How much will a capital surcharge hurt?

By Felix Salmon
September 30, 2011

The Clearing House has a new study complaining about the idea that the world’s biggest banks — the Too Big To Fail institutions — should have higher levels of capital than other banks. (The study is meant to be here, but the website isn’t working very well, so I’ve mirrored it here.pdf.) The main conclusion is that “if the Basel Committee’s G-SIB capital surcharge is implemented in the U.S., these banks would have to either increase the borrowing costs to their customers by 60 basis points” — an outcome so self-evidently horrific that the study doesn’t even bother to explain how harmful it would be.

But of course a closer look at the study shows that borrowing costs wouldn’t actually need to rise at all. Here’s the key headline in the presentation:


NIM here, is Net Interest Margin, which is then used to compute borrowing costs. And “NIX ratio” is non-interest expenses, known to many as “bankers’ bonuses”.

The calculations here are not mathematically unconvincing. According to The Clearing House, the cost of bank equity will go down under the new regime — by about 70 basis points. That won’t make up for the hit to shareholders from being less leveraged.

So yes, it’s entirely possible that there is indeed a non-negligible cost to implementing this surcharge. That cost is going to have to be borne by three different groups: borrowers, bankers, and bank shareholders.

But if you look at the report, it’s predicated on the idea that shareholders don’t bear any of the cost at all all: we have to “maintain shareholder returns”, for some unknown reason. This is silly, for reasons convincingly explained by Martin Wolf — the returns that banks are offering to their shareholders are far too high. Back in the 50s and 60s, banks had a return on equity around 7%; now they require more than double that. There’s no reason why we shouldn’t go back to the old returns.

If banks’ return on equity fell from about 15% to about 7%, then there wouldn’t be any increase at all in borrowing costs, and bankers could even keep their bonuses. But more likely, some combination of the three will happen: lower return on equity, lower bonuses, and slightly higher borrowing costs, to the tune of maybe a couple of tenths of a percentage point.

This is all good. Bankers’ bonuses should be lower. And borrowing from a big bank should cost more: it helps to incentivize borrowers to move their business to smaller, less systemically-dangerous institutions.

Besides, the problem right now isn’t that banks are lending at exorbitant rates: it’s that banks aren’t lending at all. I think many small businesses, especially, would be perfectly happy to pay an extra 0.6% if that meant they could get a loan rather than not get a loan.

And it’s undoubtedly true that the more capital banks hold, the less of a risk they pose to the financial system as a whole.

Right now, there are two huge risks which could result in trillion-dollar writedowns at the world’s too-big-to-fail banks. The first is real estate: prices are still falling in the US and around the world, and at some point mortgages can and should have their principal written down. And the second, of course, is developed-world sovereigns, especially on the European periphery. If they default, then there will be a lot of writing down to go around.

Higher capital levels can’t protect us fully against either of those risks, let alone both of them. But they would help. And if banks build up their capital to a healthy point, then maybe we’ll be able to orchestrate a market-friendly set of global writedowns which doesn’t bring the entire financial system to its knees.

Maybe that’s what the big banks really fear, here: that if they’re asked to build up their capital, that only means they’re going to be asked to write down that capital later. I can see why they wouldn’t be happy about doing such a thing. But for the other 99%, the idea frankly looks rather attractive.


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“Bankers’ bonuses should be lower”? But wait, if bankers make less money, they will all quit their jobs, because they won’t work for less when they can make more elsewhere. And then our banking industry will be second rate – who will the banks be able to hire that will know how to extract so much wealth out of the economy?

Posted by KenG_CA | Report as abusive

Who really cares whether banks get “hurt”? The average citizen sure as heck doesn’t!

Maybe its about time we reenacted Glass-Steagel so that banks could get back to what doing what they should be doing…taking deposits and making loans.

Everything else is superfluous to the true role of a bank.

Posted by mfw13 | Report as abusive

Funny how every time someone suggests something sensible that might reduce bankers amazing risk free bonus rewards, the same old line is trotted out by all bankers everywhere: don’t pay them less, they’ll move elsewhere. The problem with this bluff is it isn’t true. Governments and banks everywhere are in the same boat, and if they work together the only places where bankers could move to to earn more would be places they wouldn’t want to live eg Zimbabwe, Paraguay, Bhutan or maybe Lebanon.

Computer programmers took massive pay cuts in the decade after Y2k; why not bankers? It isn’t like they’ll be poor.

Posted by FifthDecade | Report as abusive

The process is not as fast as some would like but banker pay is dropping steadily. Employment in the financial sector is also dropping rapidly… as it should.

TBTF banks like BofA are also doing what they must to survive… they’ve cut the fat (pay frozen, hiring frozen)… next the mussle, offloading non-core assets (defined as anything anyone else will buy at or above book value)… and then right through bone… 30,000 layoffs… hundreds of branch closings.

Our economy is moving in the right direction… too slowly perhaps… but moving in the right direction none the less.

Posted by y2kurtus | Report as abusive

“The first is real estate: prices are still falling in the US and around the world”

That’s not true around the world.

Real estate prices are still falling in the US and other countries (e.g. Spain) that are past a real estate bubble.

Real estate prices are not falling in China, where a real estate bubble might still be growing.

Real estate prices are not falling in Germany, which didn’t have a real estate bubble.

Posted by AdrianBunk | Report as abusive

Here’s my junk:

Subj: RE: Other Online Banking Features

Dear Christopher M. Woltmann,

Thank you for your inquiry dated 10/1/2011 regarding the debit card fee. We will be happy to assist you.

Bank of America recognizes the importance of providing quality service. We appreciate you bringing your concerns to our attention. Please accept our sincere apologies for any inconvenience this may have caused you.

We certainly understand your concerns regarding the debit card fee. Thank you for taking the time to submit your comments and suggestions concerning debit card fee. As a valued customer, your comments help us provide the best banking experience possible. We appreciate your patience as we continue to develop and enhance the ease, convenience and functionality of our products and services.

If we may be of further assistance, please contact us again by e-mail. We value you as a customer and appreciate your business. Thank you for choosing Bank of America.


Arnold Regan
Bank of America

—–Original Message—–
Dear Jorge,

I appreciate your timely response but I have a few problems with your answer.

As near as I can tell, BoA has about 1.4 million retail customers. If you put this $60 annual fee on their accounts, you are only going to realize ~ $84M in additional income. That is a drop in the bucket compared to the $B’s you guys are stuck with from the Countrywide debacle. I also realize part of this added charge is to offset income lost from backcharging retailers for card sales but I think there is still enough margin in those for BoA to come out ahead, just not as far ahead.

What it boils down to though are the enormous losses BoA faces from Countrywide. Are you sure that loosing even more of your customer base to throw a couple cups of water on a major forest fire is such a great idea?

I know you guys are trying your best to clean up the Countrywide mess and a lot of your loyal customers are hoping that you are able to pull it off but I don’t think hitting your lower income customers with a disproportionate fee is going to get you very far.

Please don’t ruin everything that is good about BoA trying save it. Get Fat Cat Buffett to put up another $60B at terms favorable to BoA as well as Berkshire. He can afford it and let him put his money where his big fat mouth is if he REALLY feels so strongly about America.

I think BoA’s banking model was the best in the business but their inherited mortgage model really sucks. Please fix the mortgage mess and leave the banking model intact.


Chris Woltmann

———Reply Separator———

Dear Christopher M. Woltmann,

Thank you for your inquiry dated 9/30/2011. We are committed to provide you with the best banking experience possible and we will be happy to assist you.

We understand your concerns about the new debit card monthly fee reported through the media. We appreciate your business and thank you for providing us with an opportunity to address your concerns.

At Bank of America we are committed to helping you understand and manage your finances.

From time to time, all banks, including Bank of America, review their pricing for products and services across the franchise. Factors considered include market forces, as well as the value of the products and services, to help ensure that the pricing reflects both the value and the costs associated with providing these products and services.

It is our goal to ensure we are clear in our communications with our customers about our fees. We lead the industry in our efforts to ensure our customers are not surprised by fees and we continue to structure our products to ensure customers understand what they are getting and how much it costs. As a result of recent regulatory changes impacting the economics of debit card transactions, Bank of America and our competitors in the financial industry are reviewing our pricing, taking into account customer and associate feedback, industry trends, the market competition and costs.

At this time, we are just letting our customers know that we plan to introduce a $5.00 monthly usage fee for customers who use their debit cards for purchases, beginning in early 2012, with phased rollout throughout the year.

After reviewing your account, we show the new debit card purchase monthly fee may impact your account relationship. If your account is impacted, you will be notified of this change in writing at least 30 days in advance of the fee implementation, beginning in early 2012. Keep in mind some of our competitors have already announced that they too will be charging debit card fees.

We believe that our debit cards offer a level of service and convenience that go beyond our competitors offers. Remember, your Bank of America debit card offers:

- Total Security Protection®, which includes $0 Liability Guarantee, Fraud Monitoring and an optional Photo Security® feature.
- Overdraft prevention: We only authorize an everyday nonrecurring debit card purchase when there are enough available funds in an account or in a linked overdraft protection account at the time of the transaction. Otherwise, we will typically decline the transaction and the customer is not charged an overdraft item fee so it puts the customer more in control.
- Acceptance at millions of locations worldwide, including online.
- Up-to-date balance information through online, mobile, text banking and alerts by email or mobile device.
- Convenient and effortless ways to save with Keep the Change® and Add-It-Up®.

Please know that your relationship with us is important and we would like the opportunity to retain your affiliation with Bank of America. We are here to serve you and wish to offer any assistance you may need with your account. We are committed to rewarding customers who bring more of their business to the bank. In many cases, we can convert your account to a different type that will better fit your needs. To view information about some of our investment, savings, credit card, loan, and very popular Keep the Change programs, please visit our homepage and check out our Products and Services as well as our Achieve Your Goals sections of Online Banking.

We apologize for any inconvenience this may have caused. We value you as a customer and appreciate your business. If we may be of further assistance, please contact us again by e-mail. Thank you for choosing Bank of America.


Jorge Burciaga
Bank of America

Posted by Woltmann | Report as abusive

I have a fall back position should my bank decide to start charging a fee for debit cards (unlikely, but possible). It’s called cash. For transactions which can’t be done with cash (on-line transactions, eg) there’s always mastercard (not from BOA). It never ceases to amaze me that when banks provide a service that helps their bottom line, the customer is expected to pay extra for it simply because it’s also a convenience. Debit cards save the bank the expense of processing little bits of paper called checks which are a whole lot more expensive to process than a series of electronic blips. They’ll pocket that savings, thank you very much, and continue to try to make money on the process of getting some of your money out of the bank. So, just go to your bank, walk up to the teller (which they have fewer of thanks to debit cards and atms) and get some of your money out and go spend it.

Posted by majkmushrm | Report as abusive

Channeling Jamie Dimon: A capital surcharge would be the end of capitalism!

Posted by weiwentg | Report as abusive

weiwentg, Dimon would also throw in that such a plan would be un-american or not in the interests of the U.S. and that it should therefore be dismissed.

Posted by Strych09 | Report as abusive

Great website you have here but I was curious if you knew of any message boards that cover the same topics discussed in this article? I’d really love to be a part of online community where I can get feedback from other knowledgeable individuals that share the same interest. If you have any suggestions, please let me know. Thanks a lot!