For many months now, economists, financial experts, and taxpayer advocates such as NTU have been sounding the alarm over capital requirements and other regulations for larger banks proposed by the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC). Intended to force the U.S. into line with a set of international standards ominously called “Basel III Endgame,” the joint rulemaking received substantial modifications in an announcement a few weeks ago from Fed Vice Chair for Supervision Michael Barr.
Have taxpayers won a reprieve from what would have been a counterproductive and harmful regulatory edict? Time will tell, but, for now, the most that can be said is that it could have been worse.
Barr’s September 10 speech outlined the decision from the Fed, FDIC, and OCC to ease the tough proposed level of capital reserves to be required by certain large banks (called G-SIBs) to 9 percent, half of what was originally to be imposed. Other institutions would face a 3 to 4 percentage-point increase in reserve requirements. Various other measures, such as exempting medium-sized banks from the new capital minimums and adjusting risk-weighting formulas for certain loans and investment-grade corporate instruments, indicate that the three regulatory entities intend to be less harsh and hasty with forcing “Endgame” on the American financial system.
And for good reason. Amid a few high-profile bank failures last year, grafting “Endgame” onto our domestic framework seemed attractive to some until more thoughtful analysis showed that banking regulators had failed to focus on those banks’ balance sheet issues. This problem has manifested itself in several ways, including new emphasis on non-financial matters (such as boardroom diversity) at banks instead of the fundamentals that shield taxpayers from bailouts. As long as regulators take their eyes off this primary mission, and look at politically fashionable aspects at banks instead, the tightening of capital requirements will not benefit taxpayers.
There are other reasons, however, that taxpayers were concerned about Basel III and U.S. policymakers’ responses to it. As NTU noted in 2023:
Establishing capital requirements for banks can be complex, but properly balancing the task is important. Set them too low, and taxpayers could be on the hook for more failures from poorly managed banks; set them too high, and taxpayers suffer from a slow economy as the lending needed for worthy investments becomes scarcer.
. . . [P]ublic officials can look to policies that help to strengthen banks’ financial positions without resorting to even more restrictive capital standards, when U.S. institutions already have some of the highest such standards in the world. Regulatory frameworks can be built to allow greater availability of private reinsurance products for banks, which provides risk transfer – a benefit for banks’ soundness that regulators should, to the extent they are not already doing so, factor into the calculation of each bank’s risk-based capital requirement. Simpler tax policies, especially at the state level, could allow banks to build long-term reserves.
Despite all of these grounds for a more cautious and thoughtful assessment of Basel III, a few critics of Vice Chair Barr’s announcement claim that he is retreating from sound rules for banks’ financial resilience. Bloomberg’s editorial board went so far as to argue that “[t]he regulators appear to be settling for the prospect of renewed banking fragility, leaving taxpayers on the hook for the next round of bailouts.” As an organization deeply concerned about any “next round of bailouts,” NTU believes this assessment is hasty. The veritable avalanche of public comments to the initial rulemaking, the vast majority of which express opposition to some degree (among them NTU), should show that there were legitimate concerns over how the regulator’s approach to Basel III would actually work to strengthen the safety and soundness of the banking system. The vast majority of the nearly 200 comments filed to the rulemaking expressed substantive concerns with the proposal. These cautionary notes came not only from banking interests, but also from organizations in agricultural, energy, housing, and other sectors.
Bloomberg’s editorial also seems to overlook some of the extant policy threats to the system that may be undermining taxpayer protections at this very moment. Among them is a convoluted bank examination regime, which sends thousands of government “examiners” from several agencies into banks’ backrooms and boardrooms for investigation of often immaterial matters with no transparency, little chance of appeal, and the prospect of massive compliance costs.
Sound familiar? This is exactly the situation that taxpayers face in many Internal Revenue Service examinations, with similar or even greater implications for the economy as a whole. Bank examiners use the “CAMELS” approach to their work, meaning they focus upon Capital adequacy, Asset quality, Management, Earnings, Liquidity, and Sensitivity. Unfortunately, the “M” in CAMELS has taken on an outsized role in recent years among those charged with eyeing the safety and soundness of banks, which is highly risky for taxpayers who are counting on the government to pay greater attention to the “C,” “A,” “E,” “L,” and “S” of that acronym as well.
Our colleagues at Americans for Tax Reform put it well in a recent analysis:
Regulators use the opaque bank examination process to coerce bank activity . . . The “management” metric imposes governance mandates on banks. Bank examiners should be prohibited from considering the “management” factor and any immaterial risks. Examiners should only focus on material financial risks. Focusing on nebulous governance issues steers examiners away from material financial risks such as the risk of not accounting for a steep increase in interest rates and its effect on bond prices.
NTU will soon provide wider commentary on serious and evolving problems of the bank examination process, which could allow major balance sheet shortcomings to translate into taxpayer bailouts. In the nearer term, one laudable response to these problems, the Fair Audits and Inspections for Regulators (FAIR) Exams Act, would require “timely responses,” transparency of information from regulators in bank examinations, and an appeals process (again, similar to that with IRS audits) for banks to obtain a fair hearing about unjust government actions.
Sponsors of the bipartisan Senate bill include Jerry Moran (R-HS), Joe Manchin (D-WV), Thom Tillis (R-NC), and Bill Hagerty (R-TN). A House companion, from Reps. French Hill (R-AR) and David Scott (D-GA), has been introduced as well. Staff on the House Financial Services and Senate Banking Committees can help elevate this legislation to the top of Congress’s agenda both this year and next.
Vice Chairman Barr was perceptive when he provided another public comment period for the newly revised regulatory response to Basel III to “get the balance between resiliency and efficiency right.” Editorialists at Bloomberg and elsewhere need to consider the wider, longer perspective on how to protect taxpayers from another financial meltdown. The second chance policymakers now have to protect the U.S. banking system against such a calamity should be eagerly embraced rather than cynically dismissed. Regulatory consolidation and clarity, more carefully targeted capital standards, and materially-focused bank examinations would do far more in this regard than rubber-stamping another round of poorly conceived regulations. Taxpayers deserve no less.