Many bankers appear happy with the new proposals for “Basel III Endgame,” and with good reason. When this all started back in 2023, the proposals were so controversial that banks launched a promotional campaign to defeat the effort. They even called out their regulators for arbitrarily raising capital requirements (by close to 20 percent for the largest banks), something very far from the norm for banks.
Now, all the original proposals have been scaled back. And considering the arbitrary nature of the original proposals, that’s probably a good thing.
Still, some people, also with good reason, are less than thrilled with a few of the specifics. For example, JPMorganChase CEO Jamie Dimon believes that the GSIB surcharge (a special capital buffer for the Global Systemically Important Banks whose failure supposedly could threaten the financial system) is still too high. In a recent letter to his shareholders, Dimon argues that “While we can accept that some level of surcharge is appropriate, given our position in the market, the proposed level just seems to punish our success, our strength, our consistency, and our balanced business model. Frankly, it’s not right, and it’s un-American.”
Dimon deserves a ton of credit for speaking his mind on this issue. The GSIB surcharge does punish success and is un-American. If anything, Dimon is being too kind.
The whole GSIB concept is twisted. If it is true that these large banks’ failures (the GSIBs) would bring down the economy and/or are too-big-to-fail, the last thing the federal government should do is explicitly identify them. And even if this scenario is a legit problem, the capital surcharge doesn’t fix it.
Worse, though, the concept has the direction of the damage backwards.
If a bank fails, its customers might temporarily have problems accessing some of their money. But that problem, by itself, wouldn’t cause the economy to go belly up because it wouldn’t materially harm customers’ ability to earn money over the long term. Customers would still earn wages going forward, and they could just go to another bank.
On the other hand, if the whole economy goes to hell and millions of its loan customers default, then JPMorganChase could be in trouble. Even then, though, the $700 billion in cash at the bank would serve as a buffer against the $1.5 trillion loan portfolio, regardless of the GSIB surcharge.
Even more broadly, it’s difficult to see how the risk-based capital framework, first authorized in the US in the 1980s, has been a success.
The idea was originally pitched as a way to standardize internationally active banks’ capital standards, but standardization never really came to pass, and the framework was forced on all US banks. It’s also now clear that the risk-based framework does not really make the banking system safer. The rules have become so complex and voluminous that the only thing they achieve is full employment for compliance officers and banking lawyers.
In fact, one of the only regulatory improvements to come out of the post-Dodd-Frank era was the community bank leverage ratio, signed into law and implemented during the first Trump administration. It’s an escape hatch. It allows small banks (those with up to $10 billion in total assets) to avoid the risk-weighted capital framework if they adhere to a higher, simpler ratio. And as of last year, almost 40 percent of small banks took the deal.
The new proposals will expand the ratio’s use, but why not go further? Congress should expand it so that all banks can opt into it and out of the risk-weighted system. Along with dropping the GSIB surcharge, that would be a huge improvement.
Optimally, Congress would ensure that banks, investors, and customers determine what the optimal levels of liquidity and equity are for banks. This change—I’m not holding my breath—would be the one most consistent with a free enterprise economy in a Republic built on principles of limited government.
If you’d like to see what happens roughly 150 years after ditching those principles for banks, check out Title 12 in the Code of Federal Regulations. Spoiler alert: It’s not very free-market or limited-government-friendly.
This post is cross-posted from Norbert Michel’s Substack, Mind The Gap.