Large banks, and Forum members in particular, have been leading the way in supporting business lending throughout the COVID pandemic. Specifically, in a previous post we documented that business lending increased by an unprecedented $272 billion among Forum members in the first quarter of 2020. More still, we also highlighted recent academic research demonstrating that large banks have led the way in providing business lending during this pandemic. In this post, we call attention to the negative incentives to lend and support the economy that are embedded in the GSIB capital surcharge. All Forum members are subject to the GSIB surcharge. The GSIB surcharge penalizes banks that lend more and grow their balance sheets by assigning them higher capital surcharges. A higher surcharge increases a bank’s capital requirement, which in turn raises the cost of funding loans, and reduces the ability of banks to lend and support the economy. If no changes are made to the GSIB surcharge methodology, large banks that have increased their lending and supported the economy during the pandemic will see a significant increase in capital requirements that will impair their ability to continue supporting the economy. Forum members have been a considerable source of strength during these challenging times. Capital regulation that penalizes lending should be reconsidered to ensure that Forum members can continue to support the economy during this unprecedented challenge.
Business Lending and the GSIB Surcharge
The GSIB surcharge is an additional capital surcharge that is applied to all large banks that play a critical role in our economy – so-called Global Systemically Important Banks. The surcharge is determined in the fourth quarter of each year via a complex regulatory formula that uses a variety of inputs. A key input to this formula is the size of a bank’s balance sheet, which includes the aggregate value of all business loans made by the bank. Figure 1 below depicts the change in Forum member business lending between Q4201 and Q12020 as well as the change in the aggregate GSIB score of all Forum members over the same period.
As can be seen on the bar on the right, business lending increased by $272 billion over the first quarter. As we have previously noted, this is an unprecedented increase in business lending. The bar on the left shows that the aggregate GSIB score has increased too, by 218 points. This change is also unprecedented. The 218-point increase over the first quarter of 2020 is the largest quarterly increase in the aggregate GSIB score on record.
How will this large increase in the GSIB score impact Forum members and the economy? The GSIB score and surcharge is not officially tabulated until the fourth quarter, but if this increase in the GSIB score remains through the fourth quarter, four of the eight Forum members will experience an increase in the GSIB surcharge of one-half of one percentage point, or 0.5%. And of course, we are still a long way from the end of the fourth quarter. If Forum members continue to lend and support the economy, their GSIB scores and resulting surcharges will rise even more.
An increase in the GSIB surcharge directly translates into higher capital requirements, which increases the cost of funding loans and other important financial services that are supporting the economy through this pandemic. To put an increase in the GSIB surcharge of 0.5% in perspective, consider that for the typical Forum member, an increase in the GSIB surcharge of this magnitude would require it to raise an additional $6 billion to $8 billion in capital, which would raise the cost of funds and ultimately the costs of borrowing by consumers and businesses. While it is impossible to know with certainty the precise impact of this increase in the cost of lending, it is clear that such an increase in cost makes it harder to continue lending and supporting the economy through the pandemic.
Revisiting the GSIB Surcharge
The rationale for tying the GSIB surcharge to the amount of lending and the size of a bank’s balance sheet is itself questionable and, in any case, never contemplated the increase in lending and overall balance sheet size that has occurred in this public health crisis as large banks support the economy. This rigid and formulaic approach to large bank regulation should be reconsidered in light of the current economic situation and the substantial contribution that large banks are making to the economy right now. Moreover, there is significant precedent for reconsideration of the regulatory regime during the pandemic. Namely, the Federal Reserve has pursued a variety of regulatory changes that are directly aimed at ensuring that banks can continue to lend and support the economy during these times. One example worth citing would be the Federal Reserve’s recent removal of certain low-risk assets from the calculation of the leverage capital ratio. This change was enacted by the Federal Reserve for the express purpose of “increasing banking organizations’ ability to provide credit to households and businesses.” Yet, without any change to the GSIB surcharge methodology, these same low-risk assets will increase the GSIB score of Forum members, increase the cost of credit and result in the same deleterious consequences regulators are actively trying to avoid. Moreover, the increase in the GSIB surcharges will be focused on precisely those institutions that have been providing the bulk of the support during the pandemic.
Large banks, and Forum members in particular, have been leading the way as they support the economy through significantly increased business lending during the pandemic. This unprecedented increase in lending is also resulting in an unprecedented increase in GSIB scores that will result in significantly elevated GSIB capital surcharges in the fourth quarter of 2020 if no changes to the GSIB score methodology are made. The Federal Reserve has enacted a series of reasonable and well-considered regulatory changes during this pandemic to help ensure that undue regulatory burden does not hamper the efforts of the banking sector to support the economy through the pandemic. Without any changes to the GSIB score methodology, regulators risk hampering the ability of large banks to play an essential and outsized role in supporting the economy. A re-evaluation of the GSIB surcharge in light of these developments is both warranted and prudent.