Washington, D.C. — As lawmakers and regulators design policies to guide the economy through the economic crisis, a new report from the Center for American Progress calls on the Federal Reserve to strengthen bank capital requirements.
The report argues that while bank capital requirements have improved since the Great Recession, they were still too low heading into the Trump administration. Despite this, Trump-appointed regulators lowered them further in the years preceding the coronavirus pandemic. As the economic fallout of COVID-19 began wreaking havoc on the financial system, regulators further undermined capital requirements designed to ensure banks have adequate loss-absorbing buffers. Cumulatively, these actions have weakened the banking system at the start of what many believe may be the worst economic crisis in a century.
In order to ensure that this economic downturn doesn’t precipitate a banking crisis, the report makes the following recommendations to improve the resiliency of the banking system:
- Suspend all bank capital distributions: The Fed should step in and enforce a full suspension of all bank capital distributions during the coronavirus crisis, including dividends and discretionary bonus payments. Retaining capital will help banks withstand greater losses and support lending to the real economy.
- Perform robust crisis stress tests: The results of the most recent stress tests, scheduled to be announced in June, are based on December 2019 balance sheets, which are not reflective of the banks current state. The hypothetical shock in the tests is less severe than the current crisis. The Fed should make sure this year’s stress tests better reflect the current environment.
- Be willing to require banks to turn to equity markets for additional capital: The Fed should be prepared to require that banks turn to equity markets to raise additional capital if the stress tests indicate that they lack sufficient loss-absorbing capacity to weather further economic deterioration.
- Indefinitely delay the implementation of the stress capital buffer (SCB) rule: The Fed should not be lowering capital requirements right now. The SCB materially weakens leverage capital rules in particular. It is financial stability malpractice to erode this type of capital requirement as the financial system undergoes stress.
“Improvements to the quantity and quality of bank capital over the past 10 years is one of the main reasons why the banking system has remained stable over the past two months, compared with shadow banks that require immediate government lifelines. However, regulators’ decisions before and during this crisis lowered bank capital requirements and left the banking system more vulnerable than it should be during this period of stress,” said Gregg Gelzinis, senior policy analyst at CAP and author of the report. “Regulators need to act quickly to shore up capital requirements so that the banking sector does not teeter and exacerbate this already catastrophic economic downturn.”
Read the report: “Bank Capital and the Coronavirus Crisis: 4 Ways the Federal Reserve Can Improve the Resilience of the Banking System” by Gregg Gelzinis
For more information or to speak to an expert, contact Julia Cusick at [email protected].
To find the latest CAP resources on the coronavirus, visit our coronavirus resource page.