It’s a truth universally acknowledged that big banks resist when the government proposes more financial regulation. This familiar story is playing out once again as regulators around the world seek to impose higher capital requirements on systemically important banks — those deemed “too big to fail.” This is a fancy way of saying they want banks to set aside larger rainy-day funds so they won’t need taxpayer bailouts in the next crisis. Prominent bankers argue there’s no need for the proposed rules, known, arcanely, as Basel III endgame. JPMorgan Chase chief executive Jamie Dimon has called Basel III “flawed and poorly calibrated.” Industry lobbyists claim banks will have less money to lend if they have to use it for their capital cushions.
Big banks have made similar warnings every time regulators have called for higher capital requirements since the calamitous 2008 financial crisis. Yet the financial system is still flourishing. Loans remained widely accessible after past capital increases, economic research has found (though lately borrowers are struggling with high interest rates). Ratcheting up capital levels a bit now is wise, given the uncertain geopolitical and economic climate. But it would probably be safe to increase them less than regulatory agencies — the Federal Reserve, Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency — proposed last summer. The agencies’ plan received a deluge of overwhelmingly negative public comments. In their final rule, regulators can come up with a compromise; and the ideal time to release it would be before the November elections.
Bankers do make one compelling argument: The financial world has changed dramatically in the past 15 years, but the Basil III endgame looks backward to problems like those that precipitated the 2008 crisis instead of focusing forward to new sources of risk.
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Consider Silicon Valley Bank’s collapse a year ago. On paper, the bank had sufficient capital in the form of government bonds purchased before the Federal Reserve hiked interest rates. But it faced a run on deposits when it became apparent that those assets lost value as interest rates stayed high — which the bank had failed to anticipate. The Basel III endgame proposal rightly lowers the threshold for heightened scrutiny to $100 billion in assets as opposed to the previous standard of $250 billion in assets. (Silicon Valley Bank had about $209 billion just before its demise.) But the new rules emphasize operational risk at banks — the risk of losses from flaws in an institution’s internal controls — not interest rate risk.
Another problem is that regulators are still not paying enough attention to the big players in the financial system that are not banks. Roughly half of global assets are now held in mutual funds, insurers, hedge funds and microfinance entities, up from 43 percent in 2008, according to the Financial Stability Board. Whereas regulators meet frequently with bank leaders and perform annual stress tests on large banks, which gives regulators a pretty good understanding of where the pitfalls and risks are, there’s far less transparency in the non-bank sector. Hence its nickname, “shadow banking.” This month, the International Monetary Fund warned that shadow banks could see “large, unexpected losses in a downturn.” The Basel III endgame does essentially nothing to address that risk.
And yet the heated debate over Basel III has diverted energy and attention from the issues around non-banks. Last month, Federal Reserve Chair Jerome H. Powell testified before Congress. Lawmakers from both parties asked repeatedly about his position on Basel III. Mr. Powell said he expected “there will be broad and material changes to the proposal” and that he was “confident” the final proposal would have broad support “both at the Fed — and in the broader world.” In contrast, there were few questions about the growth of the non-bank sector and the novel risks it might pose. And in response to those queries, Mr. Powell played it safe, opining that regulators have to be smart about potential problems, without offering concrete ideas.
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More than a decade and a half ago, the behavior of big banks was indeed central to the global financial crisis. They made excessively risky bets on home loans and complex financial derivatives. When it became evident that they had lost those gambles, the ensuing chain reaction of defaults destabilized the global financial system and subjected millions to foreclosure and unemployment. Today, however, the big banks have a point that this is a risk of which everyone is well aware and against which their balance sheets are largely protected. A brand-new form of financial crisis seems likelier than a repeat of the last one. In that sense, Basel III endgame’s main shortcoming is failure of imagination.
