Regulators weigh impact of new capital rules on banks and nonbanks alike

By Kyle Campbell

With new, proposed capital rules set to debut this summer, some in and around the banking sector worry that stringent requirements could inadvertently make the financial system less safe. The key issue for certain policymakers and analysts is whether heightened regulatory standards will push more lending activity away from banks and toward less-regulated entities, such as insurance companies, debt funds and other alternative capital sources….But some see this two-track approach to regulation as shortsighted. It’s just a game of pass the potato,” Karen Petrou, managing partner of Federal Financial Analytics, said. “That’s an analytically unfortunate approach to thinking about capital requirements.” Petrou said one of the goals of regulatory reform should be to reduce unintended consequences. While anticipating those consequences can be difficult, she said risk moving outside the banking system is a well-established reaction to higher regulatory requirements. She pointed to the residential mortgage market, which has been dominated by nonbanks since the reforms implemented after the subprime lending crisis of 2008. Once a strong proponent of Barr’s holistic capital review as means for addressing overlaps and oversights in the current regulatory framework, Petrou said she is now skeptical the exercise can achieve that goal. Given the “piecemeal” changes that have been discussed since this spring’s run of bank failures — including amending the treatment of accumulated other comprehensive income and the introduction of so-called “reverse stress testing” — Petrou worries the net result of the review will be an entirely different regulatory regime.”The idea was a very constructive one, but I think it will be extremely hard to pull off if by the time we start thinking holistically we’ve redesigned the system so incrementally that it’s operating in a wholly new way,” she said.