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How to Get Banks to “Right-Size” Themselves
Posted on May 4th, 2010 No commentsAs a reminder, Dr. Dunkelberg serves as Chairman of the Board of Liberty Bell Bank.
Assuming that regulators decide that banks are indeed too large, how might a reduction in size be accomplished? There is already in place a limit on the share of domestic deposits a bank may have (although recent “resolutions” of troubled banks have resulted in these limits being exceeded). But banks were able to grow using foreign deposits (not insured by the FDIC) and by issuing bonds (guaranteed by the FDIC until recently). To be more effective, setting a minimum level for the ratio of core deposits to assets would limit growth funded by bank debt or foreign deposits and reduce leverage. For community banks, this ratio is very high since few issue bonds or have foreign deposits.
Capital requirements should also be increased with asset size. This will discourage growth since it lowers the return on capital unless increased size really produces the cost economies or extra revenues that supporters of big banks argue are present. Federal Reserve research suggests cost economies disappear at around $10 million in assets, but there is disagreement. By increasing capital requirements, banks won’t grow unless it really pays.
FDIC insurance charges should be applied to assets (less capital) instead of core domestic deposits. It is the assets that put the deposits at risk, so the insurance tax should be applied there, and should be raised as the assets carried on the balance sheet of the bank become more complex and opaque.
Off-balance sheet and “repo” activities should be more transparent and better monitored, making them more difficult to execute, and therefore rarer. These can’t be used by banks to avoid compliance (for example, by temporarily offloading those “troubling assets” that might violate regulations in a repo in exchange for wonderful cash or Treasury securities).
These regulatory changes would raise the cost of getting large, force the capital increases needed as risk rises, and force banks to actually realize the cost savings or benefits allegedly produced by “bigness” so that the return on investment will not be compromised. Regulators would not need to arbitrarily set limits on bank size since the regulations would compel banks to raise capital as needed and realize alleged scale economies to maintain a competitive return on investment. With regulations like these in place, very large banks would either prove to be profitable while being better capitalized and less risky or they would have to shrink, reduce leverage and opacity to earn a competitive return for shareholders. This is just what the “regulator doctor” ordered.
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Secretary Geithner Tells Banks to Make More Risky Loans?
Posted on November 20th, 2009 No commentsAs a reminder, Dr. Dunkelberg is Chairman of Liberty Bell Bank in Philadelphia as well as Chief Economist for the National Federation of Independent Business.
At a Treasury conference on jobs (11/18), Secretary Geitner railed against banks for not making enough loans, thus (his conclusion) hindering job growth. He must feel that banks are turning down good (profitable) loans for some reason. “Banks bear some responsibility for the extent of the damage caused by the crisis. And you carry a substantial obligation to help our communities get back on their feet”. Huh? It sounds like he is arguing that since taxpayers bailed out some banks, the banks owed it to society to make some more bad loans. We created a lot of construction jobs in the last expansion by making a lot of bad loans (which were sold to unsuspecting investors and government agencies who knew, but felt compelled to buy anyway). I don’t think we want to go that route again.
First, keep in mind that banks are not venture capital firms, they are not supposed to take unusual risks. So, complaints that banks won’t make loans to new ventures are inappropriately directed at banks. That’s simply not in their job description as the regulators will tell them when it’s time for an audit.
Second, according to the National Federation of Independent Business survey (of their approximately 400,000 member firms) in October, only 4 percent of the owners say financing is their top business problem, compared to 33 percent who report “weak sales” as the top issue. Plans to invest in inventories and capital equipment and expansion are at 35-year lows–no sense in spending money on these items if there are not enough customers. Better to wait. This means loan DEMAND is low for these activities typically supported with borrowing.
Third, the same is true for hiring–owners who have no customers to serve don’t hire workers. Meanwhile, consumer saving is up and community banks have money to lend to small firms on Main Street (not your typical Goldman borrowers). And a tax credit for hiring won’t get owners to hire workers (very costly) to get a few thousand dollars in tax credits. Workers will be hired when they can, in the judgment of owners, produce enough sales to pay for them. Lending firms more money won’t create more sales or jobs.
Trying to push banks to make more loans (a) assumes they are turning down good loans and that the government knows better about loan risk and/or (b) assumes consumers are storming the walls trying to buy stuff but that firms won’t get the inventory or buy the equipment to make stuff or hire workers to complete the sales because banks won’t lend into these opportunities. The facts tell a different story. Lenders were careless about risk in the expansion. Hopefully government is not pushing them to return to the old ways.
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