Thomas Hoenig on Public Debt Sustainability and the Current State of the US Banking System
Sep 25, 2023
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Thomas Hoenig, former vice chair of the FDIC, discusses public debt sustainability, the US banking system, and more. Topics include the Treasury market, US current accounts deficit, Fed's role as Treasury Market backstop, risk-weighted capital regulation, and challenges in selling Treasury debt.
The need for higher capital levels in banks is supported by academic research and historical evidence.
Risk-weighted capital regulations have been criticized for their complexity and susceptibility to manipulation, advocating for a more straightforward leverage ratio.
The recent banking turmoil highlights the importance of strengthening liquidity and solvency in the banking system through higher capital requirements and better management and supervision.
Deep dives
Banks face increased capital requirements and oversight
The Federal Reserve's proposed rules would raise capital requirements for large banks from about 12% to 14% on average, and medium-sized banks would also face increased oversight. This comes after the recent banking turmoil in March and April, where several banks went under or were acquired. The proposal has sparked outrage and lobbying from the banking industry, who argue that there is no justification for significant increases in capital requirements. However, the need for higher capital levels is supported by academic research and historical evidence.
Basel III in-game and risk-weighted capital regulations
The proposal from the Federal Reserve ties into the ongoing discussion around the Basel III in-game and risk-weighted capital regulations. Risk-weighted capital regulations have been criticized for being complex and susceptible to manipulation, leading to misleading representations of banks' true capital levels. The emphasis on risk-weighted assets has not proven effective in preventing past banking crises, as all assets become risky during a crisis. The argument is made for a more straightforward leverage ratio, which directly ties capital requirements to total assets and provides a clearer and more accurate measure of a bank's capital adequacy.
Liquidity and solvency concerns in the banking system
The recent banking turmoil highlights the need to strengthen liquidity and solvency in the banking system. The implosion of Silicon Valley Bank and the subsequent government intervention demonstrate that banks, even those not viewed as systemically risky, can pose a threat to the banking system if they collapse. With potential weaknesses in commercial real estate and the continuous tightening of monetary policy, there are concerns about the resilience of the banking system and potential liquidity and solvency issues. The need for higher capital requirements and better management and supervision is crucial for ensuring the stability and safety of the banking system.
The role of the Federal Reserve and the future of banking regulation
The proposed rules and ongoing discussions reflect a push for greater oversight and capital requirements to address the risks in the banking system. However, there are debates about the effectiveness and complexity of risk-weighted capital regulations, as well as concerns about the impact on banks' profitability. The challenges faced in the banking sector, such as the pressure on commercial real estate and the potential for higher interest rates, require careful consideration of regulatory reforms. Balancing the need for stability and safety with the goal of supporting economic growth and access to credit will be critical in shaping the future of banking regulation.
The need for a comprehensive approach to banking regulation
As the banking system faces new challenges and risks, it is essential to adopt a comprehensive approach to banking regulation. This includes not only capital requirements and liquidity provisions but also effective management and supervision, as well as measures to address systemic risks. The proposed rules from the Federal Reserve are part of an ongoing effort to enhance the resilience of the banking system and prevent future crises. However, it is important to continuously reassess the effectiveness and efficiency of regulatory frameworks to ensure that they align with the changing landscape of the financial industry and the evolving risks it faces.
Thomas Hoenig is a distinguished senior fellow with the Mercatus Center at George Mason University, where he focuses on the long-term impacts of the politicization of financial services as well as the effects of government-granted privileges and market performance. He was formerly the vice chair of the FDIC from 2012 to 2018 and the 20 years prior to that, he was president of the Kansas City Federal Reserve Bank. Tom is also a returning guest to Macro Musings, and he rejoins to talk about the Treasury market, public debt sustainability issues, and the state of banking in the United States. David and Tom also discuss the history of Tom’s influence on the Jackson Hole Conference, the growing size of the US current account deficit, the Fed’s role as the primary Treasury market backstop, the dangers of risk-weighted capital regulation, and more.
