Shrinking Banks Will Drag Down the Economy

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No economic problem in the U.S. can be solved without economic growth. That includes relieving unemployment, funding Social Security, reducing poverty, improving the environment or the multiplicity of other problems that seem to accumulate while recovery is so anemic. Economic growth is elemental.

A key question that must be asked is can there be sustained economic growth in the U.S. without sustained growth of its banks? Maybe so, but there has been no time in the past two centuries when that has occurred. Experience from the early 1990s says no, when a regulatory-induced credit crunch reinforced economic recession.

What do we see when we scan today's landscape? We see sluggish bank growth in line with a sluggish economy. Which is cause and which is effect? I am not sure that it matters, since banking and the economy are so intertwined, from the community to the nation's financial centers. Growth needs and produces financing for good ideas and funds entrepreneurs willing to take a chance on new opportunities. A growing banking system and a growing economy feed each other, and decline in either one will be a drag on the other.

The current banking environment is not encouraging. It includes a regulatory system in crisis as regulators struggle to implement Dodd-Frank mandates while grappling with the many problems involved in the creation of new agencies and the restructuring of the old. There are no new bank charters, other than in connection with failed bank resolutions. We're seeing a relentless assault on bank earnings, whether from the Durbin amendment fixing debit card interchange prices, the Bureau of Consumer Financial Protection's review of overdraft services or the Federal Reserve's squeezing of interest rate margins.

There also is business confusion from a badly conceived Volcker Rule and indecipherable implementing regulations, a plethora of mortgage rules that will raise costs and reduce availability of mortgages to good customers and snuff out the housing recovery aborning, while the proposed Basel III capital rules will shrink the banking industry.

Though not comprehensive, these items form a ponderous chain. Consider the latest and heaviest link, the proposed Basel III capital rules.

In banking, it is possible to have too much of a good thing.When used efficiently, a dollar of capital on reserve allows a bank today to put ten dollars to work as expanded economic activity.  The new Basel rules would demand that banks maintain more dollars on reserve for the same amount of business, or more capital for no new economic work. 

That is a dead weight drag on banks and on the economy. Where is the bank going to get those extra dollars to do nothing new? A tough sell to bank investors: please provide more money that I will squirrel away. Maybe some investors will respond, but if they do, that is money extracted out of the economy. Drag. If the banks cannot get more investor money, they can retain earnings from their shareholders and employees, and away from the economy. Drag. Since capital is a ratio, if the bank is still short on money for the numerator, it can improve its ratio by reducing the denominator, cutting its loans and other assets. More drag.

How much drag? The Federal Reserve estimates banks will need about $60 billion of more capital. But recall that banks multiply capital into ten times the amount in economic motion.  Extracting $60 billion from the economy to do nothing more holds back $600 billion of economic activity.

The experts in Switzerland that worked on designing the Basel III capital blueprint reportedly had only money center banks in mind. Surprisingly, U.S. regulators elected to apply their basic new standards to all banks in one-size-fits-all fashion. That is another big part of the drag. The rules are so complex that no banker, especially no community banker, can be confident of being in compliance after each new loan or each change in the economy. Under Basel III, all banks would have to monitor a whole dashboard of capital measures, including the Tier 1 Leverage Ratio, the Tier 1 Risk-Based Capital Ratio, the new Common Equity Tier 1 Risk-Based Capital Ratio and the Total Risk-Based Capital Ratio, each a different number with a unique definition. Added to each is a new 2.5% capital conservation buffer, on top of which, as New Jersey banker Frank Sorrentino reminded me, every bank will maintain an "examination buffer" reserved for inevitable criticism by wary examiners. The regulatory risk will breed excessive caution at a time when the economy demands energy.

You cannot grow the economy and shrink banks. Let us stop trying. Let us grow both.

Wayne A. Abernathy is executive vice president for financial institutions policy and regulatory affairs at the American Bankers Association.  Previously he served as assistant secretary of the Treasury for financial institutions and as staff director of the Senate Banking Committee.


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