Capital relief is good for big banks and the economy
The nation’s largest banks have been instrumental in supporting the economy through the coronavirus pandemic, providing vital assistance to consumers and businesses and facilitating critical financing from government programs.
To ensure the banking industry can be a key source of support during the crisis, regulators rightly made temporary and targeted adjustments to certain regulations.
Yet, some critics including in a recent BankThink op-ed, have shown a clear misunderstanding of big bank capital levels and the objective of the Federal Reserve in navigating one of the most serious economic crises to ever hit the U.S. and global economy.
The author argues that regulators “gutted” large bank capital by temporarily excluding deposits at the Federal Reserve and U.S. Treasuries from the supplementary leverage ratio’s (SLR) risk-insensitive measure of total exposure, which determines the amount of capital required by the SLR. A few points should be noted in response.
First, regulators have long held that risk-insensitive leverage capital requirements are intended to be a backstop to risk-based capital requirements. Prior to the crisis, the minimum capital requirement for a risk-based capital measure, called Tier 1, was 4% of risk-weighted assets. Today, that minimum stands at 6%, a 50% increase.
What’s more, over the past decade banks have significantly improved both the quality and quantity of capital maintained. Financial Services Forum members, for instance, have grown their capital base by $260 billion and substantially raised capital levels as a proportion of the risk-weighted asset base.
Regulators rightly made a temporary change to the SLR standard in the pandemic to help ensure that risk-insensitive leverage requirements do not move to the fore and become the binding capital constraint. This would further distress capital markets and the ability of banks to provide credit to businesses and households during an unprecedented economic disruption.
Second, large banks are currently bound by the Federal Reserve’s new capital policy announced in late June with this year’s stress test results. All large banks are prohibited from making any share repurchases through the third quarter and dividend payouts are frozen at previous levels.
Accordingly, it is hard to understand how large bank capital will decline significantly as the Federal Reserve has actively taken steps requiring banks to conserve capital. These measures outweigh any potential impact that the temporary change to the SLR could have.
Some critics also maintain that the finalization earlier this year of the stress capital buffer (SCB) rule — which was first introduced during the Obama administration and ties large bank capital requirements to stress testing — somehow represents a big bank giveaway.
Yet the Federal Reserve’s analysis showed that the SCB will have the effect of raising capital for global-systemically important banks (G-SIBs) by roughly $46 billion on average, while at the same time lowering capital requirements for smaller banks. Given that the analysis shows the SCB final rule raises capital for G-SIBs, it is difficult to understand how one would assert that the SCB represents a weakening of the large bank capital regime.
Also, this year the Fed opted not to set bank capital distribution policy with regard to the SCB. Rather, the Fed is using a new “sensitivity analysis” to determine bank capital distributions.
This year’s sensitivity analysis found that 75% of all large banks subject to the stress tests — a universe that goes well beyond the G-SIBs — would maintain capital levels above the minimum requirement.
In the parlance of the previous stress testing regime, most banks actually passed the stress tests, but are still being required to conserve capital per the Fed’s new capital distribution policy. Accordingly, the suggestion that somehow large banks are either not well-capitalized or are shedding capital simply does not add up.
All of the capital modifications announced by the Fed are temporary and explicitly designed to deal with the coronavirus crisis to help ensure that banks of all sizes can continue to support the economy in this time of great need.
Data and existing research convincingly show that large banks have been playing an outsized role in supporting the U.S. economy. Indeed, research from Boston College and Federal Reserve staff further documents that the bulk of corporate lending during the pandemic has come from large banks, showing these institutions have risen to the occasion during such trying times.
The Federal Reserve and other regulators are wisely and judiciously making temporary adjustments to certain capital rules to ensure that formulaic and risk-blind capital requirements do not unnecessarily cinch the flow of credit, which is so crucial to managing through this crisis. The Fed’s modification of the SLR in these exigent times is a shining example of what a good regulator should do in a crisis.
It is not a “rollback” or “weakening” of anything. Rather, it illustrates the central bank’s resolve in putting the economy and people ahead of inflexible rules.
As the economic and public health data clearly show, the nation is not out of this pandemic yet. Regulators should continue to prudently modify regulations that risk unnecessarily crimping private credit expansion, which would present even more challenges to an already unstable economic recovery.