Surely hell has a special place reserved for big bank advocates using a worldwide health crisis to pursue their deregulatory agenda. Witness a note issued by Bank of America on Tuesday calling for a weakening of financial regulations across the board — and pointedly, asking a panicky Congress to provide it, bypassing regulatory authorities who know better, or at least should know better. The BofA note — which echoes a whispering campaign being waged by big bank lobbyists — contains sweeping arguments to essentially undermine every meaningful reform implemented after the 2008 financial crisis.
But before addressing this unabashed promotion of self-interest by one of the country’s biggest banks, let’s start by acknowledging that there is a semblance of rationality underlying BofA’s arguments. During times of stress, it does make sense to temporarily loosen bank capital and liquidity rules. Indeed, the post-2008 crisis regulatory framework is designed to accomplish that result, without the need to resort to legislation. Both the liquidity rules (which require that banks keep a certain amount of highly liquid assets on their balance sheets) and the capital rules (which make banks more resilient by limiting the amount of debt banks themselves can use to fund themselves) have built-in buffers that are meant to be used in a downturn. And it may well be time for bank regulators to encourage banks to dip into those buffers. But the mechanisms are already in place for them to do so as regulators signaled this week.
Why loosen rules in a crisis?
Quite simply because in times of stress, credit demands on FDIC-insured banks increase. Financing available from non-bank sources- bond markets or lenders which use capital market sources for funding — tend to contract. Banks, with their stable base of FDIC insured deposits, are in a better position to keep lending, so borrowers turn to them. We can see that happening now. Companies are drawing down their credit lines with banks, as funding through other sources, such as the commercial paper market, shrinks.
But these increased draws come at the expense of banks’ own supply of readily accessible cash. They also create additional credit risk for banks, as some of these draws may not be repaid. As a consequence, banks’ own liquidity is reduced and capital as a percentage of its growing risk exposures shrinks. This puts banks in danger of breaching their regulatory minimums, in which case they would need to pull back on lending, which is exactly the opposite of what the economy needs. That is why relief from those regulatory minimums can be justified.
Of course, the system works best when banks are required to substantially increase their capital and liquidity buffers during good times, when earnings are robust and credit losses are low, so that they have ample cushions when economic conditions sour. The post-crisis framework also provided for something called a “counter cyclical capital buffer” or CCyB, enabling regulators to require banks to build extra buffers on top of the supplemental capital requirements embedded in the rules. Unfortunately, the Fed has refused to invoke the CCyB and in fact has allowed banks over the past few years to pay out, on average, more to shareholders than they have earned. This has actually depleted bank capital levels. It would be nice to have that capital now for banks to fall back upon. But we will have to deal with the situation as it exists.
Banks should use all means to conserve capital
Unfortunately, BofA wants Congress to go far beyond the relief already built into the rules, weakening virtually every aspect of post-crisis reforms and going far beyond capital and liquidity relief. BofA wants to weaken restrictions on high risk trading, let securities affiliates use stable FDIC-insured banks to support their high risk operations, scale back “living will requirements” which are designed to avoid future bailouts, and gut a key capital metric called the leverage ratio. They apparently also want capital and liquidity relief without the conditions built into the current framework — that banks restrict shareholder payouts and discretionary bonuses. But this trade-off makes sense. If regulators are going to give relief on bank capital, banks in turn should use all available means to conserve capital by retaining earnings, instead of paying them out.
And regulators should maintain those restrictions on capital distributions — if anything, tighten them — instead of loosening them as they announced they would do on Tuesday. Any responsibly managed bank should be using all available means to conserve capital at this point in time.
Big banks breached the public’s trust in 2008, then lobbied against meaningful reforms, and now seem to be using the crisis to pursue an unnecessary and dangerous loosening of rules — rules that are designed to keep the financial system safe and stable in times like these. They have a fair argument in asking regulators to allow banks to dip into their capital and liquidity buffers. They do themselves a disservice by disingenuously over-reaching to persuade politicians to undertake a complete unraveling of post-crisis rules.
Sheila Bair is the former Chair of the FDIC and has held senior appointments in both Republican and Democrat Administrations. She currently serves as a board member or advisor to a several companies and is a founding board member of the Volcker Alliance, a nonprofit established to rebuild trust in government.