Richard Bove, a Wall Street broker, writes that bank capital requirements are the prime culprits hurting lending and growth. He couldn't be more wrong!
Why are the Fed's efforts failing? Because the nation's banks are shrinking. ... There are many reasons for this. The size of the credit market is smaller today because banks will no longer make risky loans to marginal borrowers. Additionally, commercial companies have seen their cash flows improve because the economy is still growing (albeit too slowly). Therefore, corporations do not need as many bank loans.
However, the main reason bank lending has declined may be that the banks' capital requirements have increased, and this encourages them not to lend.
First of all, while regulators have taken some steps to encourage banks to strengthen their capital positions with tools such as the stress tests, higher capital requirements haven't been implemented yet, so it's hard to make them the primary culprit. Neither the Dodd-Frank financial-reform bill nor the Basel III rules that were agreed to yesterday have been implemented. It's pretty hard to believe that rules that don't apply yet are choking the banking system -- especially because those rules are designed to transition into effect over a period of years to give banks time to adapt.
Bove, however, astonishingly doesn't report the two key reasons why banks are reluctant to lend: Most important, they took enormous losses in the crisis, and they still haven't written down the value of many of their real-estate investments, both because many are using lax accounting standards to postpone inevitable losses and because the housing market is still dropping. Second, a shortage of aggregate demand means that there is less demand for credit -- businesses aren't going to expand as long as consumer spending is slow to grow. Both of these -- as well as the profits still available from proprietary trading -- have led to limited lending. Banks don't lend as much in tough economic conditions.
Bove's argument -- those wicked regulators aren't letting banks lend! -- is bunk, but it's a good preview of what we'll be hearing from the financial sector as new rules come into place. Higher capital requirements limit bank risk, and therefore profit, so that taxpayers won't have to bail them out again. Bankers will claim that they simply can't lend any money due to the new restrictions, but the reality is that they could lend if they so chose but prefer to pursue profit through other measures. The financial sector doesn't like taking responsibility for its own risk (it prefers the public do so), and attempts to hold them accountable will result in any and all economic woes being blamed on government. Don't believe it.
-- Tim Fernholz
