The nation’s largest banks are strongly resisting efforts by the Federal Reserve and other regulatory agencies to impose stringent new capital standards, which proponents say will make “too big to fail” financial institutions much less likely to drag down the entire financial system in a future crisis.
Barry L. Zubrow, chief risk officer at JP Morgan Chase, argued at a recent congressional hearing that federal regulators have done such a bang up job of oversight since the 2008-09 financial crisis that nothing more needs to be done. Putting a capital surcharge on so-called systemically important financial institutions, or SIFIs, “risks doing more harm than good, and putting U.S. firms at a distinct and unnecessary competitive disadvantage globally,” Zubrow said.
In the SIFIs’ view, a surcharge of several percentage points more than the new 7 percent capital standard requirement for internationally active banks not considered too big to fail would lead to lower profits, fewer loans to creditworthy borrowers and slower economic growth.
But Fed Chairman Ben S. Bernanke, who is headed for Basle, Switzerland, for more international discussion of the issue at the Bank for International Settlements on Saturday, isn’t buying that argument. Protecting the whole financial system is more important than protecting profits of the biggest banks the failure of which could potentially lead to another crisis, he said at a press conference Wednesday.
“It’s only been two years since we had the worst financial crisis certainly since the Great Depression and possibly in the history of the United States,” Bernanke replied when asked about the surcharge. “The failure and near failure of large financial institutions was a contributor to that. Since we can’t know what threats will come in the future, possibly the best all-purpose way to strengthen the balance sheets of banks and other financial institutions is capital.”
Bernanke is not alone in calling for higher capital requirements for big banks. Conservative economists concerned about “moral hazard” – the implied promise of a government bailout for any bank deemed too big to fail – have also called for higher capital standards to rein in risky lending by large financial institutions. If the surcharge led the SIFIs to lend less than they otherwise would, well, there are plenty of other banks who could make the loans, Bernanke said.
Fed Gov. Daniel K. Tarullo, the central bank's expert on financial regulation, who will also be in Basle this weekend, said the surcharge is both necessary and justified. “In a period of financial stress,” Tarullo said in a recent speech, “the disorderly failure of one or more SIFIs carries the potential for a devastating impact on the financial system.” That prospect led the Bush Administration to propose the Troubled Asset Relief Program and a reluctant Congress approved it, which was evidence for the proposition that, no matter what their general economic policy principles, government officials faced with a cascading financial crisis that threatens to bring down the national economy will usually support measures to rescue large banks.”
To avoid going that route again, “the regulatory system must address now the risk of disorderly failure of SIFIs,” Tarullo said.
In contrast, JP Morgan’s Zubrow said in his testimony that a 7 percent capital standard, which his bank supports, is tough enough to do the job. After all, he added, JP Morgan Chase entered the crisis with $7 in common stock or similar capital for every $100 of loans and other assets. It not only survived, it also acquired the bankrupt Bear Stearns investment bank and the failed Washington Mutual, a $300 billion savings bank.
But bad as the recent crisis was, a future one might be worse. Even a well-capitalized institution could be done in if it is so intertwined with other large banks and their failure cascaded through the system.
“Direct counterparty impacts can lead to a classic domino effect,” Tarullo said, adding that losses in unusual events can be magnified for firms deeply engaged in trading, structured products, and other capital market instruments when a firm in trouble has to sell its assets into a declining market.
The real point is that no one can predict what might bring on another crisis and what its nature might be. So the SIFI surcharge is like an insurance company charging a higher premium to insure against a loss when the risk involved is greater. The loss in this case is not the cost of a SIFI failure to its managers and stockholders, but to the country at large. And as we know from recent history, that loss can be absolutely enormous.
The U.S. bank push for lower capital standards stands in stark contrast to Switzerland, which has a special concern since it has two SIFIs, the giant banks, USB and Credit Suisse. Their balance sheets dwarf the size of the Swiss economy. Putting the safety of the economy ahead of the banks’ profitability, authorities there have proposed a 19 percent ratio of capital to assets, with more than half that in common equity.
What other countries may be willing to do may be a bit clearer after this weekend’s meeting in Basle. No country wants to put their big banks at a competitive disadvantage if it can be avoided, and having an international agreement on the minimum size of a SIFI surcharge could help avoid that.
On the other hand, the Dodd-Frank financial reform legislation passed a year ago specifically requires such a surcharge for banks with assets of $50 billion or more—and possibly for other some types of financial organizations as well, such as insurance companies. The surcharge, which will be set by a committee comprised of every U.S. financial regulatory agency, may vary according to bank size and the breadth of its involvement with other institutions.
The surcharge undoubtedly will impose some costs on the institutions and, perhaps, on the economy as well if lending were curtailed. Bernanke, however, noted that the Fed makes a cost-benefit analysis of every regulation it proposes, as it will in this case.
Higher capital standards on global banks considered too big too fail could aid community banks in the U.S., officials say. Big banks are able to fund their activities more cheaply than smaller banks precisely because, being too-big-to-fail, they are regarded as less risky.
Higher capital standards will offset part of that existing advantage for SIFIs, Bernanke pointed out.
Related Links:
Financial Reform Reneges on Too Big to Fail (The Fiscal Times)
Federal Reserve: Implementing the Dodd-Frank Act (Wall Street Cheat Sheet)
