Businesses strongly agree there needs to be healthy competition in the financial sector so they can shop for the products and services they need to finance their operations, create jobs, and contribute to growth in their communities. This means that financial institutions of all sizes and shapes, including large and complex banks, should be regulated efficiently so they can meet the needs of their customers.
One area that has been overlooked is the impact of domestic and global regulations upon U.S. globally systemically important banks (GSIBs). Why is this important? Those are the financial institutions often used by businesses who sell goods and services overseas, or underwrite financial offerings if a businesses is growing and going public.
First, what is the state of these banks? It is pretty good.
Just last month, the Federal Reserve provided passing grades to all of these firms on their annual CCAR stress testing exercise, strong evidence that these firms can endure significant stress including a major recession.
Why is this important? These banks make up approximately 25% of all small business loans, according to data from the Financial Services Forum.
Are reforms needed? Yes, because a series of overlapping requirements are making it harder for these banks to deploy capital for Main Street businesses.
One reform that would be a relatively modest undertaking, but has the opportunity to provide significant benefits to U.S. businesses and the American economy, is recalibrating the GSIB surcharge.
In theory, the GSIB surcharge makes sense. It requires additional capital be held by some financial institutions in proportion to their riskiness and the costs they would impose on the financial system in the event of failure. Banks are deemed globally systemically important based on criteria like size, interconnectedness, substitutability, and complexity. However, the success of this formula depends on the approach to measuring risk posed by the firm and the costs borne by the financial system in the event of its failure. Of concern, the policy does little to consider the impact on the availability of credit and the costs imposed on Main Street.
When the Federal Reserve implemented the GSIB surcharge in 2016, the U.S. Chamber wrote that it could “disrupt the balance between financial stability and reasonable risk taking.” The Chamber noted in its recent corporate treasurer survey that a capital surcharge on globally systemically important banks is one example of a mandate that was intended in part to promote financial stability but in reality has made it harder for banks to lend to businesses and assist with activities such as trade financing.
We are seeing the effects of the GSIB surcharge on small businesses.
Last November, the U.S. Chamber of Commerce wrote to the Federal Reserve expressing concerns regarding a nearly 50% decrease in small business lending by financial institutions, and requested that, “regulators should strongly weigh the costs to our economy imposed” by the GSIB surcharge.
The Federal Reserve should recalibrate the GSIB surcharge to increase the availability of credit for Main Street and to increase competition in the capital markets. Nearly two-thirds (63%) of businesses approve of federal regulators recalibrating capital requirements for large banks when lending money to small businesses, according to a survey of corporate treasurers recently conducted by the U.S. Chamber.
Research from the Bank Policy Institute has found that the surcharge requires U.S. GSIBs to hold approximately 50-100 basis points more capital than the stated regulatory objective requires. The inefficient allocation of capital caused by the current GSIB surcharge calculation makes it more difficult for banks to provide financing to Main Street.
The GSIB surcharge also does not take into account the significant reforms that these financial institutions have implemented, thus over-representing systemic risk. These firms have implemented new enhanced prudential standards that are intended to reduce the odds of failure. Additionally, reforms like resolution planning are intended to reduce costs to the financial system in the event one these firms were to fail.
U.S. businesses recognize that all of their banking partners need flexibility to meet their needs, especially institutions positioned to make significant contributions to our economy. Businesses also strongly desire partnering with a financial institution that “makes banking easy,” has up to date technology, and a wide range of offers – hallmarks of GSIBs that have leveraged economies of size and scope.
Policymakers have clearly expressed that the GSIB surcharge should be revisited. The U.S. Department of the Treasury noted in their June 2017 report on banks and credit unions, “U.S. regulatory requirements that exceed the applicable international standard can sometimes create an undue burden of higher costs to our economy,” and that the U.S. GSIB risk-based surcharge should be recalibrated.
There is also a growing voice in Congress echoing the views of the Treasury Department. Last month, 26 members of the House Financial Services Committee stressed that small business lending by financial institutions is not recovering, in part, because of the GSIB surcharge.
The Federal Reserve has an opportunity to mitigate costs indirectly imposed on Main Street without increasing systemic risk. The GSIB surcharge calculation should reflect additional reforms that have been implemented since it was imposed and account for the decrease in credit available to Main Street.
Without a change to the GSIB surcharge, small businesses will continue to struggle with the limited credit available to them, thwarting attempts for them increase their contributions to the economy.