With new, proposed capital rules set to debut this summer, some in and around the banking sector worry that stringent requirements could inadvertently make the financial system less safe.
The key issue for certain policymakers and analysts is whether heightened regulatory standards will push more lending activity away from banks and toward less-regulated entities, such as insurance companies,
"Rising bank capital requirements may exacerbate the competitive dynamics that result in advantages to nonbank competitors and push additional financial activity out of the regulated banking system," Federal Reserve Gov. Michelle Bowman
Regulators are poised to unveil a string of regulatory initiatives in the coming weeks and months, including a proposal for the
If regulatory changes play out as expected, large banks could face higher capital charges for certain operational risks related to activities such as securities brokerage and investment advisory. Other expenses, like a requirement to purchase long-term debt — an obligation currently faced by the largest banks that could be extended to all banks above the $100 billion threshold — could increase the cost of doing business across the board.
Greg Lyons, a partner at the law firm Debevoise & Plimpton, said activities like credit to middle market corporations, in which banks are already going head to head with private funds more frequently, are prime candidates for migrating to the nonbank sector. Meanwhile, access to other, less profitable types of loans, such as auto and commercial real estate, could dwindle if banks have to pull back.
"[Regulators] are basically telling banks that operational costs and capital are going to go up significantly, but unless merger approvals are easier to obtain, they can't grow in a way to get economies of scale to offset that," Lyons said. "So, the only practical option left for many is to reduce their balance sheet. All that does is drive more business out of the regional and super regional banking sector."
The question of whether theoretical economic or financial stability implications should shape regulatory policies is a philosophical one on which Washington's regulatory officials have a range of opinions.
Barr,
Similarly, Federal Deposit Insurance Corp. Chair Martin Gruenberg has also acknowledged that the nonbank sector poses a significant threat to financial stability — in both the U.S. and internationally — but
"It's a key risk area that requires great attention, but it requires great attention on its own terms," Gruenberg said during the question and answer portion of a speaking engagement at the Peterson Institute for International Economics
Gruenberg said mitigating the stability threats of nonbanks should be left to the Financial Stability Oversight Council, of which he is a voting member. Barr has also suggested that FSOC should explore
But some see this two-track approach to regulation as shortsighted.
"It's just a game of pass the potato," Karen Petrou, managing partner of Federal Financial Analytics, said. "That's an analytically unfortunate approach to thinking about capital requirements."
Petrou said one of the goals of regulatory reform should be to reduce unintended consequences. While anticipating those consequences can be difficult, she said risk moving outside the banking system is a well-established reaction to higher regulatory requirements. She pointed to the residential mortgage market, which has been dominated by nonbanks since the reforms implemented after the subprime lending crisis of 2008.
Once a
"The idea was a very constructive one, but I think it will be extremely hard to pull off if by the time we start thinking holistically we've redesigned the system so incrementally that it's operating in a wholly new way," she said.
Others see the issue of nonbank risk in a very different light. Dennis Kelleher, head of the advocacy group Better Markets, argues that if higher capital requirements lead to risk migrating out of the banking system, it would be a win for financial stability.
Kelleher said there is little evidence that lending is moving from banks into systemically important nonbanks. Instead, he said, most of this activity is being absorbed by middle market firms whose failures would have little impact on the broader economy. He pointed to the bankruptcy of the derivatives firm
"To the extent lending is being provided for higher-risk activities that the banks no longer participate in is a good thing, because it's a migration of risk from systemically significant banks to non-systemically significant nonbanks," Kelleher said. "Therefore the threat to the financial system in the economy has actually been reduced."
Kelleher said nonbanks becoming so large that they are systemically important is a separate issue that needs its own solution.
"Yes, systemically significant nonbanks are not adequately regulated," he said. "The answer is not to under regulate banks. It's to properly regulate nonbanks."
