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Payouts, not capital requirements, to blame for fewer bank loans -FDIC vice chairman

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WASHINGTON, Aug 2 (Reuters) - Big banks say tight U.S. financial regulation forces them to sit on capital and not put money to work by making loans, but in truth they choose to distribute all of their earnings to investors instead of lending them, a long-time regulator said in a letter to two powerful senators released on Wednesday.

Federal Deposit Insurance Corporation Vice Chairman Thomas Hoenig, frequently a Wall Street gadfly, has long said the biggest banks should be required to set aside more capital so they can weather a crisis without devastating the financial system.

Banks contend the Dodd-Frank Wall Street reforms resulting from the 2007-09 financial crisis, which included heightened capital requirements, are too constricting. They say the capital requirements force them to save dollars and pull back on loans.

Hoenig, who was a high-ranking Federal Reserve official during the crisis, cautioned Senate Banking Committee Chairman Mike Crapo and the committee's senior Democrat, Sherrod Brown, "against relaxing current capital requirements and allowing the largest banks to increase their already highly leveraged positions."

"I recognize that dividends are an important factor for investors and they should be rewarded for the risks they take. But it is also true that funding business growth, assuring future economic success, and promoting capitalism depends upon the retention of earnings," he wrote in the letter, dated Tuesday.

Using public data to analyze the 10 largest bank holding companies, Hoenig found that they will distribute more than 100 percent of the current year's earnings to investors, which could have supported to $537 billion in new loans.

On an annualized basis they will distribute 99 percent of their net income, he added, saying massive distributions provide no base for future growth.

He added that if banks kept their share buybacks, which totaled $83 billion, then under current capital rules they could boost commercial and consumer loans by $741.5 billion.

"While distributing all of todays income to shareholders may be received well in the short run, it can undermine their future returns and weaken the growth outlook for the larger economy," he wrote.

The industry, however, remains wary of having to hold on to more capital. When the House of Representatives passed legislation this year to let banks choose between meeting higher capital requirements or complying with Dodd-Frank, most of Wall Street said it would choose Dodd-Frank.

(Reporting by Lisa Lambert; Editing by Steve Orlofsky)