US Fed’s prodding of banks to use capital surplus to lend to virus-impacted borrowers must be clarified, economists say

16 Mar 2020 7:33 pm by Neil Roland

The US Federal Reserve’s encouragement of banks to stop exceeding capital requirements and use the surplus to lend to virus-affected borrowers received a conditional welcome from economists who asserted that the central bank needs to be clearer about what it will allow.

“Even if banks are willing and able to make safety-net loans, few if any have established programs to do so,” said Karen Petrou, a Washington, DC advisor to banks and regulators. “The Fed has to make immediately clear what loans it will support and how; only then will money move fast to those who need it the most.”

Darrell Duffie, a Stanford University finance professor, said in an email: “This non-quantitative guidance will be helpful, but each bank will want assurances from its regulatory supervisors that it's really OK to use a given amount of its buffers.”

The Fed’s announcement Sunday, said Alexandria, Virginia, banking consultant Bert Ely, puts bankers “between a rock and a hard place” because loosening credit will likely result in rising loan losses for them and possibly bank failures – yet also “Monday morning quarterbacking” by the Fed after the crisis ends.

— Fed announcement —

The Fed said Sunday that it “is encouraging banks to use their capital and liquidity buffers as they lend to households and businesses who are affected by the coronavirus.”

The announcement added that since the 2007-09 financial crisis, large banks have built up “substantial” capital and liquidity that surpass minimum regulatory requirements.

The banks have liquidity surplus of 20 percent to 40 percent over minimum requirements, depending on the individual bank, according to their investor disclosures, a US official said.

Banks have $1.3 trillion in common equity and hold $2.9 trillion in high quality liquid assets, the Fed said.

— Trump's easing of bank standards —

Two academics interviewed, University of Michigan law professor Michael Barr and Stanford University finance professor Darrell Duffie, said the buffers would have been higher if the Fed during the Trump administration hadn’t watered down capital, liquidity and stress-test requirements.

In particular, the professors lamented the Fed’s decision not to turn on a countercyclical buffer that would have required banks to set aside more capital during their extremely profitable recent years.

The Fed could then have drawn down more capital when needed, as during the current crisis.

“Had there been a formal countercyclical buffer to relax, the Fed's guidance could have been more precise,” said Duffie.

The Bank of England, among other central banks in Europe, is now relaxing the countercyclical buffers it had required banks to build up.

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