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New Oxford Economics Study Confirms Negative Impact of Increased Bank Capital Levels on U.S. Economic and Job Growth

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Peter McKillop
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HIGHLIGHTS

  • Study Projects Range of Losses in GDP, Jobs Due to New Capital and Liquidity Regulations
  • Oxford Economics research finds that official studies underestimate GDP impact
  • TCH urges policymakers to carefully examine economic and employment tradeoffs as they consider further increases to bank capital levels

 

New York – April 10, 2013 – The Clearing House Association (TCH) today released a study by Oxford Economics that reaffirms the expert consensus that increased capital and liquidity requirements on banks will have a negative impact on U.S. economic growth and future employment.

The study analyzed five of the most prominently and frequently cited capital cost studies using the Oxford Global Economic Model – the most widely used commercial international economic forecasting and scenario model in the world. The results demonstrated that while there is a wide range of conclusions on the severity of the impact of increased capital and liquidity requirements, all the studies conclude that there will be an economic and job cost to the U.S. economy.

“Our study’s findings clearly demonstrate the need for any regulatory program to be carefully structured to avoid any unintended consequences to economic growth and employment,” said Adam Slater, Senior Economist at Oxford Economics.

Oxford reviewed the potential effects of bank capital and liquidity regulation in five key studies – the IMF study of Elliot et al. (2012), the study by the IIF (2011), the OECD study of Slovik & Cournede (2011), the BIS/MAG studies (2011), and the Bank of England study of Miles et al. (2011). Four of these studies were considered ‘official’ efforts (i.e. from international regulatory and financial organizations) while the IIF study was from an organization representing global financial institutions.
When reviewing the studies, Oxford identified three key factors by which regulations could impact bank behavior and the economy:

  • increased capital levels that push up the cost of bank credit (bank lending rates);
  • requirements to hold more liquid assets, which may also raise the cost of bank credit; and
  • shrinking of risk-weighted assets (RWA) by banks to try to meet higher minimum capital ratios, which could lead to a rationing of the quantity of credit, or increase the cost of credit, as other credit providers could require higher rates to hold the assets.

In its own separate analysis of the data, Oxford sought to improve upon the assumptions of prior studies to better align them to the economic and regulatory reality in the United States.

Oxford estimated that a ‘worse case’ scenario of higher capital requirements could lead to a drop in GDP of 2% with a real dollar cost of $300 billion and a loss of one million jobs over nine years.

It also noted that if the phase-in period should be shortened, the decline in GDP would be significantly greater and the cushioning effects of any accommodative monetary policy on lending rates and GDP would be relatively smaller. In the ‘worst case’ scenario with this shorter transition period, GDP would be 1.5% ($230 billion) lower and unemployment would increase by 800,000 after just four years. Increasing capital levels beyond Basel III levels could result in more significant GDP declines and the loss of up to 1.7 million jobs over nine years.

The study also finds that there is a risk that the cost of enhanced capital regulations could be higher still if banks reduce risk-weighted assets – rather than raise fresh capital – to try to meet higher minimum regulatory capital ratios. The study concludes that, under such an approach, a 3% increase in the required capital ratio would reduce GDP by over 2%. Moreover, while this risk has been overlooked by some prior studies, there is evidence that banks in the Eurozone have reacted to regulatory pressures by cutting risk-weighted assets, and stress tests organized by the European Banking Authority have attempted to prevent this outcome.

To conduct its analysis, the Oxford study used the Oxford Global Economics Model which is used by more than 100 clients, including central banks, institutional organizations, and multinational companies to study future macro-economic effects of policy. Additionally, it employs a loan pricing model to assess effects of variables on bank lending rates, which is a model that is commonly used across academia to conduct similar evaluations of the effects of capital regulation. In order to achieve more accurate results than previous studies, this study refines a variety of assumptions driving earlier academic research so as to better reflect real economic conditions. Some of those assumptions include cost of equity, cost of debt, credit spreads, administration costs, baseline capital levels, size of capital buffers, size of liquidity requirements, and length of transitional period for phase-in.

“The Clearing House supports enhanced levels of bank capital to strengthen bank balance sheets. However, the Oxford study conclusively demonstrates that maintaining higher levels of capital does come with an economic cost,” said Paul Saltzman, President and General Counsel of The Clearing House Association. “While we agree that banks need to hold greater levels of loss absorbency than were held during the financial crisis, at some point the additional benefit from new capital diminishes and is outweighed by the cost to the economy. We urge policymakers to carefully consider the economic and employment tradeoffs as they debate further increases to bank capital levels.”

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