The theme of this edition of Banking Perspectives might surprise you. Most people do not think about banks when considering ways to address income and wealth inequality. Many would simply say that bankers are wealthy and therefore merely further evidence (and perhaps even drivers) of the problem, and leave it at that.
In fact, banks are quite relevant to the income inequality debate because of their role in distributing credit across the economy.
The importance of that role currently is vastly underestimated. During the financial crisis, many mortgage and credit card borrowers got in over their heads and suffered for it, and recipients of credit came to be seen as victims, not beneficiaries. Credit was seen as producing hardship, not alleviating it. Over time, however, access to credit has unquestionably proven to be a benefit for American individuals and businesses. A sole proprietorship or small business looking to grow depends on credit. Individuals looking to purchase homes or cars or to finance educational pursuits depend on credit. It borders on the tautological, then, to say the following: income inequality will be increased to the extent that access to credit shifts from low-income borrowers and small businesses to wealthy borrowers and established businesses.
For emphasis, let me restate this another way: income equality will be promoted to the extent that access to credit shifts from high-income borrowers and large businesses to low-income borrowers and small businesses.
It is also important to emphasize that bank credit is the cheapest credit available, on the best terms. Banks are the low-cost lender for an obvious and intended reason: a charter that comes with access to federally insured deposits and the discount window. These attributes allow banks to fund, and then lend, more cheaply and consistently than companies that borrow at higher rates and whose funding is more exposed to market volatility. For that reason, banks will always lend at lower rates than payday lenders or pawn shops or online peer-to-peer platforms.
Also, as Aaron Klein’s article illustrates, banking is becoming more convenient and efficient as technology remakes the industry. Moreover, as Steve Strongin observes in his article, large businesses have access to capital markets, and therefore are insulated from any increase in the cost of bank lending. Consumers and small businesses do not have such alternative funding options. Similarly, wealthier individuals can look to friends or family, or personal savings, when credit is less available; the likely alternative for lower income people is a payday loan.
Thus, I believe that those who look out for the interest of low- and moderate-income people in this country are making a fundamental and sad mistake in underestimating the income inequality effect of regulation that suppresses bank lending. At the very least, the relationship between bank credit and income inequality deserves great study, and the purpose of this issue is to vitalize that effort.
Fortunately, this issue includes pioneering work by both Francisco Covas and Alan Smith on how stress tests – in particular, the Federal Reserve’s CCAR stress test – serve as what Alan calls a “macroeconomic capital allocation tool.” Francisco’s work demonstrates how the CCAR stress test allocates capital, and the results should alarm those concerned about income inequality. The stress test strongly disfavors offering credit to small businesses and lower-income individuals. Of course, lending to the poor and small is more risky than lending to the rich and large, but his research shows that the stress test exaggerates that disparity significantly when compared to banks’ own models and the risk assessments embedded in the standardized capital approaches adopted by global regulators. In her article, Karen Shaw-Petrou highlights other federal regulatory policies having similar effects.
While they aren’t a focus of this issue, I should note two other, less significant ways that banks promote income equality. First, banks employee a lot of people; they are a labor-intensive form of finance. Second, all large U.S. banks are publicly traded, so their profits are distributed to pension funds and individual investors in addition to management. Yet much post-crisis regulation has had the effect, and often the intent, of driving financial activity (lending, investing, market making, trading) out of large, publicly held banks and into vehicles owned in some cases, as required by regulation, by the wealthy, and operating with no public charter. I know a fair number of people who have left regulated banking over the past five years for hedge funds and similar less-regulated financial entities; in those spots, they are making more money for themselves, and the revenue they generate is going to a smaller, more privileged group of investors than when they worked at banks.
Any way you look at it, banks are a democratizing force in finance. Building a better financial system, and a better social order, requires acknowledgment of that fact.
About the author: Greg Baer is President of The Clearing House Association and Executive Vice President and General Counsel of The Clearing House Payments Company. He oversees the legal, compliance, and litigation functions for the organization’s payments business and leads the strategic agenda and operations of the Association. Prior to joining TCH, Baer was Managing Director and Head of Regulatory Policy at JPMorgan Chase.
