There is another storm on the horizon for the banking community — a heavy dose of government controls. Today’s regulatory and interest rate environment continue to discourage bank lending.
Following the April meeting of the Federal Reserve’s Open Market Committee, policymakers said the “economic recovery was proceeding at a moderate pace” The Fed also said it would end in June the aggressive monetary policy of purchasing longer-term Treasury bonds.
Despite better economic conditions, policymakers see a need to further rein in the speculative nature of the United States banking industry.
Many changes to the industry are coming next month. Hundreds of rules and regulations under the Dodd-Frank Wall Street Reform and Consumer Protection Act are scheduled to go into effect on July 16.
Under the Dodd-Frank law a new agency, the Consumer Financial Protection Bureau, will have “autonomous” authority to write rules governing any financial institutions that offer consumer financial services or products. Another new government body, the Financial Stability Oversight Council, has the authority to impose strict leverage requirements on any company they deem poses a “threat to the financial system.”
Restricting leverage is the hardest requirement regulators can place on banking institutions. Leverage refers to the amount of private capital a bank holds against the loans it has made. In general, banks with higher capital ratios risk less because they have more of their own ‘skin in the game.’
For years, the required bank capital ratio was set only at the international level. The Basel Committee on Banking Supervision at the Bank for International Settlements in Basel, Switzerland, is a group of central banks responsible for determining the appropriate level of capital.
The most recent pronouncement from this group, called the Basel III Framework, says banks need a total capital ratio no lower than 10 percent, or a 10 to one leverage ratio. Some U.S. policymakers want to see large U.S. banks hold even more capital.
In an early June speech, Federal Reserve Gov. Daniel Tarullo suggested that any firm regulators identify as a risk to the financial system would need a total capital ratio above 14 percent. This roughly 7-to-1 leverage ratio will certainly curtail profitability at larger banks.
Given their smaller size, Idaho banks have never been considered systematically important. But financial institutions in our state tended to be more conservative; holding higher than average capital. The financial crisis, however, put a dent in this capital. According to the most recent data from the FDIC, Idaho financial institutions now have an 11.6 percent capital ratio, just above the national average of 11.4 percent.
Stiffer capital controls will make it tougher for banks to make money, but the current interest rate environment allows these banks to profit from risk-free assets.
By keeping interest rates near zero for an extended period of time, the Fed gives banks the opportunity to borrow funds cheaply and invest them in longer-term U.S. Treasury notes.
In an environment of increasing regulatory control and low-interest rates, it’s no wonder banks are reluctant to lend money.
PETER CRABB Professor of finance and economics at Northwest Nazarene University in Nampa