Large banks will have to stock up on their capital reserves under new rules designed to prevent bank collapses. Critics say it will reduce lending, but it could create an opening for smaller banks to win more business. iStock illustration
A rule intended to strengthen the U.S. banking system by increasing banks’ capital reserves in case of a crisis could open opportunities for Massachusetts’ smaller banks to catch business opportunities in the process.
Under the proposed rule, colloquially referred to in banking circles as “Basel III Endgame,” banks with $100 billion or more in assets will need to hold equity capital and disclosed reserves – called common equity tier 1 capital – equivalent to 16 percent of the total value of assets like loans and bonds they hold starting July 1, 2025, with a fully phased-in date of July 1, 2028.
These reserves are supposed to provide a cushion for the bank’s balance sheet should a serious economic crisis like the Great Recession cause deep losses.
The rule’s macroeconomic effects are disputed. Still, industry groups claim the new rule will curb lending by large banks, to the detriment of the nation’s economy.
Robert Broeksmit, president and CEO of Mortgage Bankers Association, said in a recent House Financial Services Committee hearing that the Basel III endgame will reduce first-time homebuyers’ access to affordable loan options. Through special purpose credit programs, large banks can provide mortgage loans and support, especially to those without money to make a 20 percent down payment on a house.
“Availability of those programs will go down or the rates will go up,” Broeksmit told Congress. “In 2011, just before the Basel agreements, banks service 91 percent of home mortgages. Now they service 47 percent. If you make that even less attractive, they will service less. Of course, there are independent mortgage bankers servicing, but this will result to less competition therefore less choice, less attractive rates available for the consumers.”
Yet, in the same hearing Alexa Philo, senior policy analyst at the Americans for Financial Reform, disagreed citing studies that US banks with higher capital were found to have higher loan growth, originations and liquidity than banks with fewer capital reserves, and had lower funding costs, enabling them to increase lending.
Enrico Camerinelli, strategic advisor at Boston banking consultancy Datos Insights, said it is advisable for US banks to start raising capital as early as now, and that based on the experience of European banks from implementing the Basel III, the transitory costs are “moderate” and “are outweighed by its permanent long-term benefits.”
“In ‘normal’ economic conditions, the implementation of the Basel III standards would result in approximately 0.60 percent lower annual growth of loans to the non-financial private sector and about 0.10 percent lower annual GDP growth in the Euro area. These costs decrease over time and the effect on GDP growth turns positive eight to nine years after the phase-in,” Camerinelli said, citing a study on the impacts of the Basel III in European banks.
Lending Opportunities for Small Banks
If Broeksmit’s predictions bear out, as bigger banks report selective lending as a result of retaining more capital to be compliant to the new rule, smaller banks have the chance to seize opportunities coming from this slowdown in lending for large banks, experts say.
“Any pullback or slow down by the larger banks, whether it’s forced by new regulations or otherwise, typically means there will be opportunities for the smaller banks in those markets,” said Larry Spaccasi, a partner at Luse Gorman. “But those banks need to be well capitalized and positioned for that growth.”
“I do think some of that is going on already, I think they are being more selective with their loans. In doing so, it’s likely we’d see an increase in their capital ratios. It will be interesting to see statistics on that this year,” he added.
During the Barclays Global Financial Services Conference earlier this month, executives at KeyBank, Citizens Bank, and M&T Bank all reported that they have tightened their risk appetite. The banks said they are growing lending more slowly and are now more selective with which clients they choose, focusing on relationship-based lending and conservative underwriting. The three banks also announced that they will sell more of their risk-weighted assets, assets that have allotted capital reserves based on risk. The riskier the asset, the higher the capital allotment.
Some examples of riskiest risk-weighted assets include unsecured consumer loans without collateral like credit cards, commercial real estate loans for property with lower values, leveraged loans, corporate loans to risky companies and mortgage-backed securities.
This pullback follows a pattern Spaccasi said the region’s economy has seen before, one that also presented smaller banks with more loan growth opportunities.
“It’s the same how Silicon Valley Bank and First Republic [Bank] were expanding their operations in Eastern Massachusetts and then having the failures and the regulatory issues and the bank runs – they had created an opportunity for a lot of smaller banks in Massachusetts that were well-positioned to take advantage of that opportunity,” Spaccasi said.
Depositors fleeing SVB and First Republic went to smaller institutions such as Metro Credit Union, Cape Cod Five, and Cambridge Savings’ digital only Ivy Bank, all reporting increased deposits since the spring bank failures.
Regulations Spread to Small Banks?
But as business opportunities trickle down to smaller banks, regulations like Basel III Endgame could also follow suit, eventually.
Spaccasi said that higher capital requirements for larger banks may also result in higher requirements for smaller banks in the future, as observed from the 2008 Great Financial Crisis until now.
“Historically, anytime you have a risk or risk mitigation types of regulations or procedures that the larger banks have to follow, those trickle down to the smaller banks, either through regulations or through the examination process,” Spaccasi said.
In 2008, but before the financial crisis kicked off, Spaccasi said that many banks were operating at a 4 percent to 5 percent capital ratio, and that “it’s hard to imagine that even the 7 percent capital level required today for some of the larger institutions will survive in practice.”
The 7 percent requirement, which combines a 4.5 percent common equity tier 1 capital ratio with a “stress capital buffer” and is set by U.S. financial regulators, will become the floor rate of capital requirements on Oct. 1. Capital requirements for the 34 largest banks range from 7 percent to 13.8 percent. The $200 billion M&T Bank and $222.3 billion Citizens Bank are required to meet 8.5 percent capitalization ratios, while $195 billion KeyBank must hit 7 percent.
Nika Cataldo
During the Barclays conference, KeyBank executives announced that the bank is holding a capital ratio of 9 percent to 9.5 percent, while Citizens executives said the bank has a ratio of 10.3 percent and M&T Bank executives said their bank has 10.59 percent ratio, which the bank expects to increase to 11 percent in the near term.
“Higher capital levels create a larger buffer for any risk, but it’s hard to create a buffer against bank runs. That is just a crisis in confidence in the institution. The higher capital, the more confidence the public, depositors, customers and regulators should have in the institution, viewing them as safe and able to survive during adverse changes,” Spaccasi said.
“But there are certain things which you can’t necessarily [foresee], no matter how much capital you have to protect yourself from, like a run on the bank,” he added.
In the proposed Basel III rule, the largest banks with $250 billion or more in assets will have to face increased capital ratios of 19 percent. Domestic banks with $100 billion to $250 billion in assets will have lower capital ratio requirements at 6 percent, but this is expected to increase moderately in the long run. Holding companies of foreign firms would have a 14 percent capital ratio requirement, which would have larger increases over time.
