As federal regulators prepare to
Several bank groups
Banks have three options for building capital: retaining earnings, reducing the level of risk on their balance sheet or shrinking. All three options lead to fewer profits being paid to investors and thus increase the cost of capital for banks. But how this translates to bank-level lending activity, let alone the broader economy, is difficult to decipher.
"What we hear most from those opposed to higher capital requirements has been fairly qualitative and not grounded in robust data," said Alexa Philo, a senior policy analyst for the consumer advocacy group Americans for Financial Reform and former Federal Reserve bank examiner. "I have not seen a credible data driven study that makes this case."
Research findings on the subject vary greatly. A
Similarly, a
"There are a lot of widely varying results, so we can come up with some very basic truisms, but with some caveats," Peter Earle, an economist with the American Institute for Economic Research, said. "The first is that the impact of the changes of [capital] requirements are going to have on lending is partially going to be influenced by the economy in which that change takes place."
For the banks likely to see the greatest impact from the
For banks between $100 billion and $250 billion of assets, the current environment is not ideal for building up equity. Many of these so-called large regional banks are still dealing with lower levels of deposits and depressed stock values as a result of this past spring's banking crisis.
Along with higher funding costs, some of these banks are also expected to see their earnings hampered by their relatively high exposures to troubled assets, such as commercial real estate loans. Komal Sri-Kumar, an independent economic consultant and fellow at the Milken Institute, said this dynamic puts regulators in a difficult position.
Imposing higher capital standards on these banks before they fully recover from recent stresses risks exacerbating their issues, Sri-Kumar said. This raises the threat level for a potential "credit crunch," in which enough banks reduce lending simultaneously to have a tangible impact on the overall economy. At the same time, he noted, the failures of Silicon Valley Bank, Signature Bank and First Republic Bank indicate that there is some amount of capital inadequacy among large regional banks, and the window for implementing needed reforms will only be open for so long.
"It is probably an inappropriate time to be looking for more capital to be raised when capital raising is so difficult and more expensive, but, on the other hand, they have to be very conscious of the political backlash if they do not increase the regulatory requirements," he said. "The Congress is watching and they are going to say, 'Well, you already had a crisis in March. Did you guys not learn anything? Why did you not toughen up the regulatory concerns?' So if you're Michael Barr, I don't see how you get out of this mess."
Barr, who outlined his view for capital reform in a speech Monday, has emphasized that capital reforms are a long way from finalization, let alone implementation. The Fed, Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency will issue a joint notice of proposed rulemaking this summer, which will kick-off a months-long public comment period. After that, regulators will take several more months to process the input and adjust the final standards accordingly. Barr has also noted that after the rules are adopted, banks will have years to get into compliance.
But research, including a working paper
"This is just the opposite of what the U.S. financial system needs as we face the growing likelihood of a recession and credit crunch," Rep. Andy Barr, R-Ky., said in a statement this week.
Yet, those who favor higher capital standards argue that the pullback in lending following previous capital increases was the result of banks curtailing high-risk activities that had little impact on the real economy.
Dennis Kelleher, head of the consumer advocacy group Better Markets, said the reduction of credit following implementation of the initial phase of the Basel III reforms was the result of banks pulling back from subprime mortgage lending and abandoning collateralized debt obligations and other "socially useless" financial instruments.
"More lending is not necessarily objectively good. It can lead to credit bubbles and other pockets of stress," Kelleher said. "The question should not be is there enough credit available for every possible borrower. The question is whether the credit that goes to the real productive economy is flowing."
Others say raising capital requirements for the largest banks could be complementary to the Fed's ongoing effort to temper rapidly rising costs by curbing economic activity. This dynamic could make it politically difficult for lawmakers who have urged the Fed to be more aggressive on taming inflation to also argue against higher capital requirements, Michael Redmond, a former economist for the Treasury Department and the Kansas City Fed, said.
Redmond, now a policy economist for Medley Advisors, said raising capital requirements for banks with $100 billion or more of assets could actually help level the playing field between large banks and smaller ones — which are more sensitive to rising rates as they tend to pay more for core deposits than their larger competitors.
"Critics are saying this is going to restrain lending, that it's going to hurt small businesses that rely on bank loans. But I'm not so sure that makes sense as a critique of this plan, because the Fed is already trying to restrain credit through monetary policy," Redmond said. "It's not clear to me that there's an advantage to only restricting credit through monetary policy as opposed to having their oars rowing in the same direction and restricting credit across the whole banking system by also raising capital standards on the large banks."
While academic studies about the costs and benefits of bank capital have produced a wide array of data, there are some common findings. Higher capital standards increase costs for banks and many of those expenses are passed along to borrowers and customers. These trends often correspond with marginally slower economic growth.
At the same time, better capitalized banking systems typically perform better in periods of crisis, leading to fewer economic losses. Because better capitalized, less risky banks can also access cheaper debt — though these savings are outstripped by higher equity costs — some capital proponents say it is wrong to frame the debate around regulations as a choice between economic growth and financial stability.
"The claim that we need to tolerate a fragile banking system in order to preserve economic growth is nonsense," Marc Jarsulic, chief economist at the advocacy group Center for American Progress, said. "Banks that use more equity to finance their business are less likely to become insolvent if assets on their balance sheets lose value. This will help reduce output-reducing episodes of financial instability."
Jarsulic added that higher capital requirements will "incentivize more efficient decisions" about who and what they finance, because the downside risk to shareholders will be greater.
Bank groups agree that holding a sufficient amount of capital is key to protecting financial stability and continuing lending activity through periods of distress. But, they contend that they are already sufficiently capitalized, pointing to last month's Fed stress test results and their collective ability to withstand recent real world events, including the COVID-19 pandemic and this spring's run of bank failures.
"The bottom line: these new Basel capital requirements would only make it harder for banks of all sizes to meet the needs of their customers, clients and communities," American Bankers Association President Rob Nichols said in a statement this week. "Policymakers, who consistently cite the breadth and depth of our banking system as a source of strength, have not yet shown that these reforms will preserve that unique banking diversity or outweigh the significant costs to the U.S. economy."
—Ebrima Sanneh contributed to this report.
