By Oscar Valdés Viera, Senior Policy Analyst, Private Equity & Capital Markets
Bloomberg’s Editorial Board recently delivered a blunt warning that the Trump administration’s fixation with weakening the safety and soundness of the banking system by cutting capital requirements is “courting a banking crisis.”
The argument to lower bank capital is based on a dangerous misrepresentation, pushed by Wall Street lobbyists, of what bank capital actually is. As we have argued before, capital is not cash sitting idle in a vault—in fact, it’s not even on the same side of the balance sheet.
Capital is money from a bank’s own investors that serves as a source of funding for the loans, securities, and other assets from which the bank earns profits. Unlike borrowed money, capital does not have to be repaid or defaulted on when losses occur. It therefore serves as a cushion that allows banks to absorb losses during periods of stress without losses spreading to creditors (including depositors) and rippling through the financial system.
Strong capital rules also require shareholders to have more of their own money at risk, making bank lending safer because they have more skin in the game. This reduces the likelihood that the public will once again be forced to bailout Wall Street’s excesses.
The Bloomberg Editorial Board not only corrects the record of what bank capital is but also points out the fact that the largest U.S. banks have outperformed many international rivals “despite facing significantly higher capital requirements”—debunking the argument that robust capital standards undermine competitiveness, another frequent argument deployed by industry lobbyists.
The administration’s capital rollback is particularly dangerous because it is only one part of a much broader campaign of bank deregulation, including efforts to weaken supervision, liquidity safeguards, merger scrutiny, and other protections adopted after the 2008 crash. Banks benefit because they get to operate with more borrowed money and return equity capital to their wealthy investors. But each rollback makes the financial system more vulnerable to shocks; and together they create the conditions for a devastating crisis. Meanwhile, risks are piling up across the economy—including in the form of an AI bubble—that could create enormous stressors.
As the Editorial Board concludes point blank: “America’s leaders are making a mistake.”