Regulators should reject big-bank arguments against stronger capital requirements

Big banks and their trade associations have mounted a massive lobbying campaign against “Basel III Endgame,” a proposal by federal regulators for stronger capital requirements. The big-bank lobby asserts that Basel III Endgame would impose punitive costs on banks and cause great harm to businesses, consumers and the U.S. economy. The doomsday scenarios trumpeted by megabanks are exaggerated and baseless and should be rejected by regulators.

A recent article reported that Basel III Endgame would increase by $150 billion the equity capital requirements for eight U.S. megabanks, which have been designated as “global systemically important banks” (“G-SIBs”). That amount would represent little more than one year of earnings, as those eight megabanks reported average annual profits of $130 billion over the past three years.   

At the end of 2023, the eight G-SIBs held $14.94 trillion of assets. They funded almost 93 percent of their assets with deposits, bonds and other debt claims, and their equity capital was only $1.06 trillion. Their combined Tier 1 leverage capital ratio — their average annual total equity divided by total assets — was just 7.24 percent. Basel III Endgame would require those megabanks to increase their combined Tier 1 leverage ratio by 1 percent to about 8.2 percent. 

In June 2018, the same eight G-SIBs had a combined Tier 1 leverage ratio of 8.47 percent. During the past six years, federal bank regulators permitted big banks to reduce their leverage capital ratios by paying generous dividends and buying back large amounts of their stock. Thus, Basel III Endgame would not even require the eight G-SIBs to restore their combined Tier 1 leverage ratio to its level in mid-2018.   

Federal regulators have allowed megabanks to exploit their “too big to fail” status by operating with capital levels that are much lower than those of smaller banks. At the end of 2023, the combined Tier 1 leverage ratio for the eight G-SIBs (7.24 percent) was far below the Tier 1 leverage ratios for large banks with assets between $100 billion and $1 trillion (9.22 percent), regional banks with assets between $10 billion and $100 billion (9.76 percent), and community banks with assets under $10 billion (10.52 percent).   

Regulators should mandate much stronger equity capital requirements for megabanks. The Federal Reserve Bank of Minneapolis and numerous experts have proposed that big banks should maintain Tier 1 leverage capital ratios of at least 15 percent to reduce their risk of collapsing during systemic crises comparable to the global financial crisis of 2007-09 (GFC). 

Stronger equity capital requirements would protect the public from the enormous harms caused by systemic financial crises, including the costs of bailing out troubled megabanks. During the GFC, the federal government provided trillions of dollars of capital infusions, liquidity assistance and financial guarantees to rescue megabanks. 

During the pandemic crisis of 2020-21, the federal government established massive fiscal stimulus programs and backstopped wholesale money markets and corporate debt markets to halt a financial meltdown that threatened megabanks. During the regional bank crisis of 2023, federal agencies spent $40 billion to resolve the failures of three large banks and provided emergency loans to stabilize other vulnerable banks.   

Total federal debt nearly quadrupled from $9 trillion to $34 trillion between 2007 and 2023, due in substantial part to huge expenditures for combating financial crises. It is doubtful whether the federal government could shoulder comparable debt burdens during future crises without undermining the credibility of Treasury bonds and the U.S. dollar.   

Higher levels of equity capital are urgently needed to strengthen megabanks. Unlike deposits, bonds and other debt claims, Tier 1 equity securities — common stock and perpetual preferred stock — are permanent investments that never need to be repaid and do not require periodic payments of interest or dividends. 

As the Minneapolis Fed proposed, regulators should require megabanks to increase their Tier 1 leverage capital ratios to 15 percent within five years. Adopting Basel III Endgame would be a crucial first step toward achieving that goal.   

Big banks vehemently oppose higher equity capital requirements because they reduce payouts to megabank executives. Much of the executive compensation paid by megabanks is linked to their return on equity (ROE). Adding more equity increases the denominator for calculating ROE, making it harder for executives to hit their ROE targets. Big-bank executives therefore have powerful motives to fund their banks’ operations with less equity and more debt.   

As shown by their unwarranted attacks on Basel III Endgame, big banks want to “privatize their gains and socialize any losses.” Regulators must demand that megabanks put more “skin in the game” by increasing their equity capital. With more equity at stake, big banks would have stronger incentives to adopt prudent risk management policies.    

The big-bank lobby asserts that stronger capital requirements would greatly reduce the availability of credit to American businesses and consumers. In fact, U.S. banks increased their lending as they built higher levels of capital after the GFC. Additionally, researchers found that U.S. and international banks with higher levels of capital and liquidity were more resilient and provided larger amounts of syndicated loans during the GFC. 

The big-bank lobby also contends that Basel III Endgame would impose “massively overstated” capital charges for operational risk arising out of fraud, other violations of law and failures of bank controls. In reality, the proposed operational risk charges are amply justified by the shocking record of big-bank misconduct over the past quarter century.

Between 2000 and 2023, the six largest U.S. banks paid over $200 billion of fines, penalties, civil damages and other sanctions for a multitude of legal violations. Big banks have paid additional penalties in 2024, including substantial fines for large-scale trading violations by Citigroup and JPMorgan Chase.

Studies have shown that larger U.S. banks incur more severe losses from operational risk, and past losses from operational risk are good predictors of future losses at the same banks.  

Megabanks must internalize more of their risks and provide better safeguards to the public by increasing their equity capital. Regulators should promptly adopt Basel III Endgame and move forward with the Minneapolis Fed’s proposal for higher equity capital requirements.

Art Wilmarth is a Professor Emeritus of Law at George Washington University Law School.