Well capitalized banks are essential for a strong banking sector, financial system, and economy where Main Street families and businesses can thrive. That’s because appropriately capitalized banks are strong enough to continue providing credit through the economic cycle, in good times and bad, which keeps the economy growing, creates jobs, and reduces the depth, length, and cost of recessions that large bank failures usually cause. Remember, the only thing standing between a failing large bank, taxpayer bailouts, and an economic downturn if not catastrophe is the amount of capital that a large bank has to absorb its own losses.
If large banks do not have enough capital to absorb their own losses and prevent their failure (i.e., if they are undercapitalized), then taxpayers end up providing that capital after the fact in the form of bailouts to prevent their failure and a collapse of the economy and a second Great Depression. This is not an opinion; it is a proven fact. That’s what happened recently with the failures and bailouts of Silicon Valley Bank, Signature Bank, and First Republic Bank and what happened in 2008 with virtually all the giant Wall Street banks. That’s why these large banks are called “too-big-to-fail”: if they were allowed to fail, they would cause the collapse of the financial system and economy. (It’s important to remember that the dangers to the country created by undercapitalized banks only arise from the largest, systemically important banks, which are those with more than $100 billion in assets or just 33 out of the nearly 4,700 banks in the country.)
Because history proves that undercapitalized large banks pose such grave and grievous threats to the country, policymakers and financial regulators must require those banks to have sufficient capital to absorb the losses that their profit-making activities might cause. That’s why completion of the so-called Basel Endgame and other capital measures are so important, as recently discussed by Federal Reserve (Fed) Vice Chair for Supervision Michael Barr.
Unfortunately, what’s good for Main Street (well capitalized banks) isn’t very good for Wall Street, especially for Wall Street CEOs and executives. While increased bank capital is essential to protect banks, the financial system, and Main Street families’ jobs, homes, and businesses, it reduces the size of bankers’ bonuses, which are greatly increased by having as little capital as possible. That’s because bankers’ bonuses are based largely on what’s called return on equity (ROE) which is amplified by low capital and high leverage. Thus, the lower the capital a bank has the higher the ROE and the higher the executive bonuses.
This perverse anti-capital incentive is made worse by the threat posed by too-big-to-fail banks. The CEOs of those banks don’t really have to worry about having enough capital or their banks collapsing into bankruptcy because, if they get into trouble, they won’t be allowed to fail and will be bailed out (as happened in 2023 and 2008). This is a moral hazard that incentivizes banks to engage in very high risk, highly leveraged activities that generate outsized returns and bonuses because if they fail, they get to shift their losses to taxpayers who fund the bailouts while the executives get to keep their bonuses. Think of the Silicon Valley Bank CEO, who had pocketed tens of millions of dollars in the years before it collapsed and who jetted off to his mansion in Hawaii literally as the FDIC was bailing out his bank to prevent its failure at a cost of $16.1 billion (which was an injection of capital that the bank itself should have had to prevent its failure in the first place).
Put differently, if a bank CEO really doesn’t have to worry about his bank failing, then he really doesn’t care if his bank has enough capital to absorb losses and prevent a failure that won’t happen anyway. And, if that CEO’s bonus is bigger the less capital his bank has, then he wants to have the least amount of capital that he can get away with. This is what is known as privatizing gains (the bankers get their bonuses no matter what) and socializing losses (the American people get stuck with the bailout bill).
Unsurprisingly, Wall Street’s CEOs, trade groups, lobbyists, PR firms, and allies never mention any of this. Instead, they make baseless, often hysterical, and exaggerated if not fabricated claims about capital requirements hurting lending, jobs, economic growth, and competition, basically anything to avoid talking about their own bonuses. They are claiming that the real danger to Americans is from overcapitalized not undercapitalized banks. However, that is a smokescreen to conceal their self-interest in keeping the amount of capital as low as possible to keep their bonuses as high as possible. There is no evidence banks have ever been overcapitalized and there has never been a banking or financial crash caused by banks that had too much capital.
That’s why the industry is engaged in a comprehensive, coordinated, and extremely well-funded two-part disinformation campaign. The first part is to deceive the public and elected officials into believing that higher capital hurts rather than protects them. The second part is to prevent regulators from requiring large banks to have enough capital to absorb their own losses and prevent failure, crashes, and contagion. The core of this campaign are dangerous and baseless false claims about capital requirements that are repeated endlessly but too rarely questioned much less scrutinized. This Fact Sheet addresses ten of the most common false claims that Wall Street banks and their allies have long been making.
The ten false claims addressed in detail below:
- Higher capital requirements will increase the cost of credit, cause banks to reduce lending, hurt the economy and Main Street families.
- The only way to implement changes to capital requirements is through the years-long rulemaking process.
- Capital standards have been increased from 2008 levels and are therefore adequate.
- Large banks were a source of strength during the COVID-19 pandemic which proved they do not need to have stronger capital standards.
- If bank capital requirements are increased, financial activity will shift from banks to the unregulated “shadow banks,” which Jamie Dimon claims will be “dancing in the streets.”
- Banks’ analysis allegedly support their arguments against stronger capital requirements.
- It is unfair for U.S. bank capital standards to be higher than standards for foreign banks.
- The stress tests as currently designed are sufficient for assessing capital needs for the banking industry.
- Banks with less than $250 billion in total assets are not systemic and do not need to be subject to higher capital levels.
- The recently proposed “reverse stress tests” will improve the stress testing process.