New rule hurts the U.S. economy
As bankers, financial experts and regulators sifted through the financial rubble in 2009, many came away with the conclusion that banks were undercapitalized, and lacked the equity to back up their assets.
Last week, the Federal Reserve approved a rule requiring eight systemically important banks to hold additional capital. Its purpose is to retain financial stability in the United States in the event of a bank failure. But it may not be doing enough to facilitate lending and stimulate economic growth.
To remedy the excessive leverage that was common before the financial crisis, lawmakers and regulators have sought to reduce capital ratios, requiring banks to support assets (loans) with greater proportion of equity to provide a cushion against asset decline.
Basel III, an international banking accord adopted after the financial crisis, did just that. Now capital ratios for major banks worldwide are as low as 10 to 1. However, the Fed now asserts that capital ratios need to be even lower.
This creates at least two challenges for lenders. First, U.S. banks compete globally, so when the Fed requires them to hold more capital than non-U.S. banks, they lose market share.
The second problem is subtler, but just as significant. Today the rate at which money changes hands — an important gauge of commerce that economists call “money velocity” — is far lower than it has been at any time in the past 40 years.
While current economic standards are not necessarily favorable for a thriving housing market, legislators are on the right track toward increasing stability in the nation’s financial system. The new rule and related legislation will no doubt support a market that protects taxpayers.
But legislators and industry participants must continue to push for legislation that doesn’t stifle lending, and allow them to continue to operate in a competitive manner and to execute the kind of lending that strengthens the economy.
Excessive regulation runs the risk of leaving a fragile economy starved of the capital it needs to grow. It is critical that regulatory policy encourages banks to get back into the business of lending again, something they have been reluctant to do in the wake of the financial crisis.