The banking industry is balking at regulators' proposed capital rule changes, arguing that they will infringe on their lending abilities, benefit nonbanks and encourage more M&A.
Regulators unveiled their much-anticipated Basel III endgame proposal, confirming that banks with more than $100 billion in total assets will be subject to the enhanced rules estimated to result in a 16% aggregate increase in common equity Tier 1 capital requirements for them.
Banks have come out swinging against the proposal, arguing that current capital requirements are sufficient and the proposal as is will restrict their lending and other activities and only benefit nonbanks. Some regulators expressed similar concerns about the overarching effects the proposal could have.
Limiting lending, benefiting nonbanks
Banking trade groups, industry experts and even regulators themselves said the proposed rules will hinder banks' lending abilities, thus pushing consumers toward nonbanks.
The proposal "is unquestionably [a] positive for nonbank lenders," BTIG analyst Isaac Boltansky wrote in a note. "The higher capital requirements and tougher stress tests will almost certainly lead to banks reducing their footprint in certain business lines, which has historically proven beneficial for nonbank lenders." Nonbanks will have the opportunity to take market share "in business lines penalized under the new standard," Boltansky wrote.
The Financial Services Forum (FSF) — whose members are the CEOs of the eight largest US financial institutions, including JPMorgan Chase & Co., Bank of America Corp., Wells Fargo & Co. and Citigroup Inc. — believes there is "no justification for significant increases in capital" held by the largest US banks.
The FSF urged regulators to consider the broader impacts, including "the harmful economic impact of this proposal along with the demonstrated strength of the banking industry, the competitive advantage it may provide large European banks, and the movement of banking services into the nonbank sector, an already growing source of financial instability," FSF President and CEO Kevin Fromer said in a statement.
Another trade group, the Bank Policy Institute, argued that the proposal is harmful for consumers and small businesses as it could push them toward "unregulated parts of the financial sector," President and CEO Greg Baer said in a statement.
"Today's announcement is continued good news for private equity, private debt, hedge funds, finance companies and other unregulated firms, which are exempt from the Basel experience and will continue to attract what used to be the business of banking, at higher costs to consumers and greater instability for markets," Baer said.
American Bankers Association President and CEO Rob Nichols dubbed the proposal as "unnecessary and overly broad" and "puts economic growth and resiliency at risk by restricting credit availability for businesses and other borrowers," Nichols said in a statement.
Federal Reserve Chair Jerome Powell acknowledged those concerns in a statement following the proposal, though he was among the four members of the Board of Governors who voted to proceed with the proposal.
"High levels of capital are essential to enable banks to continue to lend to households and businesses and conduct financial intermediation, even in times of severe stress," Powell said in a statement July 27. "But raising capital requirements also increases the cost of, and reduces access to, credit. And the proposed very large increase in risk-weighted assets for market risk overall requires us to assess the risk that large US banks could reduce their activities in this area, threatening a decline in liquidity in critical markets and a movement of some of these activities into the shadow banking sector."
Encouraging M&A
Fed Governor Michelle Bowman and Governor Christopher Waller voted against the proposal, expressing concern that it would not comply with a congressional mandate in a Dodd-Frank Act amendment to tailor standards for companies with more than $100 billion in assets depending on various differences between them. They also pointed out that the proposal as is will encourage more regional banks to pair up through M&A.
"The consequences of increasing capital requirements for all firms above $100 billion in assets may be to force smaller firms to merge or consolidate, to achieve the necessary economies of scale to comply with higher capital requirements," Bowman said in a statement. "Ultimately, this may have harmful effects on competition, and may reduce banking options in some geographic or product markets."
BTIG's Boltansky agreed that requiring banks with more than $100 billion in assets to hold more capital "will further underscore the logic for consolidation in the regional and super regional bank sphere."
Banks will increasingly use M&A to leap over the $100 billion asset threshold "to benefit from the added scale while coming to terms with the associated regulatory burden. Said differently, the new regulatory requirements make organically growing to ~$105B both uneconomical and unwise," Boltansky wrote.
Fifteen banks had more than $250 billion in assets at March 31, while an additional 21 banks had between $100 billion and $250 billion in assets as of the first quarter, according to S&P Global Market Intelligence data.
Potential for changes in final rule
Given all the concerns, industry experts expect banks to push back on the proposal during the longer-than-usual 120-day comment period that ends Nov. 30, which will likely lead to changes in the final rule.
"This game is just getting started," Ian Katz, managing director at Capital Alpha Partners LLC, wrote in a note July 27. "This is a particularly complex and long proposal, so even leaving aside the intense political and industry pressure the regulators will face, it's logical that there will be meaningful alterations to the proposal."
BTIG's Boltansky believes the proposal will face "pronounced" headwinds that will likely lead to "structural changes" in the final rule.
Piper Sandler analysts hope the dissent from the industry and some regulators like Bowman and Waller will lead to "some room to maneuver between now and final rule issuance," they wrote in a July 27 note. "While the starting gun has now been fired officially with the release of today's NPR, we still have a long road ahead of us."
Randal Quarles, former vice chair for supervision on the Fed Board and chairman and co-founder of The Cynosure Group, believes the 16% aggregate capital increase is likely to come down because of the concerns from members of the Fed Board, he said in an interview.
However, another analyst predicted the final rule will be largely the same as the proposal.
"We view the rule's 120-day comment period and 3-year implementation period between 2025-2028 as reasonable, and expect the rule to largely go into effect as proposed," Edward Mills, managing director and Washington policy analyst at Raymond James, said in a note July 27. However, "the dissenting votes at the Fed by two [former President Donald] Trump appointees highlights the potential impact of the 2024 election on the final implementation of these rules."
Regulators expect to finalize the rules in 2025 and then fully phase them in on July 1, 2028, giving banks three years to comply.
"Regardless of changes from here, banks likely feel a sense of urgency to comply with new rules ahead of any deadline," the Piper Sandler analysts wrote. "We're certain they have already begun to alter their behavior accordingly (curtailing repurchase and '[risk-weighted asset] diets,' which we expect to continue, are among only the most visible examples of behavioral changes)."