The Fed Is Ignoring the Biggest Lesson of 2008? We Disagree.

The Fed Is Ignoring the Biggest Lesson of 2008? We Disagree.

BPI and the Financial Services Forum responded to a recent article by the Bloomberg Editorial Board suggesting the Fed should implement the countercyclical capital buffer (CCyB), despite significant increases in capital in the past decade. That response letter is included below:

To the Editor:
We disagree. In arguing that the Federal Reserve has failed to raise bank capital requirements sufficiently, the editorial ignores completely the significant increases in capital in the past decade.

The six largest U.S. banks have roughly tripled their common equity from $270 billion to $772 billion since 2009. The ratio of common equity Tier 1 to risk-weighted assets — the capital ratio generally considered the most loss-absorbing form of capital — for these firms has risen from 4.7 percent to 12.1 percent.

These changes were largely driven by the Fed — most notably, its stress-testing regime, of which the editorial makes no mention. In 2018, the 35 largest U.S. banks showed they held enough capital to remain well capitalized and continue to lend to businesses and households even after enduring a hypothetical financial crisis that included an increase in unemployment from then 4.1 percent to 10 percent; a 65 percent drop in the stock market; a 30 percent drop in housing prices; a 40 percent drop in commercial real estate prices, and a global market shock of unprecedented severity. Still, the editorial argues that the Fed raise capital still higher by imposing a “countercyclical capital buffer,” for three flawed reasons.

First, it notes that the largest U.S. banks have less than $7 in equity for every $100 in assets, and thus presumably should have more. The largest banks now hold — as required by Fed liquidity rules, not mentioned in the editorial — about 25 percent of their balance sheet in cash and cash equivalents.

Second, it cites a widely disputed study from the Federal Reserve Bank of Minneapolis — not the Fed itself — that argues capital requirements should be doubled, even though by that study’s own measure, a capital increase of that size would cost twice as much in lost U.S. economic growth as its benefit from reducing the likelihood of future crises.

Third, the article argues that a countercyclical buffer is in place in some European countries. Although true, those countries — the Czech Republic, Denmark, Iceland, Ireland, Lithuania, Luxembourg, Norway, Slovakia and Sweden — are in a vastly different position in terms of economic growth and capital markets activity, and none of the countries listed has as rigorous a stress-testing regime as the U.S.

The Fed’s framework states the buffer would be implemented when “systemic vulnerabilities are meaningfully above normal.” The Fed, however, has not raised such systemic concerns. The case to raise capital requirements higher has yet to be made. Banks are strongly positioned to serve consumers, businesses, and communities — even during times of economic distress. The Fed should not needlessly impose a requirement that would harm economic growth with little benefit to the safety and soundness of the financial system.

 

Greg Baer
President and Chief Executive Officer
Bank Policy Institute
Kevin Fromer
President and Chief Executive Officer
Financial Services Forum

 

Disclaimer: The views expressed in this post are those of the author(s) and do not necessarily reflect the position of the Bank Policy Institute or its membership, and are not intended to be, and should not be construed as, legal advice of any kind.