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Can Policymakers 'Fix' the Banking System and Foster Economic Growth? Can Policymakers 'Fix' the Banking System and Foster Economic Growth?

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ANALYSIS

Can Policymakers 'Fix' the Banking System and Foster Economic Growth?

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Under the Basel 3 requirement, capital surcharges would apply to some 28 unidentified institutions internationally expected to include, among others, Goldman Sachs, whose CEO Lloyd Blankfein testified before the Senate in April.(AP Photo/Susan Walsh)

A recent furniture commercial features a 1989 Queen song that repeats the refrain “I want it all” three times followed by, “and I want it now.”

This message not only apparently sells couches but also evokes the spirit of the American psyche and could be part of the reason why so much frustration and disappointment is associated with the nation’s financial services policy.

 

Policymakers at once want banks to help promote economic recovery by financing business and consumer loans, while also fixing their underlying problems, like overleveraging and poor underwriting that helped fuel the financial bust the country cannot seem to crawl out of.

But directives to lend more and shore up are running into tension. Critics are questioning whether these are mutually exclusive goals that need to be reprioritized, or if both policy leaders and bankers simply need to recalibrate their expectations for growth and mending.

In the “economy should come first” camp are bankers who argue potential growth is being stymied by the onslaught of regulations, like higher capital standards and increased legal risk stemming from efforts to settle claims from faulty mortgages. Regulators, on the other hand, contend that fixing fundamentals first will help rebuild confidence and put the economy back on sounder footing with sustainable investments.

 

The latest battle came on Wednesday with the Basel Committee on Banking Supervision, an international body of regulators that sets banking standards, announcing it had agreed to require the world’s largest and most systemically significant institutions to hold additional capital buffers of between 1 percent and 2.5 percent, or roughly $200 billion, depending on a bank’s systemic importance.

It comes on top of another requirement known as Basel 3 that banks hold capital equal to 7 percent of risk-weighted assets, and the two are slated to be phased in between 2013 and 2019.

The capital surcharges would apply to some 28 unidentified institutions internationally and is expected to include at least Goldman Sachs, JPMorgan Chase, Citigroup, Morgan Stanley, Bank of America, and Wells Fargo, in the United States. Banks that fail to comply could be hit with an additional 1 percent surcharge. But each member nation takes its own approach to adopting Basel accords, timetables often slip, and the U.S. would go through its own comment and review process first.

The banking industry has loudly criticized such surcharges as counterproductive to economic growth. JPMorgan Chase chief executive Jamie Dimon called the capital buffers “anti-American” earlier this month and challenged Federal Reserve Board Chairman Ben Bernanke in June by asking if the “cumulative effect” of regulations could be why “it's taking so long for credit and jobs to come back?”

The Clearing House, the nation's oldest association of banks, complained about the pending capital surcharges in a letter to Treasury Secretary Timothy Geithner this week, saying they would decrease the banking industry’s return on equity by 4.9 percentage points and could increase borrowing costs to consumers by 60 basis points.

 

"These costs can be expected to dampen prospects for economic and job growth,” wrote Paul Saltzman, the president and general counsel for the group.

Analysts said the move is intended to make it less attractive to be a mega-sized global interconnected institution, and could ultimately force banks to shrink.

Still, many argued that capital is not what is putting a damper on lending right now.

Sheila Bair, a senior adviser at Pew Charitable Trusts, who stepped down as chairman of the Federal Deposit Insurance Corp. in June, told National Journal that most big U.S. banks are at, or near, targeted capital levels, and have plenty of time to phase in additional requirements.

She said banks are sitting on piles of cash and are more constrained by risk aversion and decreased borrower demand than they are by capital.

“The impact on credit availability and credit costs is really overstated. The system is awash with liquidity right now.... I don't think that higher capital is going to have any kind of a significant impact on economic recovery.”

It is true that it increases banks’ costs to hold more capital but they can use that money as leverage to provide loans and fund other activities.

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