Higher Capital Demands Force Banks To Sidelines

[Geee]

Investors Business Daily:

The American banking industry is successfully emerging from the challenges of the financial crisis and is poised to be an important catalyst for our nation's economic recovery. At this very moment, however, incessant regulatory demands for more capital threaten to put banks into hibernation.

This is both unfortunate and misguided, because whatever challenges the American banking industry faces, having too little capital is not one of them.

We all know that healthy capital levels are necessary for a safe and sound banking system. Throughout the recent financial turmoil, overall capital levels for the American banking industry remained high, as regulators' stress-tests of the largest 19 banks demonstrated.

And today American banks' capital ratios are at their highest levels in history, with over $1.5 trillion in capital generating nearly $14 trillion in loans and other financial services.

Yet regulators are asking banks to take those ratios even higher, with seemingly little regard for the consequences such a pro-cyclical move will have on our fragile economic recovery.

Consider the case of a little Texas bank with a large concentration of performing small business loans — loans that Washington complains are in short supply. Faced with a regulatory order to increase its capital and shrink its loan portfolio, the bank said "never mind."

It decided to closed up shop and has reorganized as an independent financial services company that will keep investing in small businesses and doing its part to grow the economy, minus the lead balls of excessive capital ratio demands in its pockets.

Regulators here and abroad must recognize that such demands on banks amounts to bad economic policy. They are market inefficient and permanently reduce the economic growth potential of the nation.

Up until now, the general rule has been that $10 in capital allows a bank to support about $100 in loans and other assets. A regulatory directive to require banks to use, say, $12 to do the same amount of business they used to do with $10 means that this extra $2, or $200, or $200 billion will not be used to make one more loan or provide any additional financial services. These funds would just be idle, undeployed capital doing nothing to assist business expansion or create jobs.

With many investors sitting on the sidelines, raising this additional capital in the markets can be a difficult proposition, especially when you have to tell investors that the increased capital will be used to do the same amount of business, not any new business.