The federal government’s Basel Endgame proposal will have real costs for everyday Americans. These capital requirements will create a drag on our economy for years to come — and will hurt working families and small businesses.
The recently unveiled proposal from the Federal Reserve, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency aims to require financial institutions to hold significantly higher capital, as much as 16–19% more, depending on the size of the institution. This would limit banks’ capacity to offer things like mortgages, car loans, credit cards and small-business loans.
For many, the dream of owning a home will become more elusive, as the proposal drastically increases the capital charge for home mortgages with lower down payments, putting homeownership further out of reach for many buyers.
Small businesses will struggle because the proposal will make it harder to obtain financing, meet payroll and support their local communities.
Regulators claim this is necessary to protect the stability of the financial system, but it will have real consequences for families and small businesses across the country.
When capital requirements are set excessively high, it makes it much harder to secure a loan or credit — this is especially true for working families and small businesses.
Bank capital requirements in the U.S. have increased significantly since the Global Financial Crisis, largely driven by the post-crisis reforms of Basel III and stress testing. Common equity tier 1 capital (the highest quality and most reliable form of capital) increased nearly 3.5x since 4Q07.
Every year the Federal Reserve conducts a stress test of banks to determine whether banks have enough capital on hand to withstand a severe economic downturn — a hypothetical scenario that is often so severe that it assumes a recession worse than any since World War II. Banks’ performance on these tests and their ability to withstand real-world scenarios like COVID-19 demonstrate their resilience. Additionally, the “loss-absorbing capacity of large banks” (the amount banks can withstand losing without requiring emergency support) was $2.8 trillion as of the end of 2021. That’s 9x higher than the banks were estimated to lose during the Fed’s 2022 stress test.
Banks will be required to treat certain businesses and business activities as riskier than others, which could have a disproportionate effect on small businesses, municipalities, middle-market and large corporates, mutual funds, pension funds, insurance companies and corporates that use derivatives to hedge risks.
It further increases costs for mortgage borrowers with less than 20% down payments – the borrowers most affected by rising prices.
Banks would be less able to extend or increase credit card limits and home equity lines of credit (HELOCs).
Credit utilization rates factor into FICO scores, so a reduction in credit availability would reduce FICO scores, thereby further increasing borrowing costs for many prospective homebuyers.
It is based on an agreement struck among U.S. and global regulators without Congressional mandate or the protections of the Administrative Procedure Act. It was never submitted to the U.S. Senate (as is done with other international agreements). It was never formally approved by the OCC, Fed or FDIC. The deliberations and decision-making at Basel were never made public.
The agencies have continued the opacity in their own processes. Although Vice Chair Barr promised to conduct a “holistic review” of U.S. capital requirements, no records of the review were made public. The agencies failed to provide any meaningful analysis as explanation and justification for the proposal.
The proposal lacks a robust benefit analysis to justify the capital increases. The proposal includes a dedicated section titled “Impact and Economic Analysis,” with two separate sections focusing on the effect on lending and trading activity. However, concerning the economic effects, the proposal merely references academic papers without conducting any actual analyses of how bank behavior would change, considering their current balance sheets and capital targets.
Only a few weeks before the proposal was released to the public, Federal Reserve Governor Lisa Cook testified that she was not provided an opportunity to review a draft of the 1,000-plus-page proposal.
U.S. Senate Committee on Banking, Housing, and Urban Affairs Executive Session, June 21, 2023
Congress recognized that not every bank poses the same level of risk; therefore, not every bank should be held to the same rules. The new proposal effectively reimposes a “one-size-fits-all” regulatory standard and represents a de facto repeal of the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA, also referred to as “S.2155”).
Private capital markets—private equity, hedge funds, loan mutual funds, finance companies and business development companies—have significantly increased their market share since the adoption of Basel I in early 1990s.
The adoption of this proposal would further boost the migration of business debt and other types of lending (mortgages) to nonbanks.
Academic studies generally find that borrowers are generally worse off borrowing from nonbanks than from banks, as nonbanks are:
- Charging significantly higher interest rates than banks do
- Lacking the funding or the expertise to conduct loan workouts
- Unable to provide liquidity to their borrowers during a crisis
No.
Instead of increasing stability, this will increase risk by creating market instability outside of regulators’ reach and pushing consumers to unregulated, more expensive financial services products. Private equity and hedge funds are exempt from the Basel requirements, and they will reap the benefits of diverted banking demand, driving higher consumer costs and greater market instability.
The capital requirements set by the Federal Reserve will have a dramatic effect on the U.S. economy. Studies show that every percentage point increase in capital requirements slashes about $42 billion of domestic output per year.
The banking agencies should engage in a robust and thorough economic analysis of the proposal’s effects. Federal agencies need to go back to the drawing board and ensure that future policy allows millions of low-income Americans and small businesses to thrive.