GOP Banking Leaders Find Consensus on Higher Capital, Fewer Rules

WASHINGTON — The chairmen of the House and Senate banking committees appear to agree that banks that hold higher capital should get a significant break on other regulatory requirements.

In separate speeches this week, both House Financial Services Committee Chairman Jeb Hensarling and Senate Banking Committee Chairman Richard Shelby endorsed that idea, arguing that the current regulatory system is too complex.

"I believe that a well-capitalized banking system is much more preferable to the Dodd-Frank approach of regulatory micromanagement," Shelby said Wednesday at the American Bankers Association conference. "Where there is sufficient capital, there should be no need for excessive regulation."

With a lame-duck president and a compressed congressional calendar this year, legislation pushing that idea may be difficult to pass in 2016, but broad agreement on the concept could tee up future action.

Mark Calabria, director of financial regulation studies at the Cato Institute and a former senior staffer for Shelby, said Hensarling is probably looking ahead to the next two years, assuming the Republicans maintain the House.

"I think part of this is trying lay the groundwork to try and get some movement now," Calabria said, adding that Hensarling knows President Obama would likely veto any changes to Dodd-Frank. "I think building the momentum is important for the next administration, so I think there is a degree to which this is trying to lay the groundwork for next year."

During his speech on Tuesday, Hensarling said his proposal would favor higher capital standards and less regulation, which he argued has been trickling down to community banks, hurting their bottom line.

"If financial institutions elect to hold strong Tier 1 capital, then they should gain relief from both Dodd-Frank and Basel's burdensome regulations, neither of which were meant for community banks and shouldn't apply to them to begin with," the Texas Republican said.

Common equity and retained earnings make up the bulk of what regulators consider Tier 1 capital. Banks are required to hold regulatory capital that is the equivalent of 8% of risk-weighted assets, a portion of which must be Tier 1 capital.

"To avail themselves of this approach, some banks will have to raise additional equity capital," Hensarling said.

At its heart, the argument is that banks do not need to pay high costs to ensure they are complying with various complex rules if they hold enough capital to withstand adverse scenarios.

"If what you are worried about is protecting the bank against failure — if you are trying to preserve safety and soundness — there is logic to saying that if the bank has a high enough capital ratio, we are not going to go in and try and micromanage what they are doing, because they've got a big shock absorber to cover it," said Oliver Ireland, a partner at Morrison & Foerster.

Some government officials have made similar arguments in the past, including Federal Deposit Insurance Corp. Vice Chairman Thomas Hoenig, who has been a proponent of a higher leverage ratio as opposed to the current capital requirements that rely on risk-weighted assets.

"Consistent complaints about Basel III and the Dodd-Frank approach to capital are that it creates a really complicated system, but that capital requirements are not actually stringent enough and a simpler leveraged ratio would provide a meaningful capital buffer," said J.W. Verret, who was the chief economist at the House Financial Services Committee from May 2013 until April 2015 and is now a senior scholar at the Mercatus Center at George Mason University.

Verret added that reducing regulations while also increasing capital requirements wouldn't be a pass for big banks, many of which might actually prefer to continue to operate under the current regulatory regime.

"Anyone who says this approach of high and simple leveraged ratio is good for big banks doesn't know what they are talking about. I think this approach is going to be tough on big banks," Verret said.

Shelby said that relying on banks to hold more capital — instead of relying on regulators to ensure institutions are financially sound — might make the system safer.

"An over-reliance on regulators to achieve financial stability can sometimes mean just the opposite," Shelby said.

As Hensarling did on Tuesday, Shelby also endorsed forcing regulators to conduct a cost-benefit analysis to determine whether a federal regulation should be implemented.

"The benefits of this massive effort remain unclear and the costs have yet to be calculated," Shelby said.

However, whether cost-benefit analysis works is debatable. Aaron Klein, director of the Bipartisan Policy Center's Financial Regulatory Reform Initiative, said it is less effective when it comes financial regulation.

"Cost-benefit analysis does not work well for tail-risk events," Klein said.

He added that it may even give the government more power, not less.

"You empower a group of modelers making impossible assumptions with tremendous authority in place of judgment," Klein said.

Ireland called cost-benefit analysis a "nice idea" but said that, in practice, "it is extraordinarily difficult" to implement.

But Verret defended the concept, arguing that it "allows you to apply a searchlight across the board to the entire market and allows you to engage the costs and benefits of rules and effective rules, so I think it is absolutely an important part of rulemaking."