Last week, Sherrod Brown (D-OH) and David Vitter (R-LA) introduced S. 798, the Terminating Bailouts for Taxpayer Fairness Act to the United States Senate. The bill seeks to address the issue of “too big to fail” banks, largely through increased capital requirements.
A one-page summary of the bill, available on Senator Brown’s website, provides that
Regulators would walk away from BASEL 3, and institute new capital rules that don’t rely on risk weights and are simple, easy to understand, and easy to comply with.
- Regulators will determine the appropriate level for banks under $50 billion in assets.
- Regional banks will be required to have 8 percent equity to total assets.
- The largest banks will have a minimum 15 percent capital requirement. They will be faced with a clear choice: either become smaller or raise enough equity to ensure they can weather the next crisis without a bailout. Federal regulators have the option of increasing the capital level as an institution grows.
- Capital requirements will focus on common equity and other pure, loss-absorbing forms of capital.
- Regulators will calculate firms’ balance sheets in a more accurate way, by counting off-balance-sheet assets and obligations and considering counterparty credit risk in calculating derivatives exposures.
- Regulators would be able to use risk-based capital as a supplement for banks over $20 billion, if their supervisory authority proves insufficient to prevent institutions from over-investing in risky assets.
The proposed legislation resulted in a flurry of media comment. The New York Times Dealbook questioned why the capital requirements were lower for smaller banks:
Mr. Vitter and Mr. Brown acknowledge that their bill would set the capital bar for regional banks even lower than current market practices, including by lowering leverage capital ratios to 8 percent from 10 percent of assets. Yet this would increase, rather than decrease, the risk of bank failures.
The bill also contains a number of other benefits for community banks. It would expand the definition of “rural” lenders that could offer balloon mortgages; reduce some impediments for small banks and thrifts to raise capital or pay dividends; create an independent bank examiner ombudsman that institutions could appeal to if they felt they had been treated unfairly by their examiner; and adopt privacy notice simplification legislation.
There are certainly policy considerations that might justify favoring smaller banks over larger ones. Historically, these have included keeping capital in local hands, favoring agrarian lending to industrial lending and avoiding concentration of power in urban elites.
Prohibition against branch banking by national banks for most of American history is an example of a law in furtherance of these policies. Those laws have for the most part been scrapped because they fostered inefficient uses of capital and, in many cases, bad management. But at least they were honest about what they were trying to do.
And, S&P released a report (covered by Business Insider) that was critical of the effect the proposed legislation might have on banks’ ability to extend credit, and the resulting effect on the economy:
We would be most concerned about the impact on the economy because it appears banks would need to build significantly more capital, which would likely impede their ability to extend credit. In addition, the proposal does not appear to be comprehensive–it focuses primarily on capital and does not address liquidity. Under our methodology, we would potentially no longer factor in government support if we believed that once large banks are broken up, we would not classify these banks as having high systemic importance. Clearly, if enacted, a transition period will be required as many moving parts in this legislation are absorbed by management teams and investors alike.
The American Banker published an editorial criticizing the bill, arguing that “[e]ven if Brown-Vitter’s capital requirements were implemented, U.S. banks would be at a competitive disadvantage vis-à-vis European banks and other international banks that have not implemented Basel III.”