about CHF 16 billion (FINMA) |
| 28 April 2023 | Federal Reserve publishes its review of the supervision and regulation of Silicon Valley Bank | Board and management failed to manage risk; supervisors did not fully appreciate the bank’s vulnerabilities and did not act forcefully enough; the tailoring approach and a change in supervisory policy weakened standards; 31 supervisory findings were still open when it failed, about triple the number at peer firms (Federal Reserve) |
| 1 May 2023 | First Republic Bank closed by the California regulator; JPMorgan Chase Bank assumes all deposits | About $229.1 billion of assets and $103.9 billion of deposits at 13 April 2023; estimated cost to the Deposit Insurance Fund about $13 billion (FDIC) |
In our reading, the regulators’ accounts illustrate three of the book’s points. The run at Silicon Valley Bank, whose deposits were overwhelmingly uninsured, showed how quickly short-term funding leaves a bank whose solvency is in doubt, and the Federal Reserve’s review traces the doubt to a rapid rise in unrealised losses on the bank’s securities as interest rates rose. The systemic risk exception that protected every depositor of two failed banks was a guarantee extended after the event, which is the implicit subsidy the book describes made explicit. And the review’s finding that supervisors had identified problems without acting forcefully on them echoes the authors’ complaint, in the first edition, that ineffective enforcement as well as weak regulation lay behind the earlier crisis. The liquidity risk guide and the guide to EVE and NII cover the two mechanisms, funding and the value of equity, that the run combined.
Where the rules stand in October 2026
The expanded edition was published at the end of 2023. The table brings the rules it discusses up to the date of this guide, from the standard-setters’ and regulators’ own documents. The bank regulatory thresholds guide gives the full ladder of US categories and the thresholds at which each rule applies.
| Rule | What it requires | Status in October 2026 |
|---|---|---|
| Basel III leverage ratio | Tier 1 capital divided by an exposure measure that includes off-balance-sheet items; a 3 percent minimum, tested from 2013 and moved into the binding Pillar 1 requirements from 1 January 2018 (Basel Committee) | International minimum; the authors’ target is roughly seven to ten times higher |
| US minimum capital ratios | Common equity tier 1 of 4.5 percent, tier 1 of 6 percent and total capital of 8 percent of risk-weighted assets; a 4 percent leverage ratio; a 3 percent supplementary leverage ratio for advanced-approaches and Category III institutions (12 CFR 217.10) | In force |
| US enhanced supplementary leverage ratio for the largest banks | Final rule of 25 November 2025: the standard for each holding company and its banks is based on systemic risk, capped at one percentage point for the bank subsidiaries, so their overall requirement is no more than 4 percent; aggregate tier 1 requirements for the affected holding companies fall by less than 2 percent (Federal Reserve, FDIC, OCC) | Effective 1 April 2026, with early adoption allowed from 1 January 2026 |
| US Basel III endgame, 2023 proposal | Proposed 27 July 2023 for banks with $100 billion or more of assets; an estimated 16 percent aggregate increase in common equity tier 1 requirements for affected holding companies; transition from July 2025 to July 2028 (Federal Reserve, FDIC, OCC) | Superseded by the 2026 re-proposal |
| US Basel III endgame, 2026 re-proposal | Proposed 19 March 2026 for the largest, most internationally active banks (the Category I and II organisations), with optional adoption by others; companion proposals revising the standardised approach for other banks and the G-SIB surcharge; the agencies estimate that capital in the system would modestly decrease but remain substantially higher than before the financial crisis | Comment period closed 18 June 2026; no final rule among the Federal Reserve’s banking-regulation releases up to early October 2026 |
Two things stand out against the book. Nothing in the rules approaches the authors’ target: the unweighted minimum for most American banks remains a 4 percent leverage ratio, and the supplementary measure for the largest is 3 percent plus a buffer that the 2025 rule reduced for their bank subsidiaries. And the direction since 2025 has been towards lower requirements, which is the direction the book argues against. For an auditor neither point is a finding; regulatory minimums are policy. But they are the context in which a bank’s own capital target is set, and a target set at a margin above a minimum that the book regards as far too low is a target whose basis the board should understand. The guide to internal audit in banking covers the wider bank audit programme.
The nine ideas worth keeping
- Capital is not a reserve. It is the share of funding that comes from the owners; rules about it limit borrowing, not lending.
- Leverage magnifies losses before it magnifies anything else. A bank with 3 percent equity has nothing left after a 3 percent fall in the value of its assets.
- Return on equity measures risk as well as performance. A rising return on equity can mean more borrowing rather than better banking; targets and pay tied to it reward leverage.
- Equity looks expensive because debt is subsidised. Implicit guarantees and the tax treatment of interest make debt cheap for banks; the cost moves to taxpayers rather than disappearing.
- An unweighted ratio needs no model. Equity against total assets cannot be improved by a change in risk estimates; risk-weighted ratios can.
- Losses the accounts have not recognised are still losses. The failures of 2023 turned on the gap between book values and market values.
- Contagion turns one bank’s problem into everyone’s. Banks are linked through lending, derivatives and confidence; the dominos are why the public ends up underwriting them.
- Arguments against more equity are claims to be tested. Unintended consequences, competitiveness and the cost of equity each come with evidence that can be checked.
- Payouts are capital decisions. Every dividend and buyback is equity that could have absorbed losses; the authors would stop them during the move to higher equity.
The vocabulary: fourteen terms defined for practitioners
| Term | What the authors mean | What it looks like in an audit |
|---|---|---|
| Capital | Equity: funding from the bank’s owners, not money set aside | The numerator of every ratio in the board pack; check the language that describes it |
| Equity | The owners’ claim, which absorbs losses first | Tangible common equity, with and without unrealised securities losses |
| Leverage | Borrowing relative to equity | Total assets to equity, and how it moves under stress |
| Leverage ratio | Equity, or tier 1 capital, against total unweighted assets or exposures | The 4 percent US minimum and the bank’s own target above it |
| Risk-weighted assets | Assets weighted by estimates of their risk, the denominator of risk-based ratios | Classification and model risk in the denominator |
| Return on equity | Profit as a share of equity, which rises with leverage | Targets and incentive plans that reward borrowing |
| Implicit guarantee | Creditors’ expectation that governments will support a failing bank | Funding costs that do not reflect the bank’s own risk |
| Subsidy | The value banks gain from implicit guarantees and from the tax deductibility of interest | The part of the cost of debt the bank does not bear |
| Too big to fail | A bank whose failure the authorities will not allow | Resolution planning and its credibility, mostly at larger banks |
| Banking dominos | Contagion through interconnection and confidence | Counterparty and depositor concentration |
| Resolution | Arrangements for dealing with a failing bank without a bailout | Recovery and resolution plans where they apply |
| Payout restriction | Stopping dividends and buybacks while equity is built | The board’s capital distribution decisions |
| Technical insolvency | The authors’ description of Silicon Valley Bank’s position months before the run, which they say supervisors failed to recognise | Equity recomputed at market values |
| The bankers’ new clothes | Claims that sound authoritative but do not survive scrutiny | Assertions in capital papers to be tested rather than accepted |
What it means for internal audit: auditing capital and its reporting
A bank’s internal audit function does not set capital policy, and the book’s proposal is addressed to legislators and regulators. What the book gives the function is a way of reading the capital process it does audit: the board pack, the capital plan, the distribution decisions, the incentive plan and the assumptions behind each. The map takes eight audit activities in turn. The board risk reporting guide covers what directors should see, the guide to risk appetite statements covers how appetite cascades into limits, and the corporate governance audit programme covers the board processes around them.
| Audit activity | What the book implies | Procedure it changes |
|---|---|---|
| Capital reporting to the board | Unweighted measures and market values matter as much as risk-weighted ratios | Check that the board pack shows equity against total assets, and tangible equity after unrealised securities losses, beside the regulatory ratios |
| Capital planning and targets | The basis for a target should be argued, not assumed | Read the capital plan’s justification for its target; test any cost-of-equity claim and any reliance on peer comparison alone |
| Capital distributions | Payouts are capital decisions | Trace each dividend and buyback approval to the capital plan and to the stress results available when it was approved |
| Incentive compensation | Return-on-equity targets reward leverage | Review executive scorecards for the weight on return on equity and for any capital or risk modifier |
| Interest rate risk and securities valuation | Losses the accounts have not recognised are still losses | Recompute equity at the market value of securities; see the interest rate risk guide |
| Liquidity and deposit concentration | Short-term funding leaves fastest when solvency is in doubt | Test uninsured and concentrated deposits against the contingency funding plan; see the liquidity audit programme, the liquidity stress testing guide and the deposit behaviour guide |
| Regulatory change and advocacy | Capital rules are changing, and lobbying is part of how they change | Check how the bank monitors proposed capital rules and who approves the positions taken in its name, directly or through trade associations |
| Stress testing and appetite | Scenario losses should be large enough to matter | Compare the severity of the bank’s capital scenarios with the losses of the crises it has lived through |
The thread through the map is the question the book asks of every claim: measured against what, at what values, and who bears the loss? An auditor who asks it of a board pack will often find that every figure in it is accurate and that the pack still does not show the board what the book would want it to see. That is not a control failure in the narrow sense; it is a reporting design choice, and pointing it out is the kind of insight that the Global Internal Audit Standards’ statement of purpose asks of internal audit alongside assurance.
The criticisms, and what the book leaves to the auditor
The book’s critics fall into two groups. Some economists accept the diagnosis and question the prescription. The reviewer in the Journal of Financial Innovation found the 20 to 30 percent range about as arbitrary as the Basel figures it would replace, supported only by intuition and a historical average, and argued that the past is no guarantee of adequacy when future crises may be worse. He also pointed out that taxpayers, depositors and shareholders are often the same people, which complicates the story of a subsidy flowing from one group to another, and asked who would hold the new equity. Others reject the diagnosis. Harry DeAngelo and René Stulz argued in the Journal of Financial Economics in 2015 that high leverage is efficient for banks, because what banks produce is safe, liquid claims that investors treat almost as money; in their model, leverage limits on regulated banks make it harder for those banks to compete with unregulated lenders. The authors have answered many objections to their case in their catalogue of flawed claims, and the question of what more bank equity would cost society is not settled. Supporters have been emphatic: Roger Myerson, in a review essay on the book, ranked it with Keynes’s General Theory in the attention it deserved.
For an auditor the more useful observation is about scope. The book argues about how much equity banks should have. The controls over how the capital figures are produced, the governance of the capital plan and the liquidity management that decides whether a bank survives the weeks before its solvency is tested are a different subject, and they are where internal audit’s work lies. The banking guide, the liquidity risk guide and the guide to regulatory findings carry them. A second caution concerns scale. The book’s policy argument is about the banking system as a whole; at a regional or community bank the lessons are about governance, reporting and incentives rather than about systemic regulation, and an audit report that recommended a 25 percent leverage ratio would be making policy rather than giving assurance.
Editions, reading time and how to read it
| What | Details | Best for |
|---|---|---|
| First edition | Princeton University Press, 2013 | The original argument, written after the 2007 to 2009 crisis |
| New and expanded edition | Princeton University Press, published at the end of 2023 and dated 2024; adds a preface to the 2024 edition and Part IV, four new chapters; paperback ISBN 9780691251707 | The edition to buy |
| Other formats | An ebook edition from the same publisher | Reading on screen |
| Reputation | The publisher lists it as a book of the year in the Wall Street Journal, the Financial Times and Bloomberg Businessweek; Martin Wolf of the Financial Times called the expanded edition the second edition of the most original and important book to emerge from the 2007 to 2008 crisis | Deciding whether to read it |
| Reading plan | Chapter 1 and Part I; then chapters 7 to 9 on the cost of equity, incentives and subsidies; then Part IV | A bank auditor with three evenings |
| Companion reading | The authors’ working paper The Parade of the Bankers’ New Clothes Continues (January 2024 version, with 44 claims) for the claims; the Big Short summary for the 2008 losses; the When Genius Failed summary for leverage in a single fund | Placing the argument |
Read it with the bank’s most recent board capital paper beside it and a pencil. Each time the paper uses a phrase the book discusses (capital held, the cost of equity, a level playing field, the need to support lending) mark it, and after the book ask whether the paper’s argument survives. The exercise takes an evening and is the most direct way to turn a book about policy into an audit programme.
A one-hour discussion guide for an audit team
- Ten minutes: the vocabulary test. Ask each person to define capital in one sentence. Count how many answers describe money set aside.
- Fifteen minutes: three numbers. From the latest board pack and financial statements, compute equity against total assets, tangible equity after unrealised securities losses, and the regulatory leverage ratio. Discuss why they differ and which the board sees.
- Ten minutes: the claims. Find the paper that set the bank’s capital target and list its arguments. Mark each that matches a claim in the book’s opening chapter.
- Fifteen minutes: the incentives. Read the executive incentive plan, identify how much of the award depends on return on equity, and check whether any capital measure modifies it.
- Ten minutes: the plan. Decide which of the eight tests in the audit map the function has performed in the last two years, and which belong in the next plan.
Worked example: Lakeshore Bancorp audits its capital story
Lakeshore Bancorp is a fictional US bank holding company with $9 billion of assets, one bank subsidiary, $7.6 billion of deposits and an internal audit function of 22. At its size it is far below the thresholds at which the supplementary leverage ratio and the expanded approach in the Basel III endgame re-proposal apply. Its minimum requirements are the generally applicable ones, including the 4 percent leverage ratio, and, as banks outside the advanced-approaches category may, it elected to exclude most accumulated other comprehensive income from common equity tier 1. In its 2027 plan the function scheduled an audit of capital management and capital reporting, and the audit manager used the book’s questions to frame the scope. The bank audit universe example shows where such an engagement sits in a bank’s plan.
The starting figures were these. Shareholders’ equity was $820 million, after $60 million of after-tax unrealised losses on available-for-sale securities recorded in other comprehensive income. Goodwill and intangibles were $120 million, so tangible common equity was $700 million, 7.9 percent of tangible assets of $8.88 billion. The bank also held $1.2 billion of held-to-maturity securities at amortised cost, with an after-tax unrealised loss of $110 million that appeared in the notes to the accounts and nowhere in equity. Because of the election, common equity tier 1 added back the $60 million, giving $760 million, a common equity tier 1 ratio of 11.5 percent and a tier 1 leverage ratio of about 8.6 percent. Net income for 2026 was $96 million.
| Question from the book | What the function found | What changed |
|---|---|---|
| Measured against what, and at what values? | The board pack reported the common equity tier 1 ratio (11.5 percent) and the leverage ratio (8.6 percent) only. Tangible common equity was 7.9 percent of tangible assets, and about 6.6 percent after the $110 million held-to-maturity loss | Finding: the pack to show tangible equity with and without unrealised securities losses beside the regulatory ratios, every quarter |
| Is the target argued or assumed? | The capital plan set a 10 percent common equity tier 1 floor described as in line with peers and justified by the cost of equity; no analysis linked it to the losses it was meant to absorb | Advisory recommendation: tie the floor to the bank’s own stress losses and document the cost-of-equity assumption |
| Are payouts treated as capital decisions? | Dividends and buybacks totalled $68 million in 2026, 71 percent of net income; the buyback was approved in March, before the year’s stress results were available | Finding: distributions to be approved against current stress results, with a payout trigger tied to tangible equity |
| Do incentives reward leverage? | Return on tangible common equity carried 40 percent of the executive scorecard, with no capital modifier | Referred to the compensation committee, which added a capital and risk modifier for the 2027 cycle |
| How fast could funding leave? | Uninsured deposits were 31 percent of deposits, about $2.4 billion, and the twenty largest depositors held $640 million; the contingency funding plan assumed run-off over thirty days; discount window collateral was pledged, but the bank had not tested a borrowing in 2026 | Finding: a faster run-off scenario added and a test borrowing scheduled |
| Who speaks for the bank on capital rules? | The bank had commented on the 2026 standardised-approach proposal through its trade association; the board had not seen the position taken | Observation: positions on proposed capital rules to be reported to the risk committee |
The audit produced three findings, an advisory recommendation, a referral and an observation. None of them required Lakeshore to hold more capital, and the regulatory ratios were comfortably above the minimums; the function was careful to say so in its report, because a finding that read as a demand for a higher ratio would have been policy rather than assurance. What changed was what the board saw and how it decided. The untested discount window borrowing mirrored one of the Federal Reserve’s findings about Silicon Valley Bank, which had not tested its ability to borrow at the discount window in 2022, and the function cited the review in its report. The chair of the board risk committee observed at the closing presentation that the pack had shown the bank’s capital at the values the regulatory framework uses, while the audit had shown it at the values a depositor would care about, and that the two differed by about a fifth. That sentence went into the minutes and into the design of the 2027 board pack, and the treasury audit guide and the liquidity audit programme were used to scope the follow-up work.
Frequently asked questions
What exactly do Admati and Hellwig propose?
That banks be required to fund themselves with equity of 20 to 30 percent of their total assets, measured without risk weights, and that during the transition they pay no dividends or other distributions and issue new equity. They argue that the cost to society would be small, because the main cost to banks is the loss of subsidies.
Is equity really not expensive for banks?
The authors argue that it is expensive to banks only because their debt is subsidised by implicit guarantees and the tax system, so that higher equity moves costs rather than creating them. Some economists disagree, arguing that banks’ short-term debt is a product investors value, so limiting it has a real cost. The dispute is not settled, and the book states one side of it for a general reader.
What does the 2024 edition add?
A new preface and a fourth part of four chapters (Too Fragile Still, Bailouts and Central Banks, Bailouts Forever and Above the Law?), written after the 2023 failures. Princeton describes them as covering the shortcomings of current policy and the threat banking’s dominance poses to the rule of law and democracy.
Does the book apply to a regional or community bank?
Its policy proposals are aimed at the system, but its questions apply at any size: what the board sees, how the capital target is justified, how distributions are decided, how incentives are built, and what unrealised losses would do to equity. The bank regulatory thresholds guide shows which rules apply at each size.
Where do US capital rules stand in October 2026?
The revised enhanced supplementary leverage ratio for the largest banks took effect on 1 April 2026. The Basel III endgame was re-proposed on 19 March 2026 and its comment period closed on 18 June 2026; no final rule had appeared among the Federal Reserve’s banking-regulation releases by early October 2026.
Where does the book sit in the reading list?
In the risk section of the internal audit reading list, as the argument about capital that the crisis narratives imply.
Related guides
- Internal Audit in Banking: The Complete Guide to the Most Regulated Audit Job — the bank audit context
- Bank Regulatory Thresholds in 2026: The US Ladder, Tailoring Categories, EU, UK and Japan — which rules apply at which size
- Liquidity Risk: Types, Metrics, Warning Signs and How Banks and Companies Manage It — the funding side of fragility
- EVE vs NII: The Two Lenses of Interest-Rate Risk in the Banking Book — unrealised losses and the value of equity
- Board Risk Reporting: The Quarterly Risk Pack That Directors Actually Read — what the board should see
- Too Big to Fail by Andrew Ross Sorkin: Summary and Lessons for Auditors — the 2008 crisis the book responds to
- The Best Books for Internal Auditors — where this book sits among the others
- All book summaries — the full set of summaries for auditors
- Dark Towers by David Enrich: Summary and Lessons for Auditors — a bank whose growth outran its controls.
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