An article in the Wall Street Journal argues that for investors to continue to see banks as good investments, the banks need an ROE of at least 12%. The average ROE for U.S. banks in 2012 was only 7%. The article states that ROE for U.S. banks has declined since the financial crisis in part because banks have “set aside more capital and reduced the debt they can take on to turbocharge profits.”

a. Why would banks have set aside more capital and reduced debt as a result of the financial crisis?

b. Why would increasing capital and reducing debt have reduced banks’ ROE?