Perhaps this week marks the turning point from which the pendulum swings back from the post-financial crisis flood of bank regulation to deregulation, says William Hines of Aberdeen Standard Investments. Still, it should be ensured that deregulation supports, not hinders, a fully functioning economy.
This week, the Federal Reserve proposed tightening U.S. bank stress tests and reducing the amount of capital that large U.S. banks must hold. The stress testing measures, which target the capital buffer for stress situations, actually suggest a reduction in capital-related requirements for banks and mean that banks will now only have to meet one set of criteria instead of two different ones, says William Hines, investment manager at Aberdeen Standard Investments. Capital requirements will increase slightly for large banks and decrease slightly for small banks, he said.
The move would also complicate the calibration of capital requirements for the larger, more complex banks. That makes sense: because the larger banks are more significant to the financial system, better equipped and therefore better able to meet the requirements. The expert says other recommendations from the U.S. regulator also make sense: For example, the buffer should now be based on a steady balance sheet in a stressed environment, rather than one that continues to grow. "Correct to assume that in reality, not many bank balance sheets will continue to grow in a stress scenario", says Hines.
Lowering the supplementary capital ratio
The other proposals announced this week relate to lowering the increased supplementary capital ratio. This ratio is a measure of how much capital systemically important banks need to maintain. A reduction, banks say, could free up capital for other activities such as lending. Bank officials have long complained about the increased supplementary capital ratio. So they'll be happy about the cut, Hines believes. The relaxation would also be logical from an investor perspective. While the response of regulators after the financial crisis has been largely coordinated internationally, some national regulations have inevitably been more stringent than others. The current proposals to lower the supplementary capital ratio bring the U.S. in line with international competitors, so they also make sense from a competitive perspective.
"However, regulators must do everything they can to ensure that banks actually use the freed-up capital for economically productive purposes. Because if they just paid out higher dividends or did share buybacks which they could, if bank executives were left to their own devices then that would clearly be suboptimal", comments the expert.
Regulations do not become superfluous
All of the above measures, however, don't look like a bonfire for regulations, as some observers would have you believe. The strict oversight that was put in place after the crisis was necessary. The question is whether all the measures introduced are still necessary. "At this point, it looks like a reasonable rebalancing of some rules", Hines says. One of the unintended consequences of regulation is thus eliminated. Namely, banks have withdrawn from lower-risk, lower-return activities (such as repo financing, custody accounts, central clearing services) that were actually quite useful.
The proposals now being put forward do not significantly increase risk in the financial system and should help to enable, rather than hinder, a fully functioning financial system. "The trick now, as regulators begin to loosen the rules, is also to know when to stop again", concludes the expert.