Does Dodd-Frank Restrict Banks from Lending?

In the Republican assault on the Dodd-Frank law, one frequent criticism of this regulatory measure enacted by the last administration is that it restricts banks from making loans and consequently is hurting the economy and job creation. Gretchen Morgenson of the New York Times questioned the veteran bank analyst Richard Bove, of Rafferty Capital Markets, about this and this was his response: 

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By GRETCHEN MORGENSON for the New York Times, Feb. 18, 2017

. . . Indeed, a look at recent bank results shows that lending among the big institutions is rising, not falling.  In the fourth quarter of 2016, the most recent period, Bank of America, Citigroup, J. P. Morgan and Wells Fargo all reported increases in their average loan figures. . . .

There is no doubt that Congress’ regulatory response to the financial crisis of 2008, which was largely fueled by reckless mortgage lending, tightened the rules for banks. Chief among them was a requirement that these institutions set aside greater amounts of capital to cover potential losses. That was justified, but it is crimping lending.

And there are other reasons these institutions are relatively restrained in their lending, Mr. Bove said. . . .

 Bank managers cannot control interest rates. But they can control the amount of dividends they pay out to shareholders, and the amount of stock they buy back in the open market. And generous distributions to shareholders by bank officials are a big factor in diminishing the money left over for making loans.

Stock buybacks and lush dividends come out of a bank’s retained earnings, also its source for increased lending. And Mr. Bove characterizes these payouts as financial engineering, pursued by bank executives interested in making their stocks perform better. He criticizes this practice, because while dividends and buybacks are good in the short-term, fewer loans will translate into reduced long-term earnings power at a bank.

The amounts being paid out are considerable. During 2016, Wells Fargo returned $12.5 billion to shareholders through common stock dividends and share repurchases net of stock issued to employees. And in the most recent quarter, J. P. Morgan returned $3.8 billion to shareholders. That included $2.1 billion of net stock buybacks.

. . . But officials at these institutions often contend that buying back stock and paying rich dividends are ways of returning excess capital to their shareholders, who are entitled to that money. . . .

But buying back shares and paying rich dividends to shareholders diminishes a bank’s common equity. And among 18 large banks that Mr. Bove follows, 14 showed declines in common equity in the fourth quarter of 2016 as a result of increased interest rates, buybacks and dividends. The combined decline in equity totaled almost $18 billion; in his view, that means the banks have lowered their ability to lend by $250 billion. To be sure, none of these banks are paying out all of their excess capital in dividends or stock buybacks. And that leaves them with a much fatter cushion for bad times.

But Mr. Bove said that he had recently spoken with some bank executives who are considering paying out all the growth they report in retained earnings or common equity. “This would effectively negate any contribution that profits would make to retained earnings,” Mr. Bove wrote in a recent research note. “The combination of further interest rate increases and large buyback programs would accelerate the decline in common equity and the ability of banks to make loans.” . . .

One of Dodd-Frank’s bigger errors was to require smaller banks that had played no role in the crisis to ramp up their compliance duties as well. This was unfair and, yes, burdensome. Mr. Bove said he believes that some of the regulations should be reversed, but the elements he cited are not those that Republicans are focusing on.

“The Republicans in the House and Senate cannot even agree with each other as to what should be deregulated,” he pointed out in a recent research note. “In the Senate, they want a big-government approach to change the structure of the industry. In the House, there is a desire to get rid of irritating amendments to Dodd-Frank. Nothing is going to get done.”

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If Mr. Bove is right, that might be a good outcome. But this much is clear: The next time someone tells you that a wide swath of financial regulations needs to be reversed because they are crimping bank lending, you can tell them they’ve got only part of the story.

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