MNI INSIGHT: Fed May Extend Bank Restrictions on Capital Fears

The Federal Reserve looks set to extend and potentially tighten a prohibition on banks' share buybacks and a dividend cap towards the end of the year, as economic conditions are likely to remain deeply uncertain, MNI understands.

But big lenders are likely to receive continued permission to exclude Treasury bonds and deposits at the Fed from supplementary leverage ratios--a move intended to create more balance sheet space in a time of stress--beyond the current timeframe of March 2021.

According to Fed models of financial sector stress, bigger dividend payments would expose banks to substantially greater risk, and it announced in late September that it would extend a dividend cap for an additional quarter, together with a prohibition on share buybacks. These restrictions look set to roll over into 2021.

Former Fed officials have told MNI in recent months that dividend payments should have been halted altogether, a sentiment that has some sympathy within the central bank from Minneapolis Fed President Neel Kashkari.

TWIN CLIFFS

Policymakers are watching with trepidation as bearish economic factors look set to collide in coming months: a delayed, perhaps derailed second round of fiscal stimulus from Congress, threatening an abrupt end to fiscal support for households and businesses, as well as the expiry of debt forbearance arrangements linked to the coronavirus pandemic.

The withdrawal of these blanket measures delivered across the economy will have disparate impacts on different sectors. Workers and businesses in some industries, particularly those hardest hit like hospitality, restaurants, airlines and commercial real estate, may have more trouble than others.

In the wake of the Covid-19 shock, regulators gave banks and other financial firms broad leeway to offer payment holidays on obligations ranging from mortgages and auto loans to credit cards and student debt.

But with the expiry of many of those grace periods, often ranging from three to six months, banks are becoming more discerning about which borrowers get extensions and which will be forced to catch up on repayments.

Officials are also increasingly worried about the financial stability implications of another prolonged period of rock-bottom interest rates on risk-taking.

In the absence of a well-tested toolkit of macroprudential measures, the Fed must rely on capital regulation to maintain safety.

Economists at the San Francisco Fed estimate that loans to firms with elevated insolvency risks total USD40.5 billion in 2008 dollars, more than double the peak during the global financial crisis following the collapse of Lehman Brothers.