At a Senate Banking Committee hearing last week, Sen. Elizabeth Warren, D-Mass.,
"After the crash of 2008, regulators were supposed to put in place rules to require big banks to have enough capital to cover financial shocks so that taxpayers don't have to do that," Warren said. "But Wall Street executives don't want to have to put up more capital. Higher capital standards make banks safer, but they also nip into profits and make it harder for CEOs to pull in multimillion-dollar bonuses."
I'm not in the habit of quoting the same lawmaker from the same five minute Q&A two weeks in a row — some people are just lucky, I guess — but her observation in support of the Basel III endgame capital proposal struck me as emblematic of a broader presumption that lies beneath a significant portion of the Biden administration's bank regulatory agenda, and one worth exploring in greater depth.
Bank capital is often discussed as a singular thing, a pile of money that banks use to offset losses from loans that go bad or assets that had to be sold sooner than expected. Democrats generally want that pile to be bigger to ensure banks can withstand a wider range of potential losses without needing a bailout. Republicans generally think bank capital should be no larger than absolutely necessary to give banks maximal ability to lend, thereby spurring economic growth.
At the same time, Democrats and Republicans both acknowledge the outer limits of their positions — capital should neither be 100% or 0%, but rather somewhere in the middle, and the debate is about where in the middle regulators should draw that line and how they draw it.
But bank capital, unsurprisingly, is far more complicated than how I just described it. Capital is assessed as a ratio — what proportion of relatively liquid, and presumably safe, assets a bank keeps on its balance sheet relative to its total liabilities — and those ratios can be sliced and diced in any number of different ways based on any number of different assumptions.
Because
In other words, the real driver of a bank's stability is its ability to remain profitable — but there are limits to how far that can go as well. If a bank steers its profits into repurchasing its own shares — which
The point that Warren is making — indeed, that she has been making in the Senate since she was first elected 11 years ago — is that banks have a tendency to steer their profits not into more loans that benefit ordinary Americans but into decidedly less benevolent endeavors like stock repurchases and executive compensation. If they can pay their executives multimillion-dollar bonuses, the reasoning goes, then they can afford to hold more capital to protect the global financial system.
Fair enough, but just as lower capital is not synonymous with economic growth, higher capital is not necessarily synonymous with a safer economy. What the Basel capital proposal really does is realign a number of risk-weighting assumptions about the performance of various assets such that the largest banks will have to hold significantly more capital when all is said and done. A robust, if exceedingly nerdy debate can be had about the merits of the existing assumptions versus those being proposed — and that debate is happening as we speak.
But there is a danger in presuming that because banks are profitable enough that they can afford to hold more capital — and I think they probably can — and that they necessarily should.
Profitability, in banking as elsewhere, is a sign that you moved your capital into the right place at the right time. That by definition means you saw something that everyone else didn't or took a risk that others wouldn't. Sometimes those gambles pay off and sometimes they don't, and so long as those risks aren't overly concentrated, illegal or otherwise ill-advised, banks should be free to make their beds — and lie in them.
