BPInsights: December 23, 2023

Here are the top 6 false claims from policymakers about the proposal.

False Claim #1: Senate Banking Committee Chairman Sherrod Brown (D-OH): “Absolutely nothing in these rules would stop your banks from making loans to working families, to veterans, to homeowners to small businesses, absolutely nothing.”

Fact: The Basel proposal would make several products and services unviable for banks and more expensive for customers: mortgages with lower down payments, small business loans, and credit cards, to name a few. These costs directly harm consumers. For example, the proposed increase in capital requirements on credit card lines will lead to a reduction in the credit limits available to banks’ customers. This, in turn, is likely to result in lower credit scores due to higher utilization rates of those lines.  And bank customers and those who represent them – small businesses, consumer groups, civil rights groups, asset managers – recognize the truth and are speaking out against the proposal.

  • Consumers, markets and the economy are much better off when large, diversified banks are a stable, low-cost source of funding for their needs.

False Claim #2: The proposal wouldn’t meaningfully affect small business lending.

(Vice Chair for Supervision Michael Barr, House Financial Services Committee hearing, Nov. 15, 2023)

Barr: “The rule that we have proposed would not make significant changes with respect to the cost of credit for small businesses. Under the proposal, small businesses would have, generally speaking the same risk weight that they have under current rules. But it would provide for the ability for small banks to help small businesses to have a lower risk weight, if they meet specified criteria.”

Fact: The cost of small business loans would be affected by the proposal, and small businesses could face more expensive financing.

  • Nearly 90 percent of the rise in capital requirements is attributable to the new capital charge for operational risk, which functions like a universal tax on all banking activities, including small business lending. Furthermore, as banks adjust their balance sheets by moving away from capital-intensive business lines to minimize the effects of the operational risk charge, access to credit to small businesses will diminish as they are typically categorized as capital-intensive.
  • The increase in capital requirements for credit card lines will increase the cost of borrowing for small businesses.
  • Tax equity investments, which support small startups and entrepreneurship, would see their capital charges quadruple under the proposal.

False Claim #3: Only a “tiny fraction” of banks’ “enormous profits” would be necessary to meet the new requirements.

(Senate Banking Committee Chairman Sherrod Brown (D-OH), Senate Banking Committee hearing, Nov. 14, 2023)

Brown: “To be clear, the largest banks will need to redirect a tiny fraction of their enormous profits over a period of several years to get to the new capital levels. Every single bank that would be impacted by this proposal has the capacity to comply with the new levels, new capital levels and extend credit to small businesses and working class and middle class families all while remaining wildly, in most cases profitable.”

Fact: The highest capital increases are several multiples of the 16 percent average provided in the proposal; a healthy banking sector means banks must be investable.

  • Of course banks can comply with higher capital requirements – but only by cutting the kinds of lending and trading that draws the highest capital charges and shrinking their balance sheets.  The impact would be felt by their customers:
    • Studies show that every percentage point increase in capital requirements reduces GDP by about $42 billion per year.
    • For lines of business hit particularly hard by the proposal, such as market-making and providing liquidity to financial markets, the required capital tied to those business lines could double after taking into account the new market risk and operational risk charges. 
  • Banks’ stock returns have trailed the S&P 500 by 250% over the past 15 years; they currently trade on average at around book value, meaning the market ascribes them no franchise value – the rest of the S&P 500 trades at four times book. This is not an industry that can afford higher capital requirements as it fights to show investors it can improve its return on equity.
    • Banks are prepared to meet very stringent capital requirements, but whether or not banks have enough capital is the wrong question. The right questions are: What is the evidence that banks need more capital and what is the opportunity cost to the economy of overly high capital? That opportunity cost is clear: Economic growth, loans to businesses and households and healthy market liquidity.

False Claim #4: The increase in capital required for banks’ lending activities would be very limited, only up to 3 basis points.

(Vice Chair Barr, American Bankers Association event, Oct. 9, 2023)

Barr: “The estimated increase in capital required for lending activities on average—inclusive of both credit risk and operational risk requirements—is limited. Such a rise might be expected to increase the cost to banks for funding the average lending portfolio by up to 3 basis points—0.03 percentage points.2

Fact: Vice Chair Barr’s assessment misstates the numbers and ignores the larger point:

  • His claim fails to account for nearly half of the increase in capital requirements tied to fee income, or $1 trillion in risk-weighted assets. For several banks, almost all of the fee income is tied to lending activities.
    • The so-called operational risk services component includes fee income, much of which is linked to lending activities, such as:
      • Income from the issuance and usage of credit cards
      • earnings from the servicing of mortgage loans
      • fees from syndicated lending
      • revenue from operating leases on auto loans.
    • The effects of the operational risk services component vary based on banks’ business models. Lending would likely be most affected for banks specializing in credit card and auto lending – in other words, banks whose lending share of the services component is nearly 100 percent.
  • Therefore, his claim ignores the fact that in the proposal some business lines do better than others; loans to large publicly traded corporations and wealthy individuals draw relatively low risk weights while loans to small businesses and low- and moderate-income people draw very high risk weights.  Banks will be forced to shift their lending from the latter to the former. 

False Claim #5: The regulators justified the impact of their proposal with thorough economic analysis.

“…[T]he preamble to the rule and the rule itself discussed in detail the analysis that went into each provision of the rule with respect to risk calculation. The rule is designed to improve the calibration of risk for things like trading activity and operational risk, improve the calibration of our standardized approach with respect to credit risk and — and the details of that are discussed in the rule. … in the rule itself, we went through in — in quite detail, for each calibration why we thought the calibration was appropriate. And then for the rule as a whole, the rule addresses the economic costs and benefits of the approach…” (Vice Chair Michael Barr, House Financial Services Committee hearing, Nov. 15, 2023)

Fact: The regulators provided insufficient analysis – and in most cases, zero analysis – to justify either the substantial increase to capital requirements or the calibrations of specific elements of the proposal.

  • Despite having vast amounts of historical data on loss rates, and access to private sector data as well, the proposal contains no analysis of historical loss rates for U.S. banks in setting risk weights. Instead, it defers to a Basel standard adopted years ago in an opaque process that also included no rigorous public data analysis, considered foreign banks as well as U.S. banks, and did not focus at all on the regional banks to which the agencies now propose to cover with the rule.
  • Even then, the agencies deviate from the international Basel agreement in many ways for no apparent reason – and from the stated goal at the time of that agreement not to raise capital requirements overall.
  • The proposal’s lack of public explanation and justification violates the Administrative Procedure Act, a federal law that requires government agencies to make public any analysis underpinning a proposal and  subject both the proposal and any such analysis to public input through notice and comment.
  • The Federal Reserve did eventually begin a quantitative impact study to gather data from the banks to evaluate the effects of the proposal, but it began this process in the middle of its comment period, contradicting the proper analytical timeline of conducting a study, analyzing the results, and then proposing a rule on that basis.
  • The deadline for the study is the same day as the end of the comment period, meaning the public will have no opportunity to review or comment on the results or any resulting agency analysis, violating the APA’s legal requirements.
  • Vice Chair Barr has based much of his capital policy stance on his “holistic review” of capital, which he confirmed in a Senate hearing is not an actual document but exists in his mind.

False Claim #6: Fewer than 40 banks are affected.

(Vice Chair for Supervision Michael Barr, House Financial Services Committee hearing, Nov. 15, 2023)

Barr: “The proposed rules would apply to banks with at least 100 billion in assets, fewer than 40 of the over 4,000 banks in our banking system. Community banks would not be affected by this proposal. The effects for each bank would vary based on its activities and risk profile. Notably, the increases would be most substantial for the largest and most complex banks, the GSIBs. And the bulk of the estimated rise is attributable to trading and other non-lending activities.”

Fact: This statement is highly misleading because the fewer than 40 banks subject to the proposal account for 82 percent of total bank assets. Therefore, it appears to minimize the ripple effects of curtailing credit from larger banks to the real economy. A tax on large banks hurts smaller banks and the entire economy – permanently.

  • The banks affected by the proposal are a significant force in the economy: They make over 2/3 of all loans in the U.S. and nearly all of trading activity by banks in financial markets.
  • Capital increases permanently drag down GDP. Using the same methodology as the Basel Committee, the proposed operational risk requirement would diminish U.S. GDP by close to $90 billion each year.
  • Larger banks often lend to smaller banks, so it is not true that community banks are unaffected by this proposal. These relationships are vital to underserved communities – for example, larger bank lending to minority-owned banks, like CDFIs, which empowers them to, in turn, do more lending in their communities. The proposal would make many types of loans uneconomic for banks, including those to small businesses and CDFIs.
  • The beneficiaries of this proposal would not be community banks, as they lack the scale and diversified expertise to take over the business lines that large banks will be forced to curtail or vacate. Instead, such business would go to nonbanks like hedge funds and private equity firms, to the detriment of consumers. For example, nonbank mortgage lenders tend to foreclose more quickly on customers struggling to pay.
  • The proposal hits lines of business that only larger banks have the scale and expertise to handle. For example, larger banks have the flexibility to keep 30-year home mortgages on their balance sheets. They can serve multinational U.S. companies by helping them hedge their foreign currency exposure. And they can underwrite municipal bonds that finance schools, bridges and hospitals.

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Disclaimer:

The views expressed do not necessarily reflect those of the Bank Policy Institute’s member banks, and are not intended to be, and should not be construed as, legal advice of any kind.