Transcript: Bankers vs the Fed: ‘Endgame’

This is an audio transcript of the Behind the Money podcast episode: ‘Bankers vs the Fed: ‘Endgame’’

Michela Tindera
Over the past year, banks in the United States have been locked in an epic fight against regulators. They’re battling over a set of proposed rules that are known as . . . 

News clips
Basel III Endgame

Basel III

Basel III Endgame . . .

Joshua Franklin
It sounds like it’s some strange Swiss spin-off of, like, Avengers: Endgame or something like that. And I think it’s basically like the most exciting title that banking regulations have ever been given.

Michela Tindera
That’s the FT’s US banking editor Joshua Franklin. But unlike the Avengers, who the good guys are and who the bad guys are depends on who you ask. On one side, you have the US Federal Reserve. They introduce this Endgame proposal about a year ago.

Joshua Franklin
So it’s essentially saying the banks have to hold more capital. And capital is there to absorb potential losses in the financial crisis and means that banks would be in a better position to weather any stress that might come their way.

Michela Tindera
The regulators say that this is all about making banks safer. It’s to help everybody avoid another 2008 financial crisis, which sounds good, right? But if you ask the banks, the Fed is no superhero. Basel III critics claim that the regulation might end up hurting everyday Americans instead of coming to the rescue. And they haven’t been shy about it.

Brian Moynihan voice clip
It has much more an impact than people think.

Michela Tindera
The CEOs of major banks like Citigroup, JPMorgan and Bank of America have railed against these proposals in Congress.

Jane Fraser voice clip
Almost every element of the Basel III Endgame proposal would make lending and other financial activities more expensive.

Jamie Dimon voice clip
Ironically, a proposal meant to mitigate risk will actually increase risk.

Michela Tindera
And anti-Basel ads have even popped up on US highway billboards and on television.

Audio clip of an anti-Basel ad
The Fed’s considering Basel III Endgame, resulting in higher costs for consumers. It’ll raise mortgage rates, travel costs, heating bills and the price of these groceries.

Oh no, can we get these, please?

Oh, those will be . . . 

Yeah, I got it.

Life is tough enough already. Don’t let the Fed make it even tougher.

Michela Tindera
US regulators are planning to finalise Basel Endgame by July of next year. But as the clock ticks down, which side will prevail?

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I’m Michela Tindera from the Financial Times. Today on Behind the Money, we’re looking into the fight over a set of banking regulations called Basel III Endgame, why the industry is pushing back and what happens if they win?

Hi, Josh, welcome to the show.

Joshua Franklin
Thanks very much.

Michela Tindera
So Basel III Endgame. Let’s just get this out of the way first. Where is this title coming from? I mean it really does sound a bit ominous.

Joshua Franklin
So comes in part from the Swiss industrial city of Basel, which is home to the Basel Committee on Banking Supervision, which sets rules for the world’s banks to do business. You can tell by the name Basel III that there was a Basel I and a Basel II that came before it. And so Basel III was the efforts post the 2008 financial crisis to address what was clearly an issue for western banks, which is that they were undercapitalised and too risky relative to the system that they were operating in.

Michela Tindera
And so that was a big part of what went wrong for banks during the financial crisis, right?

Joshua Franklin
Yeah. So if you rewind back to 2008, when a lot of banks were having to suffer losses on mortgage loans that they were holding, what people learned was that the capital levels were very inadequate for the biggest banks. So there’s been a move over the last 15 years for banks to hold a greater amount of capital relative to the assets that they hold.

Michela Tindera
So since 2008, we’ve been trying to get banks to hold more capital. So tell me what’s exactly in these new rules?

Joshua Franklin
So these new regulations would only impact the very largest banks and then the kind of medium-sized banks underneath them. So banks with, starting with $100bn in assets and above would to varying degrees be subject to these rules. Under these rules, on average, regulators say they might have to hold around 20 per cent in additional capital, the largest banks in the US.

Michela Tindera
Now, what took so long for these rules to make it to this stage? I mean, the financial crisis was more than 15 years ago at this point.

Joshua Franklin
It’s happening now because the US, seven years ago, back in 2017, committed to introducing these reforms along with, you know, regulators in Europe, in the UK. This was a group of banking rules that are kind of minimum standards that all these jurisdictions agreed they would implement back home.

Michela Tindera
OK. So now in just the last year, it’s made its way out of Basel and over to the US.

Joshua Franklin
Yeah. One of the interesting things here is we’re kind of in the situation we’re in right now and in the fight that we’re in right now partly as a result of the 2020 election. So this is all being driven, in terms of the Federal Reserve, this is being driven by the person who sits as the vice chair of banking supervision. And in the Trump administration, that was a man called Randy Quarles who was quite sympathetic to the banks. And the way he talked about Basel III Endgame in its implementation was in a way that it wouldn’t have a big impact on capital rules. Fast forward to 2020, when Biden beats Trump, Randy Quarles’ term as vice chair of supervision at the Fed is up and is replaced by a man called Michael Barr, who launched pretty soon after taking over, a holistic review of capital rules. And he takes a more aggressive approach when it comes to minimum capital standards. So that’s really the reason why we’re in this fight that we’re in right now is because Michael Barr kind of really caught a lot of the industry off guard with just how aggressive his proposal was.

Michela Tindera
OK. So what are the banks’ arguments against implementing these regulations. I mean, what’s wrong with making things extra safe?

Joshua Franklin
The issue that the banking industry has with this is you’re fighting a war that’s already been won. There’s a discussion to be had about diminishing returns of capital requirements, where it’s like, you know, banks have to hold an extra $100bn in capital. That makes a big difference the first time you do it. It makes a big difference the second time you do it. But the third or fourth time that you do it, like, you know, you’re not really getting as much bang for your buck when it comes to safety. And that’s kind of the argument from the banking industry, which is, yes, you’re making us safer, But at a certain point, you’re going to disincentivise banks to do a lot of the basic functions that banks do, namely, lend and provide financial products to customers. So it will either make those products more expensive or banks will just think, OK, we’re not even going to bother to do them. And that would potentially end up with a worse result for the consumer and for the end customer.

Michela Tindera
And why is that?

Joshua Franklin
So every asset that a bank has, so every loan that a bank makes is assigned a risk weight based on how risky it is perceived to be. And if it’s more risky, banks have to hold more capital. And if it’s less risky, banks have to hold less capital. And what the proposal would do is dial these risk weights up. So banks have to hold more capital. So if it becomes more expensive for a bank to do these things, there’s three responses that a bank could have. They could decide to bear the brunt of that cost themselves. They could decide to pass that cost on to the consumer. Or they could just think and decide, it doesn’t make sense for us to do this business activity any more, it doesn’t make sense for us to do mortgages, it doesn’t make sense for us to do small business lending. So we’re just going to exit that business.

Michela Tindera
American banks are raising red flags about Basel Endgame. But how worried should we be? That’s after the break.

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Michela Tindera
So, Josh, I’m curious to take the superhero analogy one step further, why are the banks being so outspoken now resisting these rules? I mean, you know, 15 years ago they were considered the baddies, the, you know, villains of the financial crisis.

Joshua Franklin
I think there was definitely a feeling from a lot of the industry that they were clearly the bad guys in all of this, and the system was clearly not safe. And so they kind of had to take their medicine and they didn’t really have any choice. Fast forward to 15 years. I think the banking industry feels like they’re in a better place financially and also reputationally that they’re not exactly going to be, you know, on everyone’s Christmas cards list. But I think the reputation of banks is certainly better than it was in 2008. And so they think they feel like they just have more of a leg to stand on when it comes to objecting to changes like this.

Michela Tindera
And how has that changed the industry’s tactics to combating this stuff?

Joshua Franklin
I think one of the things that has been very successful in the banking industry’s lobbying efforts here isn’t just the fact that the banking groups themselves have been complaining, but what’s been helpful for them is the fact that you’ve had a lot of the end users of banking products complaining. So you’ve had airlines have expressed concern because they’re worried that it’s going to drive up the cost of hedging costs for fuel. You’ve had farmers complaining because it’s going to potentially drive up hedging costs for agricultural prices. You’ve had other groups who are worried that it’s going to make it even more problematic for the underbanked or the unbanked to receive banking services. So you’ve really, it’s not just the banks themselves that have been complaining, it’s also a lot of lobby groups as well for other industries that use these products that have also been complaining.

Michela Tindera
So how much truth is there to those concerns? I mean, are those things going to happen if large banks are forced to implement these new capital requirements?

Joshua Franklin
We’ll only really know kind of when the rubber meets the road if and when this is actually put into effect, but in the way that the rules are currently written when they were proposed in July of 2023 by the Federal Reserve, the US banking industry has argued that it will have enormous practical implications on everyday users of banking products. You’ve seen it in the previous 15 years post-2008 what banking rules coming out of the crisis in the US, certainly things like Dodd-Frank, the impact that that has had on the banking industry in the United States, it’s pushed more and more activity outside of the regulated banking industry.

Michela Tindera
Now, what are the groups that are for this regulation say to that?

Joshua Franklin
Advocates say, you know, yes, that may be happening, but in a lot of ways these big banks certainly are still extremely profitable. You look at JPMorgan Chase last year, made almost $50bn in profits, its best year ever. So, you know, the regulators are kind of saying, look, what are you complaining about? You guys seem to be doing pretty fine right now as it is. At the end of the day, capital is a financial resource, and it’s a choice for the banks what they do with it. They can either, you know, use it to fund their business or they can do things like buy back stock and pay dividends to shareholders. So one argument from regulators is, OK, well, maybe, you know, give shareholders less back and put that money instead in your business if you want to keep on doing these activities.

Michela Tindera
So these Basel standards impact other countries. So why haven’t we seen the same kind of pushback in, say, Europe as we have in the US?

Joshua Franklin
So I think part of it is what is decided in Basel are minimum standards that individual regulators have done to go back to their home countries and implement. But minimum standards doesn’t mean that they’re the only standards. And in Europe, I think you’ve seen, you know, certainly an implementation that it does not go too far beyond the minimum standards that Basel III Endgame calls for. In the US, they’ve gone in certainly in some instances for standards that go quite far above the minimum levels that are required.

Michela Tindera
So after all this pushback, it seems like the banks might be winning this fight. The chair of the Fed, Jerome Powell, has indicated that there could be changes made to these proposals. So where do things go from here?

Joshua Franklin
Yeah. Powell's comments were a huge boost for the banks. But I think at this point it’s still a bit of a waiting game. Until the Fed gives more of a road map about how it wants to move forward, whether or not it’s going to redraft or repropose its current proposal, which would be potentially a more lengthy process. And I think we’re expecting some movement on that, certainly before the election. But the Fed hasn’t yet given any clear guarantees about when we’re going to hear from them again on this.

Michela Tindera
OK. But we are getting closer to that July 2025 deadline. And you were saying the trajectory of this really changed when Biden won the election in 2020. So how might this year’s election in November impact this process?

Joshua Franklin
So I think that’s the one question for the banking industry is that, you know, some people maybe they have to be careful they don’t overplay their hand. Because they’ve had, so far anyway, a pretty successful lobbying campaign. They’ve really rallied a lot of support from the business community, from lawmakers, from other regulators that have agreed with them that these rules go too far. But what if you push for more dramatic changes that things get harder to accomplish then and it gets harder to complete this process before November of 2024? And let’s say there were to be a Biden victory then. Then maybe the more progressive view who argue for more capital for banks could feel emboldened by a Biden victory and think that they have more support on their side than seemed the case before.

Michela Tindera
How do you think this will all pan out? Do you think we’re going to see a sequel to this battle?

Joshua Franklin
The banking industry, while not declaring victory yet, a lot of people in that camp feel pretty confident that there are going to be material changes made to the final rule of Basel III Endgame. You’ve seen supportive comments from the chair of the Federal Reserve, Jay Powell, suggesting that there, you know, will be material changes and has talked about the need to have consensus among regulators. So I think there’s a big expectation that there are going to be changes. But I think everyone in the industry is still eagerly awaiting to see what the Fed decides ultimately to do and what kind of changes it will ultimately make.

Michela Tindera
Well, Josh, thanks for being here.

Joshua Franklin
Thanks very much.

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Michela Tindera
Behind the Money is hosted by me, Michela Tindera. Saffeya Ahmed is our producer. Our contributing producer is Max Johnston from Goat Rodeo. Our intern is Prakriti Panwar. Topher Forhecz is our executive producer. Sound design and mixing by Sam Giovinco. Cheryl Brumley is the global head of Audio. Thanks for listening. See you next week.