How pizza can explain a proposed rule about bank capital

Stephanie Hughes Jan 16, 2024
Heard on:
HTML EMBED:
COPY
If you think of the funding a bank uses to do business as a pizza, debt would be slices with unusual toppings (which come with more risk) and equity slices would be plain cheese. The proposed rule would require more of those plain slices. But the banking industry warns that would cost more. Robert Nickelsberg/Getty Images

How pizza can explain a proposed rule about bank capital

Stephanie Hughes Jan 16, 2024
Heard on:
If you think of the funding a bank uses to do business as a pizza, debt would be slices with unusual toppings (which come with more risk) and equity slices would be plain cheese. The proposed rule would require more of those plain slices. But the banking industry warns that would cost more. Robert Nickelsberg/Getty Images
HTML EMBED:
COPY

Tuesday is the deadline for comments on a proposed rule from the Federal Reserve, the Federal Deposit Insurance Corp. and the Treasury Department that would increase capital requirements for large banks with $100 billion or more in assets. The new rule is meant to make sure banks have enough money on hand to weather any big wobbles in the economy.

To get a better understanding of the new rule, it might help to borrow a metaphor from two Nobel laureates, suggested Wharton’s Peter Conti-Brown, and think of the money a bank uses to fund its business as a pizza.

There are some equity slices — that’s money the bank gets from its investors. And there are some debt slices — that’s money the bank has to borrow. 

“On the equity slices, you might think, ‘OK, this is kind of boring cheese pizza.’ Not your favorite, but you know it’s good,” Conti-Brown said.

The debt slices are more of an unknown, he said.

“On the debt slices, you’re like, ‘Hey, has anyone ever put taco sauce on a pizza? Let’s put some pineapple on this thing!’ And you’re taking risks. That pizza with taco sauce and pineapple might be disgusting,” Conti-Brown said.

You could think of the proposed capital rule as requiring banks to have fewer debt slices in their pizzas and more equity slices.

“What the regulators are saying — we’re going to have lots of good, plain, boring cheese pizza,” Conti-Brown said. “We don’t have the risks of gross pizza that people are going to hate. We don’t have the reward of really crazy pizza that people are going to love. But we’re going to have enough pizza to feed everybody.”

The banking sector, though, is concerned about the proposed rule.

“We’re going to see an environment where banks are going to be doing less activities,” warned Hugh Carney, executive vice president of the American Bankers Association, which would like to see the proposal withdrawn.

Carney said the U.S. already has robust capital requirements in place and that making them more stringent will raise the cost of doing business. “The thing to remember in this context is not each slice of pizza costs the same amount,” Carney said.

He pointed out that equity slices, so to speak, are the priciest kind of funding for banks. And that the increased expense will be passed on to their customers.  

“So the availability of credit is going to be more limited, and the cost of credit to customers is going to be high,” he said.

In other words, it could be harder and more expensive to get a loan.

The American Bankers Association points out that the proposal has also drawn concern from other entities worried about the availability of credit, including the Toledo, Ohio, chapter of the NAACP and the city of Richmond, Virginia.

The Federal Reserve’s vice chair for supervision, Michael Barr, said during a speech in October that, yes, the proposal could mean higher costs for banks. 

“But this is only half the story,” Barr said. 

Having increased capital on hand could also enable banks to better absorb losses, he said.

“The private costs of capital must be weighed against the social benefits of higher capital in creating a healthier, more resilient financial system and reducing the likelihood of financial crises,” Barr said.

In a speech this month, he said the agency is learning a lot from the comments it’s been getting. Once the feedback is in, proposed rules can take months or sometimes years to come to fruition. 

So it could be a while before we know what’s going to end up on those pizzas.

There’s a lot happening in the world.  Through it all, Marketplace is here for you. 

You rely on Marketplace to break down the world’s events and tell you how it affects you in a fact-based, approachable way. We rely on your financial support to keep making that possible. 

Your donation today powers the independent journalism that you rely on. For just $5/month, you can help sustain Marketplace so we can keep reporting on the things that matter to you.