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Although current loan demand is low relative to historic levels, once the economy accelerates and demand returns, regulations that require higher levels of capital could inhibit banks’ ability to adequately meet demand. Estimates around the impact of higher capital levels on lending vary, but all calculate some negative effect on economic growth. According to the Federal Reserve, for each percentage point of extra capital a bank must hold, growth slows by about 0.09 percent a year, a “modest” impact on lending. The International Institute of Finance calculates that the effect on economic growth is significantly higher.
This trade-off between higher levels of capital and its effect on lending is real but under-recognized. While the needs of business and consumer borrowers seem to be satisfied for now, this may not be the case when higher levels of economic growth return.
The balance between safety and growth could be in jeopardy unless our industry and government leaders examine the unintended consequences associated with requiring more stringent requirements on U.S. business.
Matt McDonald is co-author of the Hamilton Financial Index report and a partner at Hamilton Place Strategies.