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Shrinking Banks Will Drag Down the Economy

No economic problem in the U.S. can be solved without economic growth. That includes relieving unemployment, funding Social Security, reducing poverty, improving the environment or the multiplicity of other problems that seem to accumulate while recovery is so anemic. Economic growth is elemental.

A key question that must be asked is can there be sustained economic growth in the U.S. without sustained growth of its banks? Maybe so, but there has been no time in the past two centuries when that has occurred. Experience from the early 1990s says no, when a regulatory-induced credit crunch reinforced economic recession.

What do we see when we scan today's landscape? We see sluggish bank growth in line with a sluggish economy. Which is cause and which is effect? I am not sure that it matters, since banking and the economy are so intertwined, from the community to the nation's financial centers. Growth needs and produces financing for good ideas and funds entrepreneurs willing to take a chance on new opportunities. A growing banking system and a growing economy feed each other, and decline in either one will be a drag on the other.

The current banking environment is not encouraging. It includes a regulatory system in crisis as regulators struggle to implement Dodd-Frank mandates while grappling with the many problems involved in the creation of new agencies and the restructuring of the old. There are no new bank charters, other than in connection with failed bank resolutions. We're seeing a relentless assault on bank earnings, whether from the Durbin amendment fixing debit card interchange prices, the Bureau of Consumer Financial Protection's review of overdraft services or the Federal Reserve's squeezing of interest rate margins.

There also is business confusion from a badly conceived Volcker Rule and indecipherable implementing regulations, a plethora of mortgage rules that will raise costs and reduce availability of mortgages to good customers and snuff out the housing recovery aborning, while the proposed Basel III capital rules will shrink the banking industry.

Though not comprehensive, these items form a ponderous chain. Consider the latest and heaviest link, the proposed Basel III capital rules.

In banking, it is possible to have too much of a good thing.When used efficiently, a dollar of capital on reserve allows a bank today to put ten dollars to work as expanded economic activity.  The new Basel rules would demand that banks maintain more dollars on reserve for the same amount of business, or more capital for no new economic work. 

That is a dead weight drag on banks and on the economy. Where is the bank going to get those extra dollars to do nothing new? A tough sell to bank investors: please provide more money that I will squirrel away. Maybe some investors will respond, but if they do, that is money extracted out of the economy. Drag. If the banks cannot get more investor money, they can retain earnings from their shareholders and employees, and away from the economy. Drag. Since capital is a ratio, if the bank is still short on money for the numerator, it can improve its ratio by reducing the denominator, cutting its loans and other assets. More drag.

How much drag? The Federal Reserve estimates banks will need about $60 billion of more capital. But recall that banks multiply capital into ten times the amount in economic motion.  Extracting $60 billion from the economy to do nothing more holds back $600 billion of economic activity.

The experts in Switzerland that worked on designing the Basel III capital blueprint reportedly had only money center banks in mind. Surprisingly, U.S. regulators elected to apply their basic new standards to all banks in one-size-fits-all fashion. That is another big part of the drag. The rules are so complex that no banker, especially no community banker, can be confident of being in compliance after each new loan or each change in the economy. Under Basel III, all banks would have to monitor a whole dashboard of capital measures, including the Tier 1 Leverage Ratio, the Tier 1 Risk-Based Capital Ratio, the new Common Equity Tier 1 Risk-Based Capital Ratio and the Total Risk-Based Capital Ratio, each a different number with a unique definition. Added to each is a new 2.5% capital conservation buffer, on top of which, as New Jersey banker Frank Sorrentino reminded me, every bank will maintain an "examination buffer" reserved for inevitable criticism by wary examiners. The regulatory risk will breed excessive caution at a time when the economy demands energy.

You cannot grow the economy and shrink banks. Let us stop trying. Let us grow both.

Wayne A. Abernathy is executive vice president for financial institutions policy and regulatory affairs at the American Bankers Association.  Previously he served as assistant secretary of the Treasury for financial institutions and as staff director of the Senate Banking Committee.



(12) Comments



Comments (12)
The first question that a banker making a business loan usually asks is "What is the quality of management?" Quality includes "Ability" and "Integrity". Based on the events of this decade, when this question is asked of the current management of major banks, the answer cannot be favorable. Public trust is at an all time low!
And banks like Wells Fargo and US Bank are making loans at 90
Posted by FrankRauscher | Wednesday, August 29 2012 at 12:59PM ET
So True...but with so many who want to continue to blame all banks, including some of those who have commented to this piece, it continues to be hard to get anyone to listen and understand that little banks can only help our economy and present no risk to our economic future unless they are limited in their efforts..
Posted by Rhsmith999 | Wednesday, August 29 2012 at 9:49AM ET
I basically agree with randyh44, possibly a fan of Reggie Jackson.

This gives me a chance to say that you're a bit over the top lately in saying that the advocates of Glass-Steagall need to stop romanticizing it at the same time that you are romanticizing the role of banks in allegedly supporting the economy.

That might have been true back in the 19th century, when the economy was agricultural, and banks made self-liquidating loans, but in the post-WWII era, banks have become decoupled from the economy, and this progression has gotten to the point where it is the banks that drag the economy, and the financial sector needs to shrink in order to allow the economy to grow.

Your discussion of the role of capital as a drag and the idea that banks are entitled to continue to charge interchange and overdraft fees betrays a misunderstanding of the fact that technology enables costs to be reduced and squeezes profit margins to the point where there's no way for banks to survive without constant government support. Banks have long since come to rely on the government as their source of capital, and having to fill that chronic hole is indeed a drag on the economy.

Policies that have allowed banks to operate in a chronically insolvent condition have probably damaged the economy beyond repair, but fostering the growth of banks in order to nurture the cult of banking is the reason why the economy is mired in what seems to be a permanent recesson.
Posted by bob-dc | Tuesday, August 28 2012 at 9:47PM ET
uced environment. As a consequence, many local communities will suffer, as will the people who live there.
Posted by John M. Reich | Tuesday, August 28 2012 at 5:27PM ET
As Economist and Banker much of Dodd-Frank and B3 will shrink large bank balance sheets, and by extension loan books. HOWEVER those banks in the $15B to $49B asset range have a huge opportunity to take market share and make good loans.
Posted by Old School Banker | Tuesday, August 28 2012 at 5:25PM ET
Thank you for putting me in the same camp with Julie Williams. That is the highest compliment I have received in quite a while.
Posted by WayneAbernathy | Tuesday, August 28 2012 at 5:11PM ET
Wayne, you are the same shill as you've always been. What got us into this recession was banks gone wild making unsafe and unsound investments, taking advantage of consumers with things like dual-cycle billing and other hidden "gotchas" while betting the ranch on imprudent investments that nearly collapsed the economy. Then you are too big to fail and get bailed out but it's our fault for trying to bring prudence into the system. Hearing this nonsense just makes me want to bring back Glass Steagall. Let's get bankers who understand safety and soundness and don't all feel they have to be Jamie Dimon. If we had lobbyists unlike you and regulators unlike Julie Williams, we might not be in the predicament we are today.
Posted by randyh44 | Tuesday, August 28 2012 at 5:05PM ET
Boo Hoo to all of you. You have to be kidding me. This whining about regulation as the reason why you are restricting investment is bull. It is unabashed greed and this butt-backwards attempt to deliberately hold up progress just because you can't have everything your way. You poor poor persecuted things. My god, I can't believe the arrogance. The fault for this problem we are in lands squarely on the shoulders of bankers and politicians. Sickening.
Posted by dudeola | Tuesday, August 28 2012 at 4:17PM ET
Great point. The proposed risk weighting rules will have the effect of dragging down lending further in the housing sector in particular. Treating local community banks the same as Wall Street banks will do nothing but penalize the vast majority of the country. What a knee jerk reaction. Big drag.
Posted by scdrb | Tuesday, August 28 2012 at 4:04PM ET
Wow! How in the world did THIS column get past the "AB" editors? This actually SUPPORTS banking, rather than the typical "AB" thinly-veiled attacks on it by liberal-leaning authors who seem to be little more than "big government shills". Well done, Mr. Abernathy. We need more common-sense articles like this one in this publication.
Posted by Johnny Tremaine | Tuesday, August 28 2012 at 3:59PM ET
I agree. Capital has to go to work before people can go to work. The constraints on the banking system are restricting investment and lending as well as the triple whammy of high and increasing regulation; high and increasing taxes; and the unknown costs of the new healthcare mandate. If we do not change course we will be locked in a slow or no growth economy for the foreseeable future.
Posted by petwal | Tuesday, August 28 2012 at 3:30PM ET
As long as politicians continue to blame banker greed for the systemic financial crisis, the "unfair" distribution of income and the dearth of savings and productive investment in the economy, expect them to continue doubling down on counter-productive regulation.
Posted by kvillani | Tuesday, August 28 2012 at 3:06PM ET
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