Like hemlines and hairstyles, trends in bank rules seem to shift with the times.
Just three years ago, regulators suggested that the biggest banks needed about 19% more capital to protect against potential losses. Now, after a furious industry reaction and personnel changes at key agencies, they're recommending a decrease of some 6% in aggregate, in hopes of reducing complexity and boosting lending. That's after capital ratios had already started drifting lower.
Unfortunately, the benefits of these latest proposals are likely to be marginal at best. More certain is that they'll make an already highly levered financial system even riskier.
Streamlining the rules is undoubtedly appealing. The new proposal would do this, in part, by allowing the largest banks to use one method to calculate the risk of their assets instead of two, as currently required. That makes sense as far as it goes. Yet other requirements -- including leverage ratios and certain capital surcharges -- are being loosened or otherwise made more bank-friendly at the same time. The risk is creating a rule book that's more lenient but still overly complicated.
A second objective for the administration is to help banks play a bigger role in lending to homeowners and businesses. Fintechs and other nonbank lenders have come to dominate residential mortgages, while investment funds are now aggressively lending to companies. Banks say that their regulations and elevated capital requirements are to blame. No doubt there is some truth to that -- banks are held to a higher standard because they benefit from deposit guarantees and other forms of federal support.
But there are also other reasons behind the shift. According to one study, fintechs are 20% faster at processing home-loan applications than other lenders. Another found that competition from nonbank mortgage providers is associated with a lower ratio of customer complaints. Private credit funds, meanwhile, have used their ability to move nimbly and customize loans to win over corporate borrowers. More bank leverage is unlikely to reverse such trends.
Even with freed-up capital, moreover, it's far from clear that banks will start making more loans to Main Street. Instead, some are looking to expand trading units, return money to shareholders and make new acquisitions. They'll also be tempted to lend more to their nonbank competitors, which already make up their fastest-growing loan segment.
Instead of trying to goad banks to win back market share, regulators should focus on their ability to manage exposure to these opaque and risky "shadow banks." One way to do so would be to raise capital requirements on certain categories of nonbank loans.
But losses tend to emerge in surprising places. For decades, regulators have struggled in their quixotic effort to identify the "correct" level of bank capital for each asset. In the name of streamlining, they should instead bolster leverage ratios -- the most sweeping measure of how much shareholder money is available to absorb potential losses.
After all, administrations come and go, but a strong and stable financial system will always be in the national interest.
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