Stress Tests, Lending, and Capital Requirements
Posted on March 28, 2014 by James Kwak
Despite the much-publicized black eye to Citigroup’s management, the bottom line of the Federal Reserve’s stress tests is that every other large U.S. bank will be allowed to pay out more cash to its shareholders, either as increased dividends or stock buybacks. And pay out more cash they will: at least $22 billion in increased dividends (that includes all the banks subject to stress tests), plus increased buyback plans.
Those cash payouts come straight out of the banks’ capital, since they reduce assets without reducing liabilities. Alternatively, the banks could have chosen to keep the cash and increase their balance sheets—that is, by lending more to companies and households. The fact that they choose to distribute the cash to shareholders indicates that they cannot find additional, profitable lending opportunities.
This puts the lie to the banks’ mantra that capital requirements will constrain lending and therefore reduce growth (made most famously in the Institute of International Finance’s amateurish report claiming that increased regulation would make the world’s advanced economies 3 percent smaller). Capital isn’t the constraint on bank lending: it’s their willingness to lend.
Let’s look at this a little more closely. Let’s say that, instead of letting the banks increase their dividends and buybacks, the Federal Reserve increased capital requirements and said that banks had to hold onto their cash to meet those higher requirements. What would happen to bank lending? Nothing. Banks wouldn’t have to reduce their balance sheets because they already have the cash; they would just be not paying it out to shareholders.
http://baselinescenario.com/2014/03/28/stress-tests-lending-and-capital-requirements/
