Looking for an explanation for the weak — and getting weaker — economic recovery? Look no further than the nation's banks. Uncertainty about the future weight of regulations making their way through the bureaucratic maze in Washington is harming the banks, their clients in corporate America and economic growth. The regulators must get their acts together.
The resignation of Vikram Pandit as chief executive of Citigroup Inc. is only the most visible evidence of the troubles still surrounding the nation's banks, from the largest to the smallest. Until the banking sector finds new footing and begins to lend steadily again, the economic recovery can't be strong, and the stock and bond markets will remain volatile.
But the regulatory currents are swirling around the banking industry and, if not carefully handled, could further disrupt what lending the banks are doing just as uncertainty about the fiscal cliff peaks during Congress' lame-duck session following the election.
First, banks may face the loss of billions of dollars of corporate deposits between now and Dec. 31, when the Federal Deposit Insurance Corp.'s unlimited guarantee on non-interest-bearing deposits will expire. The limit will then revert to $250,000.
Chief financial officers have parked billions of dollars of cash reserves in banks because of that federal guarantee. When it disappears, the CFOs are likely to seek short-term investments that provide some return for the risk, and to pull their money from all but the highest-rated banks, hurting the ability of the others to lend to businesses.
Many banks will hold off making loans until they can determine how much of those corporate deposits will walk out the door.
Although some of the money may find its way into money market funds, they have their own uncertainties, so most corporations with cash reserves will face tremendous doubts about where to place those funds.
VOLCKER RULE DELAYS
The second issue distracting bank executives and causing them to limit lending is the likely implementation of the so-called Volcker rule.
The rule, included in the Dodd-Frank financial reform law, limits the ability of federally insured banks to make proprietary trades and to invest in private-equity and hedge funds. It was proposed by former Federal Reserve Chairman Paul Volcker, who argued that proprietary trading by banks played a key role in the financial crisis of 2007-08.
The provisions of the Volcker rule were supposed to be implemented July 21, but the regulatory agencies involved — the Comptroller of the Currency, the Federal Deposit Insurance Corp., the Federal Reserve and the Securities and Exchange Commission — have been struggling to agree on some key definitions. The final ones may not be ready before the end of the year.
Standard and Poor's estimates that if the final definitions are too harsh, they could cut $10 billion a year from bank earnings. Given the uncertainty, banks can't be blamed for being cautious in their lending.
The third issue hovering over the banks involves the capital requirements under the new international bank capital standards known as Basel III. These will require the banks to increase their common equity capital to 4.5% of assets and 6% of Tier 1 capital (which includes retained earnings), versus the current levels of 2% and 4%, respectively.
Basel III also requires a capital conservation buffer of 2.5% and allows national regulators to impose a countercyclical buffer of up to 2.5% in times of high credit growth. In addition, banks must hold more capital against commercial and residential real estate assets.
U.S. bankers are pressing regulators to modify the U.S. version of Basel III, especially to ease the burden on smaller banks, which will find the capital requirements particularly onerous. But the requirements will hurt profitability and growth for large as well as small banks — another reason for banks to limit their lending.
Although regulators are right to take the time to strike the right regulatory balance — not too tight and not too loose — they must bear in mind that delay and uncertainty inflict costs on banks, business and the economy as a whole.
It is time for them to make decisions. The economy is unlikely to show solid growth until these issues are settled, and banks and their clients can begin to adjust to the new realities.