Why Are Banks Short on Capital? (Hint: Regulation)
ENTERPRISE BLOG
By Peter J. Wallison on Regulation
In an article published this week in the New York Times, reporter Eric Lipton reviewed the various reasons that private equity firms have not been allowed by the Fed to acquire controlling interests in banks. The article mentioned the separation of banking and commerce, protecting banks against control by risk-taking investors, a fear that industrialists will dominate the economy through bank ownership, and the Fed's desire that bank holding companies function as sources of strength for their banks—every reason except the right ones.
First, the Fed's power over the banking industry depends on its ability to determine the permissible activities of companies that control banks—known as bank holding companies (BHCs). Although many large state-chartered banks used to be supervised by the Fed, they have now become national banks and are supervised by the Comptroller of the Currency. The Fed's last redoubt is its control over BHCs, which cannot generally engage in any business that is not "financial in nature," and must obtain the approval of the Fed before they can acquire or establish subsidiaries engaged in these permissible activities. If companies engaged in nonfinancial activities—such as private equity firms—could control a bank, the Fed will have lost its remaining ability to grant these approvals, and thus its principal source of influence over banking policy generally and the policies of individual banks.
Second, the banking industry, which has substantial influence in Congress, has assiduously protected the Fed's position over many years. Although the restriction on holding company activities pinches the ambitions of the largest BHCs to expand their activities into profitable nonfinancial activities, it very much serves the interests of the thousands of smaller banks who do not want competitors with deep pockets—like Wal-Mart—entering the banking business. When Wal-Mart suggested several years ago that they might acquire an insured depository institution that is not subject to Fed jurisdiction, there was an enormous outcry in Congress, which moved quickly to arrest this development through legislation. Only Wal-Mart's surrender stopped the adoption of a law that would have prevented Wal-Mart's acquisition.
In the current financial crisis, the banking industry and the economy generally have suffered painfully from the policy of prohibiting nonfinancial firms from controlling banks. It has cut the banking industry off from large sources of capital that could easily remedy its capital impairment. At a time when the stress tests will tell us how much capital the industry still needs, and how difficult it will be for banks to get it, Americans should recall that it is the Fed's interest in retaining its power and the banking industry's effort to avoid tough competition that have been major sources of the industry's capital shortage. |
