Many people seem to think that when authorities increase capital requirements, banks lend less. The advocates of this view go on to argue that, since credit is essential for economic growth, we should not impose overly tough constraints on banks. Put another way, a number of people believe that we have gone too far in making the financial system safe and the cost is lower growth and employment.

Treasury Secretary-designate Steven Mnuchin appears to share the view that financial regulation has restrained the supply of credit: in a recent interview, he is quoted as saying “The number one problem with Dodd-Frank is that it’s way too complicated and cuts back lending.” One interpretation of this is that Secretary-designate Mnuchin will support proposals like House Financial Services Chair Jeb Hensarling’s Financial CHOICE Act to allow banks to opt for a simple capital standard as an alternative to strict regulatory scrutiny.

Our reaction to this is three-fold. First, for most banks, which are very small and pose little threat to the financial system, a shift toward simpler capital requirements—so long as they are high enough—may be both effective and efficient; for the largest, most systemic intermediaries, higher capital requirements should still be accompanied by strict oversight. Second, we see no evidence that higher bank capital is associated with lower lending. In fact, quite the opposite. Third, given that the 2007-09 financial crisis was the result of too much borrowing—and that over-borrowing is a leading indicator of financial crises—it follows that not all reductions in lending are bad. We take each of these points in turn.

Last week we wrote about the Minneapolis Plan to End Too Big to Fail and its proposal to sharply increase equity in the 13 largest banks in the country. Specifically, the Minneapolis Plan calls for a pure leverage ratio—the ratio of common equity to total assets—of at least 15% and possibly as high as 24%. The current requirement is 6%, and the CHOICE Act would require only 10%. Unlike the CHOICE Act, the Minneapolis Plan also embraces important aspects of current regulation (including stress tests and living wills) to contain the systemic risks of the largest, most complex, and most interconnected banks, while simplifying regulatory compliance for small banks that do not pose a threat to the financial system. Our view is that the Minneapolis Plan provides a solid basis for legislation that would advance the public goal of making the financial system safe in a cost-effective way.

Important in this conclusion is our judgment that higher capital does not hamper the aggregate supply of credit. The alternative view appears to posit a choice between bank balance sheet shrinkage, on the one hand, and credit growth, on the other. In fact, there is no inconsistency between making banks safer and ensuring long-run growth of credit. To see why, recall that from the bank’s perspective, equity capital is one of the sources of funds while loans and securities acquisitions are uses of funds. That is, the former is a liability while the latter are assets. In theory, an increase in bank equity can be used to fund an increase in credit provision.

But that’s theory, what about experience? Here, the evidence is compelling: strong banks lend to healthy borrowers, weak banks don’t. We have written about this on several occasions. First, we noted that those countries with better capitalized banking systems in 2006, prior to the start of the crisis, experienced stronger lending growth during and after the crisis. That is, higher capital did not slow the economy. Second, we reported on research at the BIS establishing that better capitalized banks experience lower funding costs, higher growth of debt funding, and higher growth of lending volumes.

Further evidence comes from scholarly studies of Japan and Europe. Caballero, Hoshi, and Kashyap describe how, in the 1990s, regulatory forbearance delayed a thorough recapitalization of Japan’s banks for more than a decade. As a consequence, insolvent banks made loans to keep insolvent borrowers afloat. In their study of the impact of the ECB’s recent actions, Acharya et al. conclude that extremely accommodative monetary policy had a similar impact. That is, undercapitalized euro-area banks had an incentive to evergreen loans to “low-quality” firms.

These results rely on data from a range of countries. What happens in the United States when bank capitalization rises and falls? To answer this question at an aggregate level, we have plotted below bank credit (relative to GDP) on the vertical axis and bank capital (relative to assets) on the horizontal axis. The filled-red circle at the top right is the most recent observation from the third quarter of 2016.

Commercial bank credit (ratio to GDP) and equity capital (percent of bank assets), 1992-3Q 2016