With the Senate's passage of the financial regulatory bill last Thursday, it is all but certain that Congress will approve the most sweeping overhaul of banking regulations since the Great Depression.
The intent, of course, is to prevent future crises. Everyone applauds that goal.
But as lawmakers reshape our very complex industry, we urge caution, particularly in the areas of capital and liquidity requirements.
Lawmakers and regulators need to understand that banks provide fuel for the economic engine. And to provide that fuel, they need to be able to produce a reasonable return on equity.
If that return is not there, investors will not be there either. Capital will be hard to come by.
And less capital means fewer dollars available for lending. Fewer loans for business mean less employment, reduced spending and a weak or stagnant economy.
Higher liquidity requirements would have a similar effect, depleting the funds available for lending to businesses, corporations and consumers.
We agree some new regulation is needed.
After all, the crisis caused considerable anxiety and pain as retirement funds lost value, homes were foreclosed on, small businesses went under and jobs were lost.
But is it fair to blame banks for all of this suffering?
Of course not.
As we all know, many of the problems affecting the markets today originated outside the regulated banking industry. Indeed, the government itself is responsible for the historically low interest rates that pumped up the mortgage industry.
Our global economy adds another twist to the problem of capital and liquidity. Before the crisis, European banks and regulators, unlike their U.S. counterparts, focused on risk-weighted assets and capital. This meant that banks could hold significantly less capital for assets that were deemed not very risky, such as Treasury bonds.
We think they had the right idea. Less risky assets should be subject to lower capital requirements. But now, all regulators want more capital.
The Risk Management Association's capital working group has argued that the leverage ratio proposed by the Basel Committee would work against a well-structured, risk-based capital requirement.
The leverage ratio would give institutions an incentive to shift toward higher-risk activities for which the best-practices estimate of risk capital is higher than the leverage-ratio requirement.
Such a shift toward higher-risk activities driven by a leverage-ratio minimum was experienced in the U.S. during the commercial credit crisis in the late 1980s and early 1990s and also during the run-up to the current crisis.
Intertwined with minimum capital requirements is the consideration of pro-cyclicality and the need to recognize that banks should not be put in the position of having to raise capital or increase reserves in times of economic stress.
This means establishing a more sophisticated approach to capital regulation that would employ "through-the-cycle" risk estimates and put less reliance on "point-in-time" requirements.
It demands adopting a more forward-looking accounting model for reserving based on expected losses that would let bankers more accurately account for credit losses throughout the economic cycle.
There is a clamor for strict leverage limits to be set by Congress and enforced by the regulators. Congress lacks the expertise to set lending limits — and if it were to set limits that are too restrictive, the economy could be adversely affected.
The amount of leverage an institution can safely sustain could change, depending on the risks on its balance sheet and changing economic conditions. Flexibility is needed when setting limits. An experienced regulator is a much better judge of financial institutions' safety and soundness than is Congress.
The public demands a solution that guarantees against a future financial crisis.
Everyone, especially the financial services industry, would like to prevent another crisis, but we question whether such a guarantee is even possible. The issue is complex and fraught with uncertainty, extending beyond political borders.
We in the industry must make sure that Washington understands the direct link between leverage and profitability — and between profitability and the economy's general well-being.