After delivering a speech at a conference in Atlanta during the summer of 2011, then Federal Reserve Chairman Ben Bernanke received a pointed question from JP Morgan Chase CEO Jamie Dimon, who after listing several new post-crisis banking regulations, asked the Chairman: “Has anyone bothered to study the cumulative effect of all these things, and do you have a fear like I do, that when we look back and look at them all, that they will be a reason it took so long, for our banks, our credit, our businesses, and most importantly job creation to start going again?”
The encounter was typical Dimon—he could have just as easily made his point in private. Instead he used the forum to voice the growing discontent amongst many on Wall Street that a litany of new rules and regulations were restricting banks abilities to extend credit to the real economy. The financial press seized on the confrontation as the main story, while paying scant attention to Bernanke’s reply: “Has anybody done a comprehensive analysis of the impact on — on credit? I can’t pretend that anybody really has. You know, it’s — it’s just too complicated. We don’t really have the quantitative tools to do that.”
It is surprising to hear the Chairman of the Federal Reserve, a Ph.D. economist with a large staff of other Ph.D. economists, acknowledge that regulators don’t have the quantitative tools to do a cost-benefit analysis of the rules they put forward. However, given the volume of new rules, their staggered implementation deadlines, and an evolving financial industry landscape, it was understandable when Mr. Bernanke concluded by stating that “a little bit of time” was needed for regulators to “figure out where the costs exceed the benefit.”
Fast forward to 2016, and the August release of the Financial Stability Board’s (FSB) second annual report to the G20 on the implementation and effects of financial regulatory reforms. The report is intended to provide G20 leaders with a status update on jurisdictions progress toward implementing agreed upon financial reforms and the impact these reforms are having on the financial system and the broader economy. Section 3 of the report is the closest the global regulatory community comes to addressing Dimon’s cumulative impact question, and it hardly gives a definitive answer.
According to the FSB, post-crisis reforms “have enhanced resilience and hence the financial system’s ability to absorb shocks and support growth.” To support this conclusion, the report points to improved bank capital and leverage ratios, as well as enhanced bank funding profiles. It is true that regulated financial institutions are better positioned to withstand the next crisis, but what about Dimon’s point about reforms restricting the flow of credit to the real economy, thus slowing down the pace of recovery? The FSB doesn’t think this argument holds much water, as evidenced by data showing post-crisis year-over-year growth in both total and bank lending in all regions. The challenge of course is that there is no counterfactual, we have no way of knowing what lending would be absent reforms. It is also hard to separate the impact of an extended period of historically low interest rates, which has incentivized non-financial businesses to borrow more.
The biggest impact reforms are having on the flow of credit may be in regards to who is extending credit. According to the FSB, “non-bank financial intermediation has grown in several advanced economies (particularly in Europe) and EMDEs since the crisis, and now represents about 40% of total financial system assets in 20 jurisdictions and the euro area.” The report provides little by way of explanation for this growth in shadow-banking, but Dimon and his big bank colleagues would surely point to more conservative capital and liquidity requirements as the primary culprit—the logic being that shadow-banking entities have stepped in to fill the gap in credit once supplied by regulated commercial banks. Considering that non-bank financial entities remain largely out of the regulatory perimeter, it is fair to ask whether the growth in shadow banking is cause for concern—a question the FSB’s report avoids.
The FSB isn’t completely unwilling to entertain the notion that post-crises reforms have had any deleterious effects. Section 4 of the report calls out three areas that warrant further analysis to understand if new rules and regulations may be having some unintended consequences. First identified in 2015’s report, they are: market liquidity; effects of reforms on emerging market and developing economies (EMDEs); and maintaining an open and integrated global financial system.
Changes to market liquidity, specifically in fixed-income markets, have been thoroughly analyzed by both international standard setters and domestic regulators, and the FSB’s report summarizes their main findings. There are multiple metrics used by market participants to measure liquidity in any given market, and most of these, like bid-ask spreads, point to improved market liquidity. However, the report notes that in certain sovereign bond markets, it may be getting harder to trade larger blocks without significantly influencing the security’s price. The report briefly mentions several possible explanations, of which enhanced regulation is one, but the main conclusion is that: “It is difficult to reliably attribute changes in market liquidity conditions in different segments, if any, to specific drivers.”
The FSB comes to similar conclusions when assessing the impact of reforms on emerging markets and the global integration of the financial system—it is simply too difficult to measure the impact of any one change. But this doesn’t mean that regulators aren’t trying. In the annex of the FSB’s report, reference is made to a workshop held this past May that brought together national regulators and academics to share evidence on the effects of reforms and discuss methodologies for evaluating the effects of reform. The papers that were presented at the workshop aren’t publicly available, but the report’s summary echoes Bernanke’s comments from five years prior: “participants noted that attributing the effects that combined reforms are having on overall macroeconomic and financial conditions is empirically difficult, given the many factors shaping aggregate conditions and the lack at this stage of adequate post-implementation data.”
Most regulators would say that even if there were a way to empirically prove that more conservative post-crisis regulatory reforms have slowed the pace of recovery, this would be a willing tradeoff for a stronger, more resilient financial system, better equipped to maintain the flow of credit during the next crisis. But this is easy to say when you don’t have—and may never have—hard figures to compare.
During that same encounter, Dimon stated: “I have this great fear that someone’s going to write a book in ten or twenty years, and the book is going to talk about all of the things we did in the middle of the crisis to actually slow down recovery.” We still have time, but right now it doesn’t look like that book will be written.