No, Making Banks Hold More Capital Is Not Going To Wreck Lending Or The Economy

James 'Jamie' Dimon, chief executive officer of JPMorgan Chase & Co., listens during a panel discussion on the opening day of
James 'Jamie' Dimon, chief executive officer of JPMorgan Chase & Co., listens during a panel discussion on the opening day of the World Economic Forum (WEF) in Davos, Switzerland, on Wednesday, Jan. 23, 2013. World leaders, Influential executives, bankers and policy makers attend the 43rd annual meeting of the World Economic Forum in Davos, the five day event runs from Jan. 23-27. Photographer: Chris Ratcliffe/Bloomberg via Getty Images

Uh-oh, everybody: Bankers are warning that the U.S. economy could be in deep trouble. Not because bankers wrecked it again, like that last time, but because we are being mean to bankers.

Fortunately, these bankers are probably wrong.

Like they do, bank flaks have rushed to warn that the higher bank capital requirements proposed on Tuesday by the Federal Reserve, Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation will slow down lending and economic growth, make U.S. banks less competitive against European competitors and be cruel to puppies and kittens.

The first quote in Wednesday's Wall Street Journal story (subscription only) about the new capital rules, in fact, is just such a warning from a banking representative:

"Ever-higher capital requirements, while a critically important element of safety and soundness, can become prohibitive and actually lead to reduced capability to lend," Rob Nichols, president of the Financial Services Forum, a lobbying group for the Too Big To Fail set, tells the WSJ.

The third quote in that same story (after a quote from former FDIC chief Sheila Bair, for balance) comes from yet another banking flak -- former Minnesota Gov. Tim Pawlenty, now president of the Financial Services Roundtable, another bank lobbying group, who warns that U.S. banks could be "put at a global competitive disadvantage" if they have to hold more capital than other banks.

These are your boilerplate banker arguments against regulation, made most frequently and famously by JPMorgan Chase CEO Jamie Dimon in response to the threat of higher capital requirements and tougher restrictions on bank risk-taking in the wake of the financial crisis.

In fact, these responses are so depressingly predictable that Stanford finance professor Anat Admati and Martin Hellwig of the Max Planck Institute, authors of the recent book, The Bankers' New Clothes: What's Wrong With Banking And What To Do About It, have put together a point-by-point rebuttal of these and several other such arguments. See Claims 9 and 10 and 22 and 23, for starters.

"Many banks, including most of the large banks in the United States, are not even using all the funding they obtain from depositors to make loans," Admati and Hellwig write. "If banks do not make loans, therefore, the problem is not a lack of funds nor an inability to raise more funds for profitable loans, but rather the banks’ choices to focus on other investments instead."

In other words, bank capital requirements don't affect banks' desire to lend money nearly as much as the quality of the borrowers, the economic climate and other factors. That echoes the findings of a 2010 study by Federal Reserve economists Jose M. Berrospide and Rochelle M. Edge, who wrote (emphasis added):

While our empirical results suggest relatively modest effects of both capital shortfalls and capital ratios on loan growth, we find more important roles for other factors such as economic activity and increased perception of riskiness by banks. One interpretation of this result is that banks...give relatively little consideration to their capital position when deciding whether to lend and instead allow other factors such as loan demand and risk to guide their decisionmaking.

More importantly, if banks have more capital, then they will be better-funded and more likely to lend in the next crisis. They will certainly be less likely to need massive taxpayer bailouts, at the very least -- which is the point of this whole capital-raising exercise.

In any event, the capital these banks will need to raise under these new rules will still be fairly modest -- $89 billion or so, split between eight of the biggest banks in the world, over a period of five years. That amounts to $2.25 billion per bank, on average, per year.

"These are banks that on average have profits that exceed $4 billion per quarter, or $16 billion per year," notes Dennis Kelleher, CEO of Better Markets, a financial-reform advocacy group in Washington. "At most, it would impact profits less than 10 percent per year for each of the next five years. So the capital requirement is laughably low."

That $89 billion is also a loogie in the Pacific compared to the estimated $12.8 trillion the financial crisis cost the U.S. economy, according to a Better Markets study.

"When they say financial reform designed to protect the American people and prevent another crisis hurts growth or employment, they completely ignore that the last financial collapse and the next will do more harm to growth, employment and the standard of living of all Americans than any rule or regulation or all of the rules or regulations," Kelleher says. "They never mention that."

As for the issue of whether U.S. banks will lose their competitive edge if they have more capital, that is ridiculous on its face -- measurably healthier banks should have an easier time raising money and attracting customers. What the bank flaks seem to want is for banks to be able to take bigger risks for bigger short-term returns, which is not behavior we exactly want to encourage, is it?

"If some countries foolishly allow their banks to pursue very risky strategies and to borrow excessively," Admati and Hellwig write, "this is not a reason why other countries should do the same."



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