Fighting “Too Big to Fail” Hurts Credit, Expert Says

Banking regulation that inhibits financial-market liquidity could end companies’ “just-in-time” access to capital markets, a treasury expert tells ...

Efforts to eliminate government rescues of “too-big-to-fail” banks by downsizing them and preventing the birth of new ones would cause liquidity and credit-access problems for U.S. companies, according to a treasury consultant testifying before a Senate committee hearing on Wednesday.

Anthony Carfang, founder of Treasury Strategies, said in his prepared testimony that the effect of capping the size of U.S. banks and limiting their riskier activities, such as derivatives trading, would deplete the “highly liquid capital pools” that allow U.S. businesses to tap financial markets efficiently.

But current and former U.S. banking regulators, including former Federal Reserve chairman Paul Volcker, defended the need to limit the size and “interconnectedness” of individual banks to reduce the chance of failures and the need for “massive” government support.

Banks have complained that the Dodd-Frank Act, any further caps on the size and scope of individual banks, and the Volcker Rule — which bars proprietary trading and investments in private equity and hedge funds — will reduce financial-market liquidity. As a result, corporate issuers could see tens of billions in added borrowing costs over time “as investors demand higher interest payments on less-liquid debt,” according to a paper published by consultancy Oliver Wyman last year. The lack of liquidity could arise from bankers curtailing such activities as commercial underwriting and holding securities inventory in order to make secondary markets, the paper said.

In his prepared remarks, Carfang explained the effects on treasury departments: “Highly liquid capital pools allow treasurers to keep less cash on hand and to use a just-in-time financing system that allows [them] to pay [a company’s] bills and raise the capital needed to expand and create jobs.”

As evidence of how efficient treasury departments are at using the capital markets, Carfang compared the amount of cash U.S.-based companies hold versus their European peers. U.S.-based businesses have about $2.2 trillion of cash reserves, or 14% of the nation’s gross domestic product, while corporate cash is 21% of the GDP in the euro zone and 50% of the GDP in the United Kingdom, said Carfang. Further size limits on banks or imposition of the Volcker Rule would cause U.S. companies to maintain larger cash buffers, he said.

Carfang also said regulations like the Volcker Rule would “create a subjective regulatory scrutiny of trades,” making capital-raising more expensive and time-consuming for companies. The cost of capital would rise even higher as banks passed on compliance costs, he said.

But Thomas Hoenig, a director the Federal Deposit Insurance Corp., said there was a clear case for a strict regulatory division of banks, perhaps even beyond what is contemplated in Dodd-Frank. In his prehearing testimony, Hoenig said large banks have taken on noncore banking activities that increase their risk and create complexity, and “that makes it more difficult for the market, bank management, and regulators to assess, monitor, and contain risk-taking that endangers the public safety net and financial stability.”

Under a broadly outlined proposal, Hoenig said commercial banks could provide payments services, lend, and offer deposits, as well as underwrite securities, provide M&A counsel, and sell trust and wealth-management products. But they would not be allowed to conduct broker-dealer activities, make markets in derivatives or securities, or trade securities or derivatives for either their own account or customers.

Volcker did not advocate strict ring-fencing of commercial and investment banking in his testimony. He said, however, that under current rules, financial institutions other than commercial banks would be able to continue a full range of trading and investment banking. If they are deemed “systemically significant,” they would be subject only to additional capital requirements and greater surveillance. He cautioned that for these banks and their customers, “there should be no presumption of official support — access to the Federal Reserve, to deposit insurance, or otherwise.”

In defending big banks, Treasury Strategies’s Carfang said multinational companies require financial institutions that can deliver an array of global services under one roof. “The Volcker Rule and size caps would virtually eliminate U.S. banks from offering both the scale services, scope services, and localized specialties that today’s U.S. businesses need,” he said.

The hearing before the Senate Committee on Banking, Housing, and Urban Affairs was titled, “Is Simpler Better? Limiting Federal Support for Financial Institutions.”

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