Who Pays for Bank Regulation?

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In the wake of the financial crisis, a wide range of new and revised rules, regulations and practices have been imposed on the US banking industry. These include measures to strengthen and raise capital, reduce leverage, improve balance sheet liquidity and bring greater standardization and transparency to derivatives markets. They also include new rules around credit card availability and debit-interchange fees, along with heightened regulatory and judicial scrutiny of bank lending and other practices.

While many of these steps are designed to strengthen the safety and soundness of the banking system, they also act as a tax on banks: by changing relative prices, regulation makes some activities more expensive and others cheaper. Taxed activities become more expensive for banks to produce and for their customers to consume. As in many markets, higher costs typically reduce the amount of activity undertaken. Thus the bank tax affects the distribution of activities across different types of consumers and businesses in a way that allows clear winners and losers to emerge. This then leads to two questions: ‘who ultimately bears the cost of bank regulation?’ and ‘what are the broader economic implications?’.

In practice, the microeconomic cost of regulation is determined by two factors: the size of the regulatory burden and the degree to which less-regulated alternatives are accessible. As a result, consumers and businesses that have ready access to alternative sources of finance are less likely to pay the incremental tax that regulation imposes. Conversely, consumers and businesses without access to effective alternatives to bank lending are more likely to pay. This is particularly true in cases where the new rules single out certain activities as especially concerning and impose further taxes, whether in the form of higher capital charges, more stringent regulatory supervision or activity-specific legal and regulatory costs and restrictions.

While there is some added subtlety to the results of our analysis, we find in general that low-income consumers and small businesses – which generally have fewer or less effective alternatives to bank credit – have paid the largest price for increased bank regulation. For example, for a near-minimum wage worker who has maintained some access to bank credit (and it is important to note that many have not in the wake of the financial crisis), the added annual interest expenses associated with a typical level of debt would be roughly equivalent to one week’s wages. For small and mid-sized businesses the damage from increased bank regulation is even greater: their funding costs have increased 175 basis points more than those of their larger peers, when measured against the pre-crisis period. That funding cost differential is enough to seriously damage the ability of smaller firms to compete with their larger competitors. This fact has become all too evident in the economic statistics and is already changing the shape of American business, as small and mid-sized firms, the historic engines of US job creation, shrink and sometimes disappear, displaced by large corporations. Read the full report.