Media reports suggest that bank regulators will soon mandate that larger banks increase their capital requirements. The intent is to decrease the risk of bank failures which then require government intervention.

Such a regulatory move would be poor policy. It would lead to a further reduction in the availability of bank credit. By definition, increasing capital buffers reduces the capital available for credit. Less credit availability reduces economic growth. Banks are already reducing the supply of credit because of general unease about the state of the economy and as a consequence of the failure of Silicon Valley Bank . A further contraction in credit would be yet another drag on economic activity.

This matters. The economy is already slowing because of the necessary but very rapid pace of interest rate increases by the Federal Open Market Committee of the Federal Reserve. By one measure, experts put the probability of a recession this year at 66% . Any further economic slowing could cause the economy to slip from slow growth to outright contraction, resulting in a sharp rise in unemployment.

Moreover, raising capital requirements would, at the margin, force businesses and some consumers to find credit in the "shadow" banking system away from the bright lights of regulatory oversight. When more lending activity occurs in the shadow banking system, risk increases. The shadow banking system is an iceberg where only a small part of the hazard is visible.

To compound the potential policy error of increased capital requirements, the proposed increase in capital ratios would fall most heavily on the largest banks, which already have fortress balance sheets and are subject to frequent stress test audits by the Federal Reserve.

The risk?

Already ultra-safe financial institutions would become even more resilient to financial shocks but at the cost of credit contraction and heightened recession risk. It would be extreme folly to increase overall economic risk in order to reduce risk at already-safe financial institutions. There are obvious alternatives to raising capital requirements in order to reduce risk in the national banking system.

First, the United States has too many banks. The country has over 4,000 banks. Other large, wealthy countries operate efficiently with significantly fewer banks. Policymakers should encourage banking consolidation. Larger banks are better able to diversify risk, both geographic risk and also business-sector risk. Second, with fewer banks, federal banking regulators would be able to conduct more frequent and more thorough audits. The failure of Silicon Valley Bank was a consequence of both management failure and regulatory failure. Finally, in order to discourage excess risk-taking by bank executives, we should enact legislation to authorize banking regulators to claw back for a five-year period compensation paid to the executives of a failed bank. If bankers know that they will lose accumulated wealth for taking excessive risks, they will make prudent management decisions.

Yet raising capital requirements on large banks represents bad policy.

James Rogan is a former U.S. foreign service officer who later worked in finance and law for 30 years. He writes  a daily note  on finance and the economy, politics, sociology, and criminal justice.