Pew: Overcapitalized Banks Will Magically Become Lean, Mean Operators

Douglas Elliott of the Pew Financial Reform Project says banks won’t cut back lending even if their capital requirements are boosted because, among other things, they’ll get the benefit of “reductions in administrative costs.”

Huh? Someone please explain the connection (if any) between a bank’s capital size and mix and its operating efficiency. If anything, relatively overcapitalized institutions would be expected to have more slovenly spending habits, right?

Or does larded-up capital mean banks will be able to skimp on pesky items such as underwriting and collections? This does not sound like a recipe for success.

Say, where else have I heard this we’ll-make-up-the-difference-with-cost-cuts argument lately? Oh, right... In both cases, it’s the opposite of convincing.

Comments

[Gordon McDo...:]

I don’t think this post properly characterizes the totality of Doug's argument.

First, this is policy piece, designed to expand the scope of discussion of this issue. Around this issue, we in DC are hearing from not disinterested parties that higher capital requirements will choke off lending. We asked Doug to evaluate that assertion, plain and simple. So, the key insight from the paper is not the administrative costs piece you pull, but the assertion that banks may take a number of actions in response to higher capital and won’t necessarily, as is being asserted, pass the full costs thru.

A second key point is the following, “The various actions required to restore an acceptable return on common equity appear unlikely to be large enough, even in the aggregate, to significantly discourage customers from borrowing or move them to other credit suppliers in a major way.” A statement he provides quantitative analysis to support. So, the administrative costs assumption that you are highlighting is ultimately insignificant. If you pull it from the analysis it does not materially change the results.

All this being said, I for one would welcome similar quantitative analyses by other disinterested parties; this is an important question and we need to better understand what may happen when capital requirements get raised (which they will be, without question).

Maybe you could take a crack Matt?

Sep 25 06:07 AM