Will pandemic compel Congress to ease bank capital requirements?

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WASHINGTON — It may be getting too late in the current stimulus talks for Congress to ease a Dodd-Frank Act capital requirement, but the measure sought by large institutions and the Federal Reserve could make a comeback in future pandemic relief, observers said.

The Fed and congressional Republicans have pushed the idea of weakening the minimum capital benchmark known as the Collins amendment, at least temporarily, as part of the negotiations for a new round of coronavirus aid. They say the amendment makes it harder for institutions to support economic growth especially with this past spring’s deposit surge, which required banks to raise capital.

Many say that, even though talks are ongoing, Congress is unlikely to address the capital measure in the Phase 4 stimulus bill, with Democrats opposed to changes and lawmakers focused on more immediate economic effects from the pandemic. But with deposits expected to keep growing, and Congress shifting from economic rescue to recovery, easing the capital rule could come back into play.

“I think in this round, it’s not going to get attention, but it needs to because this is [important to] the next phase of recovery,” said Dec Mullarkey, managing director at SLC Management.

Senate Republicans are considering a provision in their $1 trillion Health, Economic Assistance, Liability Protection and Schools Act that would give the Fed temporary authority to lower the Tier 1 leverage ratio below the capital "floor" set by Dodd-Frank, and exclude certain low-risk assets in banks' calculation of that ratio.

The amendment, offered by Sen. Susan Collins, R-Maine, was included in Dodd-Frank as a way to strengthen large banks' balance sheets. It was intended to prevent large banks that follow international agreements on risk-based capital rules to set their capital levels below those for smaller banks.

But with deposit growth at an all-time high of $2 trillion since January, supporters of congressional action say higher capital resulting from deploying that liquidity has hamstrung banks from supporting areas of the economy that need help.

“Somebody's got to … reemploy people once this thing is over, and they're going to need capital, and the banking system is the major source of that,” said William Dickens, a professor and chair of the economics department at Northeastern University.

Senate Banking Committee Chairman Mike Crapo, R-Idaho, told reporters last week that negotiations on including revisions to the Collins amendment in the stimulus bill were ongoing to “see if we can get that worked out,” according to published reports. A spokesperson for Crapo declined to say where the negotiations currently stand.

Deposits surged from $13.2 trillion in January to $15.5 trillion in June, according to data from the Fed and the Federal Deposit Insurance Corp. The sudden growth is attributed to stock market volatility as well as the federal government’s efforts to prop up the economy with stimulus checks, aid to small businesses, enhanced unemployment benefits and the Fed’s massive intervention in the form of unlimited asset purchases.

Regulators already addressed similar concerns about rising deposits related to the so-called supplementary leverage ratio for large banks. In April, the Fed temporarily allowed banks to exclude Treasury securities and deposits held at Federal Reserve banks from the calculation of their supplementary leverage ratios.

Banks have sought a similar change in how their Tier 1 leverage ratio is calculated. But the Fed cannot lower the minimum amount of Tier 1 capital for banks without Congress revising the Collins amendment.

“If Congress chooses to do this, we would want it to be explicitly temporary. This will not be a permanent change in capital standards," Fed Chair Jerome Powell said at a July 29 news conference. He added that leverage ratio relief would allow banks to grow their balance sheets “in a way that serves their customers.”

Giving the Fed the authority to adjust the Tier 1 leverage ratio for banks could indeed enable financial institutions to make more loans to businesses looking to reopen, agreed Dickens.

“This seems to me to be something that's really important, which is maintaining the viability of the banking system,” he said.

But not everyone is in agreement that banks would use capital relief in order to make loans to their customers. Jeremy Kress, an assistant professor at the University of Michigan and a former Fed lawyer, said exempting safe assets like Treasury securities and cash from the Tier 1 leverage ratio — as the Fed already did with the SLR — would be “counterproductive for incentivizing banks to make credit.”

“I don’t think the Fed has been upfront about their motivations for this,” said Kress. “It’s not about giving banks more leeway to lend; it’s going to push them to hoard their deposits, invest in cash and Treasuries.”

Kress argued that banks should be continuing to build up their loan-loss reserves instead of putting that money to use elsewhere.

“The expiration of government stimulus efforts is a reason to have bigger cushions for the loan losses that we know are coming,” he said. “When the government stops providing stimulus is when we’re going to start seeing write-downs and defaults, and that’s precisely when they need to have the capital cushion.”

The disagreement over how exactly banks would take advantage of more capital relief is fueling the partisan debate surrounding potential revisions to the Collins amendment.

Sens. Sherrod Brown, D-Ohio, and Elizabeth Warren, D-Mass., sent a letter July 30 to Fed Vice Chairman for Supervision Randal Quarles pressing him on his request that Congress consider adjusting the Collins amendment.

“Your requests for Congress to weaken the rules put in place after the 2008 financial crisis to protect our financial system are outrageous and irresponsible, and we are writing to seek an explanation for why — during a historic economic crisis — you are seeking to hand out regulatory favors to big banks that would harm the economy and increase systemic risks,” the letter said.

Congress would probably need to set up clear guardrails to address Democrats' concern about banks taking on too much risk if the Collins amendment is changed, Mullarkey said.

“It's a challenge, and that's why it has been very explicit and very targeted, because otherwise then it's just an open opportunity for [banks] to actually do anything with that capital,” he said.

Dickens said he believes the residual mistrust of the banking system from the financial crisis could also be driving the pushback to including revisions to the Collins amendment in the final stimulus bill.

“One of the results of the mishandling of the 2008 crisis was there's a real public resentment against supporting the financial system, which I find to be very destructive,” he said. “And I think that a lot of the Democratic opposition to what's being proposed in terms of Tier 1 capital regulation is playing off of that.”

Ultimately, it’s unlikely that easing the Collins amendment will make it into the stimulus bill unless Republicans are willing to make it a priority, said Ian Katz, an analyst at Capital Alpha Partners.

“There are things being discussed that are unlikely to get into a final bill but could if the party pushing for it is willing to give something in exchange,” he said. “It's just a question of what Republicans would give in exchange for it. Or, put another way, how much do they really want it.”

However, if COVID-19 cases continue to surge and hinder reopening plans, it will be something Congress will have to address, said Mullarkey.

“I do think this will come to a point … if the economy still seems to be stop and go, businesses are really struggling and bankruptcies are rising, I think they'll really have to deal with this issue, but in some way that also incents banks to lend,” he said.

American Banker reporter Brendan Pedersen contributed to this article.

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Federal Reserve Minimum capital requirements Coronavirus Deposits Lending Sherrod Brown Elizabeth Warren Dodd-Frank