Last month, Treasury Secretary Mnuchin submitted a report to President Trump suggesting reforms to the U.S. banking system that, in his view, would promote both economic growth and financial stability. The Secretary’s report lays out a starkly different path for bank capital requirements and the Fed’s stress tests than Governor Powell favors.
The Secretary’s report made clear that high bank capital requirements reduce bank lending, particularly to small businesses and homeowners, and therefore recommended scaling back U.S. capital requirements (where they exceed international standards). The Secretary also recommends adopting a more transparent process for the Fed’s annual stress tests, including making the Fed’s models and economic scenarios available for public comment. Those changes would undoubtedly result in lower required capital levels.
Industry estimates are that the Treasury’s recommendations could free hundreds of billions of dollars in excess bank capital that could then be returned as dividends to shareholders (which would make investment in these banks more attractive). Bank of America estimated that up to $2 trillion in additional lending would be possible, if the Secretary’s recommendations are implemented.
But these industry analyses did not consider the possibility that the Federal Reserve was planning to dramatically increase the difficulty of their annual stress tests by raising the required capital needed to pass them.
It is ultimately the Federal Reserve Board that will decide how to proceed with bank capital requirements, so the Secretary’s report may represent nothing more than a wish list. The uncertainty about the Federal Reserve’s direction is magnified by the fact that the president has yet to nominate three new members of the board that could swing the board in the Treasury’s direction. The longer he waits, the more there will be to potentially undo.
In my view, Secretary Mnuchin — and not Governor Powell — is headed in the right direction.
JPMorgan CEO Jamie Dimon recently put the excessiveness of U.S. bank capital requirements into perspective. According to his 2017 shareholder later, JPMorgan alone has enough capital to withstand the combined projected stress test losses of all thirty of the largest U.S. banks. And under Governor Powell’s proposal he will need even more capital.