Banks 'flying blind' without cumulative data on regulatory proposals

Bloomberg News

Regulatory changes, both adopted and proposed, have been in ample supply in Washington as of late, but banks and analysts alike say it's hard to know just how those changes will fit together, in part because government forecasts have been scarce.

The Federal Reserve, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency have called for new risk-capital standards, long-term debt requirements for all banks with at least $100 billion of assets and changes to a capital charge leveled against the nation's biggest banks. On top of that, regulators last week finalized a long-awaited Community Reinvestment Act rule that would affect most U.S. banks.

Despite the overlapping nature of these proposals, there has been no effort to reconcile their combined impact on the banking sector or the broader economy, Karen Petrou, managing partner of Federal Financial Analytics said. 

"There is no cumulative impact statement from the agencies, and that's just a profound failure of analytical rigor," Petrou said. "The agencies not only seem unable to do cumulative impact analysis, but weirdly unwilling to despite the suggestions that they're working on something 'holistic.' It's puzzling."

Without a comprehensive overview of how these potential rule changes would interact with one another, banks and their representatives say regulators are running the risk of accidentally inducing bad outcomes. 

"Without having that kind of holistic, encompassing economic impact assessment, you have a real risk of effectively flying blind, and the risk of unintended consequences rises dramatically," said Sean Campbell, chief economist and head of research at the Financial Services Forum, a large-bank industry group. "It's really important that regulators have a comprehensive understanding of the potential impact of the suite of rules they are proposing and that they make that assessment available to the public. That is fundamentally important to making sure the rules are calibrated in a way that makes sense for the entire economy."

Some regulatory officials have also been wary of the multiple regulatory efforts being pursued concurrently and their potential cumulative impact. Fed Gov. Michelle Bowman has noted that the array of policy moves could "reshape the contours of the bank regulatory framework in meaningful ways."

Bowman has not called for an all-encompassing economic impact analysis, but she has emphasized the importance of research in ensuring that regulators respond appropriately to apparent shortcomings, including those exposed by a string of bank failures this past spring.

"Before we undertake reforms intended to address issues that led to bank failures, we need to develop a comprehensive understanding not only of those root causes, but also of the costs and unintended consequences of potential reforms," Bowman said in a speech last month. "Research can protect against over-reactive regulation, especially that which is not efficient, calibrated and tailored to address the actual risks and challenges facing the banking system."

Private sector groups have published forecasts about specific proposals and are advising individual banks on how specific change might impact them directly. But, despite calls from trade associations for a cumulative accounting of these multiple policy changes, none have undertaken the task themselves.

Francisco Covas, executive vice president and head of research at the Bank Policy Institute, said calculating sector- and economy-wide changes from potential policies is squarely the role of the regulatory agencies themselves. He added that, even if BPI or other groups wanted to take up the task, the exercise would be too costly and time consuming, with logistical hurdles too high for anyone but the regulators to clear.

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"The number one challenge is resourcing and data," Covas said. "We would need to have a broad set of data — most of which is confidential — and we would need it from a long period of time, which the Fed already collects. To get all that data and all the proper agreements in place, by that time the comment period would be closed and we'd have a final rule."

One area of particular concern is how the long-term debt proposal — which uses a so-called "capital refill" methodology, requiring a bank to hold enough debt to fully replenish its going concern capital, should it be depleted — would interact with new risk-based capital rules in the so-called Basel III endgame package. 

In the footnotes of their long-term debt proposal, the Fed, FDIC and OCC acknowledge the new capital rules, if adopted, would "mechanically increase" total loss absorbing capacity, or TLAC, requirements for some banks. As a result, several global systemically important banks would fall short of their debt requirements. The document also argues that if banks hold more capital, their long-term debt costs should actually decrease. But there is no detailed analysis of how the two rules would work in tandem. 

Stakeholders would also like to see comprehensive analysis of other changes that have been floated and finalized recently, including the long-awaited CRA reforms. Though that package has no impact on capital requirements, it stands to influence key banking activities, such as mortgage lending — which would also likely be impacted by the Basel III endgame proposal. 

Similarly, the Fed's proposed change to the cap on fees charged to merchants for debit card transactions — which was also issued last week — would not conflict with other policies directly, but Petrou said it would contribute to a more challenging overall funding environment that could cause banks to raise prices or offer fewer services to lower-income customers. 

Petrou said regulators are not statutorily bound to provide comprehensive analysis on all these policy moves, but she said choosing not to amounts to a "grievous analytical failure," one that could jeopardize already vulnerable communities. She added that fulsome analysis could help the agencies make the case for the changes they seek.

"One of the things that's really stunned me is not just the lack of cumulative impact, but frankly the poor quality of each of the proposals' impact sections," she said. "Leaving aside whether you agree or disagree with the conclusion, it's extraordinarily unpersuasive work."

The Basel III endgame proposal is often cited for its lack of impact calculations. The document is more than 1,000 pages long but fewer than 20 pages are dedicated to economic analysis and are solely on the changes at hand, not concurrent proposals. 

In an apparent response to the calls from banks and other groups for more time and information, the Fed extended the comment period on the capital proposal and launched a data gathering campaign to explore the potential impact of the changes. But, the comment period on the proposal will close before results of the collected data could be shared. 

Because of this, some in the sector say the gesture is too little too late, arguing that the time to collect and analyze data was before making the proposal. In September, several bank trade groups sent a letter to the regulatory agencies urging them to make more data available to the public then re-propose the rule with a fresh comment window.

Dennis Kelleher, head of the consumer advocacy group Better Markets, said such a step is not necessary, noting that any additional information that comes from the data collection only needs to be opened up to public comment if it leads to a material change to the proposed rule.

"All of it is irrelevant unless the data is relevant to the rule," Kelleher said. "Under the [Administrative Procedures Act], the public has to have a fair opportunity to comment, we know that's the case, so if it is material to the rule, then there will be an extension or a reopening and the banks will get their wish. But nobody knows what the data will show."

Kelleher said most regulatory changes that have been finalized by bank regulators under the Biden administration have included some changes in response to comments. He expects the same to hold true with the current slate of proposals being considered. 

He also said impact analyses of all scopes are biased toward not increasing regulatory standards, arguing that while costs incurred on banks are easily quantified, the benefits of a sounder financial system are difficult to ascertain. 

"The industry always wants to do a quantitative cost-benefit analysis, because it always benefits them," Kelleher said. "Quantitative cost-benefit analysis is usually industry-cost-only analysis, because the benefit to the public of having a financial system — a banking system that doesn't collapse — is incredibly hard to quantify."

Industry groups refute this claim, noting that the financial and other losses incurred during the subprime mortgage crisis were often cited during the passage and implementation of the Dodd-Frank Act. 

Others say the benefits of conducting a broad cumulative analysis are dubious in their own right. 

Nathan Stovall, director of financial institutions research at S&P Global Market Intelligence, said it is nearly impossible to forecast how exactly the various proposals will impact banks when taken in conjunction with one another, particularly because their implementations will be spread out in stages over several years. He also noted that, to some degree, the banking sector is getting ahead of regulators, with many banks increasing their capital preemptively. 

Stovall said the regulatory changes — as well as the more aggressive approach to supervision being taken by government examiners — will have significant impacts on the banking sector over the coming years. But, he added that he does not expect the additional hardships to be more than the sector can handle. He pointed to the sweeping reforms that came out of Dodd-Frank as proof that banks can absorb regulatory changes. 

"Ten years ago, we saw way more changes, and they were things regulators had never done before," Stovall said. "This is more like a turning of the screws rather than coming in with a sledgehammer."