Many banking regulations vary based on banks’ size, risk profile and business model. These regulations are based on fixed thresholds, such as the size of a bank’s total exposures. But when these thresholds are not adjusted to account for economic growth and inflation, they can become an unnecessary constraint on banks’ ability to lend. Without such adjustments, banks could face unnecessarily stringent regulations despite their risk level not actually increasing. That mismatch limits banks’ ability to make loans and support the economy, and it contradicts the Congressional goal of tailoring requirements to banks’ different profiles.
- Evolving economy: Economic growth and inflation do not increase risk in the financial system. Sectors of the economy grow proportionally as the economy expands. Households’ incomes rise and their credit improves, so consumers can afford to take out larger loans to buy houses, purchase cars, renovate homes or finance a business. Economic growth enables new businesses to launch and existing businesses to expand their operations. Banks support these activities by extending credit. Inflation causes prices to rise and borrowing levels increase accordingly.
- Overdue: In the 2019 tailoring rules, the agencies “acknowledge[d] the thresholds should be reevaluated over time to ensure they appropriately reflect growth on a macroeconomic and industry-wide basis, as well as to continue to support the objectives of this rule” with a “plan to accomplish this by periodically reviewing the thresholds and proposing changes through the notice and comment process, rather than including an automatic adjustment of thresholds based on indexing.” Now more than five years later, following a period of rapid inflation, that periodic review is overdue, and the case for automatic indexing is clear.
- Indexing for economic growth: Using nominal GDP as a benchmark to adjust the regulatory thresholds established by the banking agencies (that is, the $75 billion thresholds for nonbank assets, weighted short-term wholesale funding, off-balance-sheet exposure and cross-jurisdictional activity) is attractive because it would capture economic growth in a manner similar to the changes already being considered for the GSIB surcharge rule.
- Current context: The need to update regulatory thresholds for economic growth has become more urgent in light of the significant inflation and financial system expansion after the COVID-19 pandemic.
- Examples: The GSIB surcharge imposed on the largest banks is an example of a threshold that should be updated for economic growth. Another example is the tailoring thresholds – nominal thresholds for certain risk-based indicators to determine how much prudential regulations are adjusted for banks of different sizes.
- The largest banks’ capital requirements have increased 10 basis points a year on average, solely based on economic growth and inflation.
