Surging Deposits and GSIB Surcharges: Capital Regulation Risks Undermining Economic Recovery

14 Aug 2020
Read Time 5 mins
Categories :
GSIB Surcharge
, Value of Large Financial Institutions

During the COVID pandemic, Financial Services Forum members have been supporting the economy in a number of important ways. As we have previously documented, Forum members are taking a leading role in providing businesses and households with a safe, liquid and remotely accessible place to store their cash during these uncertain times. In this post, we further document the significant increase in deposits among Forum members and describe how this surge may result in increases in GSIB capital surcharges, leading to gains in the cost of credit and a reduction in much needed support for the economy. We also describe how increasing GSIB capital surcharges could undermine Federal Reserve policies that are aimed at supporting the economy. We conclude that the Federal Reserve should reconsider how it calculates the GSIB capital surcharges this year to ensure that efforts to support the economy are as effective as possible during these difficult times. 

Forum Member Deposits and GSIB Surcharges

Figure 1 shows the percentage change in deposits for Financial Services Forum members over the first six months of each year from 2010 through 2020. As shown in the chart, the over 17 percent increase in Forum deposits in the first half of 2020 has been remarkable, as deposits have typically increased by roughly one to three percent over each six-month period.

Source: Federal Reserve Y-9C and Forum member earnings releases

The large increase in deposits reported in Figure 1 is one clear sign of the significant value that Forum members are providing to households and businesses in these trying times. At the same time, there is an unhelpful consequence of more deposit taking by Forum members. When a bank receives deposits, it immediately puts those assets “to work” by making loans and purchasing securities, such as corporate bonds that fund businesses. The increase in deposits immediately leads to an increase in the bank’s asset size. All Global Systemically Important Banks (GSIBs) are subject to an additional capital requirement known as the GSIB capital surcharge that requires them to maintain an extra buffer of loss-absorbing capital. The regulatory formula that determines the size of this extra capital buffer is mechanically related to the bank’s asset size. Accordingly, the significant increase in deposits that has occurred over the past six months is contributing to a potential increase in GSIB surcharges that would be realized in the fourth quarter of 2020 when the Federal Reserve conducts its annual update of the surcharges.

This trend is troubling for a number of reasons. First, the increase in deposits and assets that we are experiencing now represents an important response to the pandemic by Forum members—the U.S.-based GSIBs—as they work to support the economy. Accordingly, it is not appropriate to mechanically increase capital requirements during these challenging times because of an inflexible regulatory requirement that is not suited to these exigent circumstances. Second, mechanical increases in capital requirements at this point in the economic cycle would be counterproductive. As capital requirements rise, the cost of lending rises and it is harder for banks to extend credit. In turn, this weakens any recovery that is taking hold as badly needed credit is restricted. This basic principle is not controversial.  Indeed, the Federal Reserve recently stated that “the capital framework emphasizes the value of not increasing capital requirements under stress and thus exacerbating a downturn.” Finally, this is all the more important given the outsized role that large banks are playing in supporting the economy right now. As clearly shown in recent research, large banks like Forum members have been providing the bulk of business credit during the pandemic. An automatic increase in capital requirements for our nation’s largest banks would impair their substantial efforts to support the economy.

Federal Reserve Policy and GSIB Surcharges: Coordinating the Economy’s Left and Right Hand

It is important to consider why deposits have increased so significantly at our nation’s largest banks. Clearly, one reason for the increase in deposits is that businesses and households have faith in the strength, liquidity and resiliency of large banks and Forum members in particular. In uncertain times, people are looking for stable institutions to safeguard their financial resources, and Forum members provide that stability with significant amounts of capital and liquidity. In addition, the U.S. government’s response to the pandemic in terms of direct stimulus payments and the Paycheck Protection Program to provide loans to small businesses have increased the amount of cash circulating in the economy, which is finding its way into bank deposit accounts.

One other important source of deposits, however, relates to the Federal Reserve’s policy of purchasing U.S. government securities. These asset purchases are intended to reduce interest rates to make it easier and more affordable for businesses and households to obtain credit at lower rates. In particular, in its most recent FOMC statement, the Federal Reserve indicated that this program is intended to “support the flow of credit to households and businesses.” When the Federal Reserve purchases securities, the cash that is received by the seller finds its way into a deposit account at a bank. As a result, the Federal Reserve’s asset purchases increase deposits in the banking system and at large banks such as Forum members.

Source: Forum member earnings releases, Federal Reserve H.4

Figure 2 shows the increase in Federal Reserve security purchases and deposits at Forum members over the first half of 2020. As shown in the figure, security purchases have increased by roughly $2.4 trillion while deposits at Forum members have increased by about half that amount, or roughly $1.1 trillion. While these asset purchases are aimed at improving the flow of credit, the consequences of rising deposits among Forum members with the potential associated increase in capital requirements risks undermining this objective. Households and businesses largely obtain credit through the banking system. Even if the Federal Reserve succeeds in lowering borrowing rates, there may not be an immediate impact on credit availability if banks are subject to increased capital requirements that make it more costly to extend credit. Accordingly, the Federal Reserve should consider the aim of its asset purchase program in concert with regulatory policy, which may greatly limit its effectiveness.

Conclusion

Forum members have been leading the way in the banking sector’s response to the pandemic by extending significant amounts of credit into the economy and providing households and businesses with safe, reliable and remotely accessible deposits. The large increase in deposits at Forum members risks reducing the availability of credit because of the mechanical relationship between deposits and GSIB capital surcharges. If increased deposits are allowed to result in an automatic increase in GSIB surcharges, the cost of funding loans and providing credit to the economy will increase. The mechanical link between deposits and GSIB surcharges also may limit the effectiveness of the Federal Reserve’s asset purchase policy because the resulting increase in cash deposits will put upward pressure on capital requirements and make it harder for Forum members to extend credit to the economy. While the Federal Reserve has publicly stated that raising capital requirements in a downturn is problematic, current policy risks such an outcome in the fourth quarter. The Federal Reserve should reconsider how GSIB surcharges are updated in the fourth quarter of 2020 to help ensure that efforts to support the economy in these difficult times are as effective as possible.

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