America’s biggest banks have just been stress-tested. Not surprisingly, they have passed with flying colours and now plan to shower their shareholders with increased dividends and share buy-backs.
The 32 banks sailed through the tests, first implemented in 2009 after the global financial crisis tore holes in big bank balance sheets.
Their supervisor, the US Federal Reserve Bank, said on Wednesday that, under its scenario – a severe global recession, significant declines in commercial property and housing prices and rising unemployment – the banks would have lost a total of only $US708 billion ($1.03 trillion) and their capital would have shrunk by only 1.6 per cent.
That they passed the test isn’t a surprise because not only has the Trump administration made it less stringent, but last year the Fed, after intense lobbying and threatened legal action against the tests by the banks, gave them access to the scenarios it would use and the models it uses to calculate their impacts on the banks.
In effect, the examiner gave the banks its questions in advance of the exam.
Even had a bank or banks failed the test, it wouldn’t have impacted the amounts of capital the banks would be required to hold because the Fed has frozen the current stress capital buffer until 2027 as it continues to change, not just the stress tests themselves, but the wider capital and liquidity requirements regime.
The administration, from the moment Donald Trump regained office, made it clear it wanted to wind back the intensity of bank supervision and the bank prudential requirements that were imposed globally in the wake of the 2008 crisis – a crisis triggered by sub-prime lending within the US.
International banks are in the midst of what has been labelled the “Basel III Endgame,” or the final tranche of bank regulation that has been co-ordinated by the Swiss-based Basel Committee on Banking Supervision, and implemented in phases over more than three decades, with the goal of creating a globally consistent regulatory framework for banks.
The US, however, is shifting against the direction of the post-2008 tide of regulation, with the Trump administration committed to rolling back/weakening some of the key regulations developed by the global standards-setter.
Late last year, the administration lowered the leverage requirements (the relationship between capital and assets) for US banks, reducing the amount of capital they were required to hold by a total of about $US213 billion.
The biggest banks had been required to hold capital equivalent to a minimum five per cent of their total assets, regardless of the riskiness of the assets. That was reduced to a range of 3.5 to 4.5 per cent.
Earlier this year, the Trump-appointed vice chair of the Fed, Michelle Bowman, who oversees bank and their regulation, changed the regulatory capital requirements for US mortgages, from a standardised approach to none that assesses the “risk sensitivity” of mortgage loans, which could also reduce the amounts of capital required to be held.
Bowman is also in the process of slashing the Fed’s bank supervision workforce by 30 per cent.
Last Thursday the big US banks lodged a formal submission seeking to further reduce their capital requirements.
They want to hold less capital against their trading activities and unused credit lines and also to cut the level of the capital surcharge that is levied against globally systemically important banks under the Basel rules.
The submissions said that the eight largest banks with global operations would see their capital levels fall by about $US22 billion, or 2.7 per cent, if the Basel Endgame requirements were adopted.
The US banks, and indeed banks elsewhere, have argued that their regulation is too conservative and constricts their capacity to lend or engage in capital market activity, harming the economy and increasing the price of credit.
They have raised a specific issue with their ability to provide liquidity to the $US30 trillion-plus Treasuries market if the Basel Endgame is implemented in the US, saying US debt markets could be harmed, particularly once that market moves to central clearing next year and their capital requirements for counterparty credit risk rise.
One of the stated reasons for the administration’s shift towards lighter regulation of the US banks, apart from increasing their capacity to lend and lowering the cost of credit, is to boost their presence in the Treasury market in the hope that lowers the cost of government borrowings.
The government’s gross debt was $US36.2 trillion when Trump re-took office, but has since exploded to $US39.32 trillion – more than 120 per cent of US GDP – and prompted Trump officials to consider every option for lowering the cost of servicing that debt, tipped to hit $US40 trillion by September.
It has been a factor in Trump’s own efforts to try to seize control of the Fed in order to lower US interest rates and part of Kevin Warsh’s agenda as the new Fed chair, who wants to reduce the Fed’s holdings of banks’ reserves and shift responsibility for managing the liquidity and risks in the US system to the banks.
Whether reducing the amounts of capital the banks hold against market risks would actually have a material effect on market liquidity or pricing is doubtful.
In the post-crisis era, their level of activity in the Treasuries market has been diminished to the point where it is almost inconsequential, with holdings of only about 2 per cent of the market. Their role as market makers and liquidity providers has been largely taken over by hedge funds and other non-banks.
In effect, the examiner gave the banks its questions in advance of the exam.
Bank stress tests are hypothetical, can be unrealistic and may lead to bank regulators being overly conservative (the Australian Prudential Regulation Authority is regarded as being at the conservative end of the spectrum), which unnecessarily reduces risk-taking and returns to shareholders, although the more conservatively a bank is capitalised and the more high-quality liquidity it holds the lower its cost of capital should be.
The wider point is that the post-2008 Basel regime was designed to avoid another threat to global financial stability, avoiding the economic fallout that occurred after that episode as well as the need for the large-scale government interventions and taxpayer-funded bail-outs that occurred after that crisis.
Shareholders should pay the insurance premiums to provide cover for – and reduce the risk of – another banking crisis.
There is undoubtedly scope for fine-tuning of bank regulation to get the balance between reducing the risk of bank failures and their returns on capital right, but it is a balance that should be skewed towards insuring against failure.
The US is the epicentre of the global financial system. Its banks, as a group, are the most dominant globally systemic banks. Its financial markets influence financial markets globally. The Treasuries market is the world’s financial haven in times of stress.
A lot of time may have passed since 2008. Memories fade and financial scars heal. There is, however, a correlation between prudential standards – the amounts and quality of the capital and liquidity banks hold – and risk to financial systems and economies.
It’s also the case that, if a jurisdiction as influential as the US lower its requirements, the rest of the world will be pressured to protect their own institutions’ competitiveness and survival.
The Trump administration is chasing higher economic growth and lower debt-servicing costs with its deregulatory approach to bank prudential reforms.
Those are worthwhile objectives, as long as the increase in systemic risk is minimal and doesn’t threaten either the US financial system and economy or the rest of the world’s.
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Disclaimer : This story is auto aggregated by a computer programme and has not been created or edited by DOWNTHENEWS. Publisher: www.smh.com.au
