Banks' stress-test capital has spurred lending, Fed economists' study says

3 January 2019 7:47pm

31 December 2018. By Neil Roland.

The additional capital that banks have had to keep to pass US stress tests has resulted in increased lending, contrary to bank arguments that Dodd-Frank requirements have constricted credit, US Federal Reserve researchers said.

In the broadest study yet of loan categories, the PhD economists found that the equity and cash that banks have added to comply with post-crisis standards has given them the resources to take new lending risks.

“[W]e find that more capital is associated with higher loan growth,” Fed economists William Bassett and Jose Berrospide wrote in the recently posted staff working paper,  “The Impact of Post Stress Tests Capital on Bank Lending.”

“Our findings suggest that the increased level of capital and the higher capital buffers brought by the post-crisis regulatory reform, which make banks safer and more resilient, altogether put banks in a better position to lend more, at least across some loan categories,” they wrote.

Banks have protested that the capital requirements have gone too far and have limited lending or changed loan allocation ways unintended buy policymakers, according to the study.

“These types of arguments may be misleading,” the Fed researchers commented.

They said banks have suggested that excess capital is kept idle in bank vaults. In fact, banks aren’t required to “immobilize” cash and equity. These high-quality funding sources are to be used to ensure that new loans are adequately backed in case of a downturn, the study said.

Stress tests mandated by the 2010 Dodd-Frank Act and ensuing federal rules aim to ensure that major banks can withstand unexpected economic shocks so that a downturn doesn’t precipitate a crisis as it did from 2007 to 2009.

— Methodology —

The study compared the additional bank capital required to pass the Fed’s stress tests with capital needed to satisfy the banks’ own exercises, which are typically less demanding than those of the government.

One comparison found that loan growth was slower at large and regional banks with more than $50 billion in assets, which are subjected to Fed tests, compared with credit increases at community banks with between $10 billion and $50 billion in assets facing only their internal exercises.

But this gap, the study said, appears to stem from differences in loan demand and other bank-specific characteristics such as funding models.

“The difference in growth,” the researchers said, “seems to be driven by factors beyond the stress tests.”

Fintech Regulation in 2018