To force large banks to get ready for the bad times during the good times, the Fed created a tool after the 2008 crisis called countercyclical capital buffering. Banks borrow most of the money they lend to customers, but the Fed requires banks to obtain a small portion of their funding from sources that do not need to be repaid — for example, by selling shares to investors or retaining profits. These funds are called capital; the amount of capital is the amount of losses a bank can endure without defaulting on its obligations. Under the countercyclical policy, the Fed can order banks to increase these capital buffers in periods of economic growth.
This would seem like such a time. But this month, the Fed declined to act. Instead it is moving to let banks shave their capital buffers.
The Trump administration argues that deregulation will spur economic growth, by freeing banks to make more loans. This is wrong in two distinct ways. First, banks say they have plenty of money but not enough customers; the binding constraint on bank lending is not regulation, but instead, weak demand. Second, a number of studies have found that well-capitalized banks are more prolific, consistent and higher-quality lenders during good and bad times.
In October, regulators proposed to ease capital requirements for all but the very largest banks. Leniency for smaller banks enjoyed bipartisan support, and Congress directed the Fed to act. But the Fed went further than required, extending leniency to banks in the same weight class as Washington Mutual, one of the largest and most consequential bank failures during the 2008 crisis. Lael Brainard, the sole Fed governor to vote against the decision, issued a highly unusual public statement noting that only a few years have passed since the Fed tightened its capital rules. She said she saw no change in financial conditions to justify weakening the rules. What has changed, of course, is that power passed from the Democrats to the Republicans, who are determined to deregulate.
The Fed also is easing the burden on the largest banks. Basic capital requirements are risk-weighted, meaning banks that make safer investments, such as buying Treasuries, are allowed to rely more heavily on borrowed money. But the rules also impose a minimum ratio limiting how low capital can go. That safety net is called the supplementary leverage ratio. And the government is planning to make it more flexible — letting banks borrow more.