I’ve mostly stayed out of the debate over reauthorization of the U.S. Export-Import (Ex-Im) Bank. My colleague Diane Katz, and some others, have run with the issue. And they’ve done a great job of pointing out the hyperbole that Ex-Im supporters rely on to make their case.
Ex-Im financing supports only about 2 percent of the nation’s exports, but we’re supposed to believe that the bank is a critical element of national security, and that letting the bank’s charter expire imperils billions in exports and thousands of jobs all across the U.S.
Aside from these exaggerations, letting the charter expire would do absolutely nothing to the existing financing arrangements, many of which will remain in place for years.
But I recently came across an Ex-Im defense I had completely missed, so I decided to chime in. (Just this once.)
Supporters have argued that banks can’t make certain loans without Ex-Im support because of the overly restrictive Basel III capital requirements. Ignore the details for just a moment and let that logic really sink in: we need the federal government to subsidize more loans because federal regulations make it too expensive to make loans.
Overregulation is a huge problem in financial markets, but more government escape hatches for a few special interests are not the solution. And these Ex-Im supporters, perhaps by accident, are actually making the case to cut regulations.
The Coalition for Employment Through Exports notes that “[c]ommercial banks with mid-market customers who export are now subject to new regulatory constraints, such as Basel III.” As a result, “[t]hese banks are unwilling to take on cross-border financing.”
The Nuclear Energy Institute (NEI), concerned that their industry will be unable to finance new power plant construction, has made similar claims. A recent NEI blog post states:
"Foreign utilities are typically very low credit risks. Basel III capital reserve requirements prevent them [commercial banks] from allocating billions of dollars in tier one capital for as many years as necessary to finance a nuclear power plant."
Just to be clear: I’m not at all sympathetic to the notion that Ex-Im bank subsidies are a good way to overcome Basel-induced regulatory costs.
That said, we should get rid of regulations that prevent people from making good-quality loans. And the NEI quote provides anecdotal evidence that the Basel capital rules are doing exactly that.
But it’s not because Basel III includes a specific prohibition against things like cross-border financing or nuclear power plant construction loans. For now, at least, even federal regulators aren’t willing to go quite that far.
Instead, regulators have tried to design a set of rules that assign the “right” risk levels to all the different items a bank could hold on their balance sheets. Commercial loans, mortgages, mortgage-backed securities, municipal bonds, and so on – all get their own tailored risk weights.
The end result is an amazingly complex set of capital regulations that replace bankers’ subjective risk assessments with bureaucrats’ judgment. All else equal, higher risk weights result in a higher amount of risk weighted assets, which effectively penalize the bank and require it to hold more (expensive) capital against its assets.
So there’s a built-in bias toward anything that lowers the amount of capital banks have to hold against the assets that earn them money. Commercial loans have higher risk weights than Fannie Mae-issued mortgage backed securities (MBS), so loading up on the MBS is better (all else constant).
Banks can also lower an asset’s risk weight by using federal loan guarantees. If, for instance, a guarantee is provided by a Federal Home Loan Bank or, for the sake of argument, the Ex-Im bank, the federal backing lowers the amount of capital required for that particular loan.
The official final rule on these requirements states that:
"Banking organizations use a number of techniques to mitigate credit risks. For example, a banking organization may collateralize exposures with cash or securities; a third party may guarantee an exposure; a banking organization may buy a credit derivative to offset an exposure’s credit risk; or a banking organization may net exposures with a counterparty under a netting agreement. The general risk-based capital rules recognize these techniques to some extent."
The details are a little murky, but so is the rest of Basel III.
There’s another new provision called the Net Stable Funding Ratio (NSFR). The NSFR biases banks toward making shorter-term loans to better match the maturity of their funding sources.
This maturity mismatch problem has basically been around forever, and banks have always shied away from making longer term loans in favor of shorter ones. The NSFR makes it even more expensive to make longer-term loans.
For instance, Basel’s NSFR guidance states that:
"The NSFR assumes that some short-dated assets (maturing in less than one year) require a smaller proportion of stable funding because banks would be able to allow some proportion of those assets to mature instead of rolling them over."
The rules then assign required stable funding (RSF) weights – ranging from 0 to 100 percent – for a variety of assets. There are some exceptions, but any asset “encumbered” for one year or more gets the higher RSF weight.
(The new liquidity coverage ratio probably exacerbates the maturity mismatch problem as well, but that’s even more detailed.)
The Basel committee justifies the NSFR rules by noting: “The difficulties experienced by some banks arose from failures to observe the basic principles of liquidity risk management.” It takes an enormous amount of audacity to print such a statement when these very same banks have been following the Basel rules since the 1980s.
The original set of rules has become known as Basel I. Basel II was never fully implemented because it wasn’t finished in time for the 2008 crisis. When the crisis hit, the Basel committee recognized Basel II wouldn’t have been good enough, so they scrapped it and gave us Basel III.
I guess there’s some reason to hold out hope that the new rules will actually protect us from a crisis, but I haven’t seen it yet. Based on the evidence, the opposite outcome is infinitely more likely.
The core of this particular Basel/Ex-Im issue comes down to basic economics: When you give business owners a way to lower their costs, they take it.
When you pile on more and more costs via regulations, they’re even more likely to take any way out that they can get. The solution is to reduce those artificial costs in the first place, not give out special favors.
There’s enormous evidence that banks want to make good loans, and that regulations make it more difficult to do that. The same applies to firms trying to import and export goods.
The Basel rules are imposed on virtually all banks, and the quirky roadblocks they throw up in front of firms trying to finance imports and exports are just one tiny piece of the problem. We need to get rid of both the Basel rules and the Ex-Im Bank.
Ex-Im financing supports only about 2 percent of the nation’s exports, but we’re supposed to believe that the bank is a critical element of national security, and that letting the bank’s charter expire imperils billions in exports and thousands of jobs all across the U.S.
Aside from these exaggerations, letting the charter expire would do absolutely nothing to the existing financing arrangements, many of which will remain in place for years.
But I recently came across an Ex-Im defense I had completely missed, so I decided to chime in. (Just this once.)
Supporters have argued that banks can’t make certain loans without Ex-Im support because of the overly restrictive Basel III capital requirements. Ignore the details for just a moment and let that logic really sink in: we need the federal government to subsidize more loans because federal regulations make it too expensive to make loans.
Overregulation is a huge problem in financial markets, but more government escape hatches for a few special interests are not the solution. And these Ex-Im supporters, perhaps by accident, are actually making the case to cut regulations.
The Coalition for Employment Through Exports notes that “[c]ommercial banks with mid-market customers who export are now subject to new regulatory constraints, such as Basel III.” As a result, “[t]hese banks are unwilling to take on cross-border financing.”
The Nuclear Energy Institute (NEI), concerned that their industry will be unable to finance new power plant construction, has made similar claims. A recent NEI blog post states:
"Foreign utilities are typically very low credit risks. Basel III capital reserve requirements prevent them [commercial banks] from allocating billions of dollars in tier one capital for as many years as necessary to finance a nuclear power plant."
Just to be clear: I’m not at all sympathetic to the notion that Ex-Im bank subsidies are a good way to overcome Basel-induced regulatory costs.
That said, we should get rid of regulations that prevent people from making good-quality loans. And the NEI quote provides anecdotal evidence that the Basel capital rules are doing exactly that.
But it’s not because Basel III includes a specific prohibition against things like cross-border financing or nuclear power plant construction loans. For now, at least, even federal regulators aren’t willing to go quite that far.
Instead, regulators have tried to design a set of rules that assign the “right” risk levels to all the different items a bank could hold on their balance sheets. Commercial loans, mortgages, mortgage-backed securities, municipal bonds, and so on – all get their own tailored risk weights.
The end result is an amazingly complex set of capital regulations that replace bankers’ subjective risk assessments with bureaucrats’ judgment. All else equal, higher risk weights result in a higher amount of risk weighted assets, which effectively penalize the bank and require it to hold more (expensive) capital against its assets.
So there’s a built-in bias toward anything that lowers the amount of capital banks have to hold against the assets that earn them money. Commercial loans have higher risk weights than Fannie Mae-issued mortgage backed securities (MBS), so loading up on the MBS is better (all else constant).
Banks can also lower an asset’s risk weight by using federal loan guarantees. If, for instance, a guarantee is provided by a Federal Home Loan Bank or, for the sake of argument, the Ex-Im bank, the federal backing lowers the amount of capital required for that particular loan.
The official final rule on these requirements states that:
"Banking organizations use a number of techniques to mitigate credit risks. For example, a banking organization may collateralize exposures with cash or securities; a third party may guarantee an exposure; a banking organization may buy a credit derivative to offset an exposure’s credit risk; or a banking organization may net exposures with a counterparty under a netting agreement. The general risk-based capital rules recognize these techniques to some extent."
The details are a little murky, but so is the rest of Basel III.
There’s another new provision called the Net Stable Funding Ratio (NSFR). The NSFR biases banks toward making shorter-term loans to better match the maturity of their funding sources.
This maturity mismatch problem has basically been around forever, and banks have always shied away from making longer term loans in favor of shorter ones. The NSFR makes it even more expensive to make longer-term loans.
For instance, Basel’s NSFR guidance states that:
"The NSFR assumes that some short-dated assets (maturing in less than one year) require a smaller proportion of stable funding because banks would be able to allow some proportion of those assets to mature instead of rolling them over."
The rules then assign required stable funding (RSF) weights – ranging from 0 to 100 percent – for a variety of assets. There are some exceptions, but any asset “encumbered” for one year or more gets the higher RSF weight.
(The new liquidity coverage ratio probably exacerbates the maturity mismatch problem as well, but that’s even more detailed.)
The Basel committee justifies the NSFR rules by noting: “The difficulties experienced by some banks arose from failures to observe the basic principles of liquidity risk management.” It takes an enormous amount of audacity to print such a statement when these very same banks have been following the Basel rules since the 1980s.
The original set of rules has become known as Basel I. Basel II was never fully implemented because it wasn’t finished in time for the 2008 crisis. When the crisis hit, the Basel committee recognized Basel II wouldn’t have been good enough, so they scrapped it and gave us Basel III.
I guess there’s some reason to hold out hope that the new rules will actually protect us from a crisis, but I haven’t seen it yet. Based on the evidence, the opposite outcome is infinitely more likely.
The core of this particular Basel/Ex-Im issue comes down to basic economics: When you give business owners a way to lower their costs, they take it.
When you pile on more and more costs via regulations, they’re even more likely to take any way out that they can get. The solution is to reduce those artificial costs in the first place, not give out special favors.
There’s enormous evidence that banks want to make good loans, and that regulations make it more difficult to do that. The same applies to firms trying to import and export goods.
The Basel rules are imposed on virtually all banks, and the quirky roadblocks they throw up in front of firms trying to finance imports and exports are just one tiny piece of the problem. We need to get rid of both the Basel rules and the Ex-Im Bank.
- Norbert J. Michel is a research fellow specializing in financial regulation for The Heritage Foundation’s Thomas A. Roe Institute for Economic Policy Studies. He is also a co-author of Heritage’s Opportunity for All; Favoritism to None.”
This article originally appeared in Forbes. The original piece can be found at http://www.forbes.com/sites/norbertmichel/2015/06/15/basel-iii-does-not-justify-the-export-import-bank/.
