A Columbia University finance professor has examined the contentious issue of increasing capital requirements for banks and disputes the claims made by these institutions that the new regulations would stifle lending activities.
According to Professor Tomasz Piskorski from Columbia Business School’s finance division, the impact of higher capital requirements on overall lending by banks would be relatively negligible under the proposed Basel III endgame framework being developed by federal banking regulators.
Contrary to assertions made by banks’ CEOs and consumer advocates, Piskorski highlights that augmenting banks’ balance sheets with additional capital would not necessarily result in the effects claimed by these financial institutions. He points out that balance sheets are not as vital to lending activities as they once were.
Banks typically do not retain loans on their own balance sheets, instead preferring to sell them in the thriving secondary market. Furthermore, banks are gradually reducing their involvement in consumer-facing loans, such as mortgages and car loans, as non-banking businesses increasingly take over these sectors.
Assessing the Impact of Capital Requirements and Potential Benefits
Recently, the Bank Policy Institute and the American Bankers Association issued a 314-page comment letter regarding the Basel III endgame proposal. This followed the closure of the comment period earlier this month. The banking industry has raised concerns about the potential negative effects on the US economy amidst the prevailing macroeconomic challenges of the past year.
In light of this context, it is worth exploring further insights from Fed’s Michelle Bowman, who emphasizes the importance of finding a compromise, and from Fed cop Michael Barr, who ardently defends the need for higher capital requirements.
By delving deeper into the discourse surrounding capital requirements, it becomes apparent that the introduction of such measures could play a vital role in fortifying smaller and mid-sized banks, thereby promoting stability within the financial system.
Banking System Risk Concentrated Among Smaller Banks
A recent study has revealed that the majority of risk in the banking system is currently concentrated among smaller banks with $500 million or less in assets. The study further highlighted that the larger banks, with assets of $250 billion or more, would not be at risk of failure if 50% of the uninsured depositors decided to withdraw their funds. In fact, only five banks with assets of $10 billion or more would be affected. Additionally, the study reported that only four banks with assets of $5 billion to $10 billion would fail, while 10 banks with assets of $1 billion to $3 billion would face failure. Moreover, 22 banks with assets of $500 million to $1 billion and a significant number of 143 banks with assets below $500 million would also be at risk.
Capital Requirements for Largest Banks
There is a growing debate regarding the need for increased capital requirements for the largest banks. Recent academic research following the failure of Silicon Valley Bank and two others suggests that these big banks do not currently face significant insolvency risk. Instead, experts argue that regulators should focus on smaller and mid-size banks. Professor Piskorski, who conducted an analysis on this subject, proposes that capital ratios for smaller banks could be increased by more than 5%, while there is limited necessity to raise capital requirements for larger banks. This finding has been presented to government regulators and discussed at the Basel II roundtable.
Future Steps on Capital Requirements
Following the end of the comment period on the Basel III endgame, it is expected that federal regulators will take several months to develop a modified proposal. The debate surrounding capital requirements for U.S. banks continues.
Also read: FDIC approves proposed capital requirements for U.S. banks