We all have to deal with the natural tension between speed and safety; it essentially poses a risk/reward equation that people interpret differently depending on innumerable factors. I began thinking about this during the covid pandemic, when many authorities asked us to deal with the risk of contracting covid by staying at home. It is always safest to do less, to go slower. Doing less is a good strategy for achieving safety, but it is not a good strategy for getting things done.
I thought it was interesting that the National Transportation Safety Board recommended recently that all new automobiles be equipped with technology that prevents them from speeding. (If you missed this little news item, check out ntsb.gov for Nov. 14.) Regulators are always trying to slow things down. Their nature is defensive; they are not really interested in testing the boundaries of potential.
Of course, it is much easier for regulators to require moderation than it is for them to make activities safe. For example, it is much easier to close a beach than it is to verify that everyone using it can swim.
I think this is applicable to the banking industry where we are hearing so much talk about the need for additional capital in banks. The theory is that banks absorb losses with capital, so the more capital, the less likely the bank will get into trouble to the point of needing assistance, either from a merger partner or from the U.S. government. But I cannot get past the idea that calls for more capital are really calls for banks to do less. It is easy to understand why regulators might want this; it is easier to supervise less activity than it is to supervise more. But that approach is the exact opposite of the investing public, which is looking for banks to do more with their money, not less. Nobody invests in anything because they want the enterprise to sit on the money; they invest in it because they expect the enterprise to put the money to good use and earn a return. Furthermore, bank customers want a bank to be more likely to extend them credit, not less likely.
Federal Reserve Board Governor Michelle Bowman has been vocal on this issue since calls for beefing up capital requirements emerged after the Silicon Valley Bank and Signature Bank failures of early 2023. I think she summed up the situation superbly with this observation during a speech last June: “I am concerned that new capital requirements could unnecessarily hinder bank lending and diminish competition. … Increasing capital requirements simply doesn’t get at the underlying concern about the effectiveness of supervision.”
She acknowledges that requirements for higher levels of capital mean less lending, and therefore higher costs for those who get loans. Her argument is that the regulators need to do a better job, not that the banks need to do less of their job. She is spot-on.
Bowman makes the point that if rules limit how much banks can do, the unserved portion of the market will simply turn to less-regulated nonbank competitors. While policymakers might be able to put a cap on lending, they cannot cap the total number of loans made because too many lenders exist outside the supervision of bank regulators. Rob Nichols, president and CEO of the American Bankers Association, made a good point in a recent column when he noted the impact of Dodd-Frank capital rules on bank mortgage lending. Since 2007, he said, the percentage of mortgages originated by banks has dropped to less than 30 percent from around 80 percent.
A little over six years ago, we covered the Federal Reserve Bank of Minneapolis’ effort to come up with a solution to the too-big-to-fail problem in banking. The Minneapolis Fed ultimately published “the Minneapolis Plan,” which offered a four-part blueprint for reducing the likelihood of bank bailouts. It called on banks with more than $250 billion in assets to hold capital equal to 23.5 percent of its risk-weighted assets. And, it addressed customer migration concerns by imposing a new tax on nonbanks that might benefit from tighter capital constraints placed on traditional banks.
A lot of work went into the Minneapolis Plan, but it never took off. And, in my view, that’s OK. I think it is nearly impossible to assess the cost of a diminished banking industry, even if we think more capital means less chance of a bailout-inducing crisis. Human nature will always drive the most entrepreneurial of us to make the most of available capital. This means we need regulators to enforce precise regulation on market-driven financial activity, not water down the economy by limiting the capability of the banking sector. Doing less might be a safer way to live, but I can’t see how it is more fulfilling.