By Holly A. Bell
In our current economic environment everyone loves to hate banks. They represent foreclosures, “too big to fail”, government bailouts, and this week: manipulators of a key interest rate that affects loans around the world. So did big banks take too many risks and were individuals too eager to borrow money? Probably. Is the new banking environment going to make you better off? Maybe, maybe not.
First, big banks are going to be forced to get smaller as they are going to be subject to new regulations that smaller banks are not going to have to comply with. Large banks (19 in all) are going to have to meet new regulatory capital requirements. They will be required to “stress test” their capital against a variety of potential economic scenarios. In other words they will have to demonstrate they have enough capital on hand to “continue to lend to households and businesses, even under adverse conditions” according to the Fed. While this seems like an excellent idea, there are some implications for borrowers. For example, you are less likely to get a loan even when times are good. Mortgage crisis aside, large banks, through their economies of scale and scope, had been able to offer loans (at higher interest rates) to higher risk borrowers. Not anymore.
This means banks are going to require higher credit scores for loan and credit card customers. Equifax has stated that today’s credit score of 760 is what a 720 used to be. With Experian reporting the average credit score in the US at 736 with the median at 723, many people might have trouble getting a loan. Large banks will also be unable to support their current branch banking system meaning smaller towns and certain neighborhoods will no longer have large-bank branches. As a result, large- banks will tend to have slower rates of growth or even contract in size while smaller banks, credit unions, and non-bank lenders may prosper. The non-large bank segment should also begin to have more competitive lending rates as large banks may continue to have upward pressure on rates as they attempt to return to acceptable levels of capital security as required by the government. This upward pressure is compounded by the Fed’s announcement that it expects to raise interest rates in the second quarter of 2014.
Overall, the new banking environment means that big banks will be moderating their growth and simultaneously creating less money. The potential economic impact? While economic growth will improve over time, it may be at a significantly lower rate, at least for a while.
Housing continues to impact banks.
We’ve been hearing good news about the housing market lately. We first heard that 2011 foreclosure filings had dropped by 34% and then we were told that housing starts were up 1.5% in January. Unfortunately neither of these numbers represents particularly great news. The reason foreclosure filings were lower in 2011 was that lenders were in negotiations with the Federal government on a $26 billion mortgage settlement. As a result, they delayed foreclosure filings pending the outcome of the negotiations. Now that they have finalized the deal, foreclosure filings are expected to jump from 1.9 million in 2011 to as much as 2.5 million in 2012 as lenders work through the backlog. While there are approximately 3 million homeowners currently seriously delinquent on their mortgages or in foreclosure, the new Federal deal for refinancing is only expected to help less than 1 million of these homeowners. More foreclosures mean continued downward pressure on home prices, which is more bad news for banks.
Compounding this problem is that the news regarding a 1.5% rise in housing starts in January is both lower than expected and due to demand from renters, not home purchasers. The increase was in multifamily housing starts, not single-family housing, which actually fell 1% in January. So demand for single-family housing remains below the market-clearing demand for the current surplus (with more foreclosures on the way) forcing prices down even further. And remember, bank’s loanable funds are lower, and the credit worthy population is smaller.
So is this love of hating banks justified?
While banks took too many risks, the government encouraged them to find ways to provide home loans to low and moderate-income households and minorities. In many ways they were doing what those who regulate their industry were encouraging them to do. Individuals and households who borrowed too much money also bear some blame, as well as the Federal government’s insistence on printing more money. The issues surrounding our current situation are complex, so I think there is plenty of blame to go around. While there were some greedy and/or unethical individuals, the banking industry as a whole has a lot of incentive to remain healthy and viable. With looming foreclosures, the eurozone crisis, increased regulation and accountability, and a weak employment environment believe me, banks are feeling the pressure and have not come out of the situation unscathed.
Regardless of how you feel about banks, remember we have a co-dependent relationship with them and like all relationships we can’t change the other member of the relationship, only our reaction to them. Since this is how banks are going to be for a good long while, let’s work on those credit scores, separate our needs from our wants and get busy with the rebuilding. Like it or not, this is the new normal.
Image courtesy of phanlop88
I was just hearing something about this on NPR. The largest banks are now going to have to come up with a guide to walk them through their own collapse if they fail. It’s no longer acceptable to be “too big to fail.” Simply put, they have to devise their own funerals because the Federal Government has vowed to bail them out only the one time and never again.
I still hate big banks though, especially Citigroup and Wells Fargo. (They know what they did.)
Richard: As one author put it they have gone from “too big to fail” to “too secure to fail”.
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The subject of bank risk taking is quite fascinating, there is a bit of a paradox, or some irony in the area of risk taking:
1. We disapprove of banks’ excessive risk taking prior to the crisis that facilitated the development of systemic vulnerabilities; and
2. We now disapprove of banks’ refusal to take risk, with the banks preferring to hold securities and deposits at central banks, instead of lending to individuals and businesses.
In some sense it is a reality of the market cycles, and I don’t think you regulate against the above (if you considered them market failures); the regulations would need to be very hands on e.g. prohibiting/limiting allocation of bank assets to securities/bonds/CB deposits, and limiting allocation to risky assets during periods of high credit growth…
I agree this is part of the market cycle rather than market failure. However, there is also a dose of government failure due to over-ambitious home ownership goals. Having said that, regulation is certainly not the solution. The market will work it out over time.