Introduction and summary
The COVID-19 outbreak has sparked a serious economic downturn that is placing increasingly severe stress on the banking system. Many households and businesses are likely to face grave difficulties meeting their financial obligations in the coming months. Jobless claims have increased by more than 30 million in the past six weeks, and gross domestic product (GDP) is expected to shrink drastically in the near term. Former Federal Reserve Chair Janet Yellen estimates that GDP could drop by 30 percent in the second quarter of 2020, and Federal Reserve Bank of Minneapolis President Neel Kashkari believes that the current unemployment rate could be as high as 23 percent.
As a result, banks’ loan, securities, and derivatives portfolios are likely to face serious downward pressures. Other sources of bank income have begun to dry up as well. In the first quarter of 2020, the six major Wall Street banks announced sharp profit declines, driven by large provisions for loan losses. Executives at these banks expressed extreme uncertainty regarding the depth and timeline of the economic downturn. Michael Corbat, CEO of Citigroup, stated, “No one knows what the severity or longevity of the virus’ impact on the global economy will be.” They were similarly unsure about the extent of the strain that the intensifying crisis will place on bank balance sheets. JPMorgan Chase & Co. CEO Jamie Dimon bluntly stated, “If the economy gets worse, we’ll bear additional loss.”
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In the wake of the 2007-2008 financial crisis, policymakers improved the suite of safeguards that mitigate the chances of instability in the banking system. These efforts have contributed to the banking system’s initial resilience to this crisis, unlike large segments of the shadow banking sector that required immediate government intervention. But the Federal Reserve’s bank capital decision-making over the past several years, in conjunction with the Federal Deposit Insurance Corp. (FDIC) and the Office of the Comptroller of the Currency (OCC), has needlessly increased the vulnerability of the banking system. This is especially relevant as the economic fallout from the coronavirus crisis is set to escalate in the coming weeks and months. Regulators should have required banks to continue building their loss-absorbing capital buffers while profits were high and the economy was booming. Instead, they moved in the opposite direction, chipping away at the resiliency of banks large and small. And regulators have continued to erode bank capital requirements during the coronavirus crisis. Regulators’ emergency changes have permitted banks to pay out more capital to shareholders and to proceed with concerningly low levels of capital.
This report outlines the general importance of bank capital requirements,…
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