America’s banking sector is an integral part of the nation’s economy. Companies of all shapes and sizes, across diverse communities, rely on the financing banks provide to start, run, and grow their businesses. However, federal banking regulators in Washington, D.C. may soon increase bank capital requirements that could harm businesses and by extension the American economy.
These policy changes, known as “final Basel III” or “Basel III endgame,“ were developed in 2017 by the Basel Committee on Banking Supervision (BCBS) — a standard setting body made up of bank regulators from around the globe. These standards could do significant harm to main street businesses and the U.S. economy if banking regulators fail to make some major changes when implementing the capital requirement.
Understanding capital requirements
America’s banks are overseen by an alphabet soup of federal regulators each with distinct but interrelated responsibilities, including setting rules requiring banks to hold a certain amount of capital as a means of protecting against losses on loans and investments. Here, “capital” primarily means shareholder equity and financial assets that fund lending and can be used to absorb losses. This capital serves as a buffer to help prevent banks from failing but comes with significant costs to banks, and by extension to their customers.
How businesses bear the cost
When capital requirements for banks are increased, they are forced to choose between offering less financing to customers or offering it a higher cost. As a whole, increasing capital requirements makes it more expensive for banks to provide financing to corporations, main street business, and consumers.
Research from the Basel Committee on Banking Supervision – the body that devised the new capital standards – has shown that more stringent bank regulations make bank credit more expensive for borrowers. In addition, for every percentage point increase in capital requirements, there is an associated increase of up to 13 basis points in loan spreads. Last month, the Wall Street Journal reported that large banks may be required to increase their capital by more than 20 percent.
More on Business Funding Challenges
PwC recently published research (Basel III Endgame: The Next Generation of Capital Requirements) finding, “To meet higher capital requirements, banks may reduce their trading inventories, thereby lowering market liquidity.” This means, for example, it could be more expensive for banks to provide liquidity in the corporate bond market which will increase the cost of financing for these businesses. The report also finds that requiring banks to increase capital for their trading activities will make it more expensive for businesses to hedge market risk, such as foreign exchange risk and interest rate risk.
More of the capital that would otherwise be used for productive economic purposes such as loans to businesses or helping manage risk through derivatives will have to sit idly at banks. So, if you’re an entrepreneur looking to start a new business or an existing business looking to obtain financing to expand, there will be fewer financing options, and at higher prices.
Is it necessary?
The Federal Reserve Board’s most recent Financial Stability Report found: “The results of the 2022 stress test indicate that large banks would maintain capital ratios well above the minimum risk-based requirements even during a substantial economic downturn.” So, is a capital increase on our banking system necessary?
There’s no dispute that capital is important to maintaining a healthy banking system, but policymakers must consider the tradeoffs. That’s why since the 2008-2009 financial crisis, large U.S. banks have substantially increased the amount of capital on their balance sheet. Recent issues, such as at Silicon Valley Bank, were a result of poor management decisions that crippled the confidence of depositors and investors. The proposed changes to capital requirements were not designed to address these types of issues.
Now that America’s largest banks are well-capitalized, we must ask if it is necessary to offload the cost of more regulation onto America’s businesses?
About the authors
Bill Hulse
Hulse oversees the day-to-day efforts of CCMC including policy development, advocacy, and communications.
