Republicans have another bone to pick with the Fed: Bank capital

Senate Banking Republicans have a new rallying cry against the Federal Reserve: the capital requirements are too damn high.

Several Republicans on the committee, including ranking member Sen. Pat Toomey, R-Pa., criticized the Fed's current capital requirements as overly restrictive during a Thursday hearing that featured CEOs from seven of the largest banks in the country as witnesses. 

"Some seem to think that [with] additional regulation and added capital requirements, there's no cost, so why not?" Toomey said while questioning the panel executives. "It seems to me that there is a cost of adding unnecessary capital requirements on an already well-capitalized institution."

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Sens. Tim Scott, R-S.C. and Bill Hagerty, R-Tenn., echoed these sentiments during their allotted questioning periods. 

Scott, who is next in line to replace Toomey as top Republican on the committee after Toomey retires at the end of the 117th Congress, said if banks are required to hold onto a greater share of their equity to absorb losses, it could lead to fewer loans being issued. This tightening of liquidity could have an outsized impact on small and minority-owned businesses, he added.

"Having been a small business owner, that formula looks like first time business owners [and] minority business owners are going to have a harder time getting the credit they need to grow and strengthen the economy in their neighborhoods," Scott said.

The issue was also raised on Wednesday during a similar hearing held by the House Financial Services Committee, featuring the same CEOs. During that session, Ranking member Patrick McHenry, R-N.C., said higher capital requirements means banks "don't lend as aggressively on the margins."

The calibration of bank capital requirements is the latest addition to a growing list of grievances some Senate Banking Republicans have with the Fed.

Toomey and Scott are part of a cadre of Senate Banking Republicans, along with Sens. Cynthia Lummis, R-Wyo., and Thom Tills, R-N.C., that called for reforms at the Fed in June. Key frustrations among those senators include the Fed's process for granting access to its payment systems, "mission creep" by its research division, and an overall lack of transparency and accountability. 

"I'm concerned about the enormous power that some of the regulators have, especially the Fed, and power that is exercised in an opaque fashion," Toomey said Thursday.

Capital requirements have been under closer examination since Michael Barr was sworn in as the Fed's new vice chair for supervision, the central bank's chief regulatory position, in July. During his confirmation hearing in front of the Senate Banking Committee in May, Barr said he would take a "holistic" approach to bank capital, which led many to brace for sweeping changes to the Fed's various capital requirement mechanisms.

Earlier this month, in his debut policy speech, Barr re-emphasized the need for a review of capital rules and raised the question of whether banks were sufficiently capitalized to deal with an economic shock. He also floated the idea of subjecting large regional banks to similar resolvability requirements to those faced by their global systemically important counterparts.

Barr made few firm commitments during the speech, noting that more formal action would be rolled out in the fall. Instead, he outlined a framework for the upcoming review.

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"When calibrating requirements, we will work to minimize unintended consequences, limit opportunities for gaming, and avoid excess compliance costs that do not result in risk reduction," Barr said. "Taking a holistic view will help us consider adjustments, if any, to the supplementary leverage ratio, countercyclical capital buffer, and stress testing."

Barr's remarks were lauded by Democrats and progressives as a step in the right direction. Republicans and conservatives, meanwhile, view stiffer capital requirements as a foregone conclusion.

"Fed Vice Chair Michael Barr all but indicated during a recent speech at the Brookings Institution that he intends to increase capital requirements for a large number of U.S. financial institutions, even as our economy has suffered two consecutive quarters of negative growth," Hagerty said during Thursday's hearing. "That's the technical definition of a recession."

This year's stress test results have also fueled the debate over capital requirements. All 33 institutions evaluated in the assessment passed with relative ease, with most maintaining well above their minimum capital requirements under the scenario, which was purposefully more strenuous than in 2021. 

But because some banks were forecasted to have slightly greater losses in the 2022 scenario than in the prior year's test, their mandated stress capital buffers for the coming year went up. Several heads of large banks took issue with this outcome, arguing that the test results show the banking system is sufficiently capitalized.

While discussing JPMorgan Chase's second quarter earnings on a call with investors, CEO Jamie Dimon called the Fed's stress testing policy a "terrible way to run a financial system."

Citigroup CEO Jane Fraser and Bank of America CEO Brian Moynihan also noted that changes to their banks' respective stress capital buffers would necessitate capital reallocations.

Dimon spoke out against the stress test in both congressional hearings. On Wednesday he said JPMorgan would one day be "sitting with a trillion dollars, unable to deploy to help our clients." Some bank regulatory experts have taken issue with this description, arguing it mischaracterizes bank capital as money being left idle instead of funding sourced from stakeholder equity and profits rather than deposits.

Still, bank capital is a more costly funding source for banks than deposits or other liabilities, meaning it still makes it harder for banks to issue new loans.

"In this instance, it would crowd out other financings that are needed in the market," Bill Demchak, CEO of PNC Financial Services, said during the hearing. "It's also making it more expensive and difficult for us to lend at a time when our country needs it. Cost of capital went up, funds are being used for something other than supporting our economy. Doesn't make sense to me."

Sen. Sherrod Brown, D-Ohio, chair of the Banking Committee, used his closing statement to highlight the role capital requirements have played in the regulatory regime that helped safeguard the banking system through the COVID-19 pandemic. He added that banks have benefited from many acts of Congress, some of which the industry opposed initially. 

"Let's be clear, you're well capitalized and you thrived throughout the pandemic because of the capital requirements and safety and soundness measures .. we passed in Dodd-Frank, which you lobbied against, I would add," Brown said. "Your depositors had more money in their accounts because we put money in their pockets with the CARES Act, the American Rescue Plan and the Child Tax Credit. You reformed overdraft practices after years of pressure from this committee. Most of what you boasted about today came about either because of laws this committee in the Senate passed or because of pressure we placed on your industry — often despite some of your very expensive and very often effective lobbying efforts."