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Goldman: Bank Capital Requirements Hurt 'Small' Corporations

Goldman

First Posted: 11/12/10 09:20 AM ET Updated: 05/25/11 07:10 PM ET

Requirements that banks hold more cash to prevent against economic downturns won't just hurt the banks themselves, but also the companies they lend to, Goldman Sachs says in a new report.

Rules that require banks to keep a certain percentage of their assets as rainy-day capital will be, and already have been, a drag on the overall corporate world, the report, principally authored by Goldman analyst Richard Ramsden, says (hat tip to Politico's Morning Money). "Small- and mid-sized" companies that have relied on bank financing will be hit hardest, the report says.

Under the international Basel III requirements agreed on in September, banks will eventually (by 2019) have to keep the equivalent of 8.5 percent of their assets on hand, to guard against a crisis. As Goldman notes in the report, the actual percentages could be higher, depending on a particular country's rules.

Goldman's argument goes like this: the new rules will mean banks can't extend as many loans, which drive loan prices higher. Demand for the loans, the report says, suffers, and "smaller" corporate borrowers, which can't issue bonds as easily as their larger cousins, are hit hardest. From the report:

"These firms are likely to grow more slowly than the larger firms and multinationals that enjoy more flexibility in financing. Slower growth among smaller and mid-sized firms may act as an overhang on economic growth and the job creation that these firms traditionally propel. And because the adjustment to higher prices and constraints on credit availability is a dynamic process, the potential ongoing rise in capital requirements means that smaller firms are likely to bear the cost for some time to come, acting as a continuing drag on bank loan growth."

According to the report, these so-called smaller companies include Genzyme, Symantec, Adobe and eBay.

As Citigroup CEO Vikram Pandit argued last month at The Economist's Buttonwood Gathering, high requirements could throw a wet blanket on the economy. "There is a point at which more is not necessarily better," he said, referring to capital requirements. "Double-digit ratios will have direct negative impacts on lending, capital formation, aggregate demand and growth."

But experts outside the financial community disagree.

Mervyn King, governor of the Bank of England (that country's central bank), said last month that even the higher requirements won't be high enough.

"Even the new levels of capital are insufficient to prevent another crisis," King said. "Some of the calculations of the alleged economic costs of higher capital requirements presented by the industry seem to be highly exaggerated."

What's more, evidence suggests that companies are in a relatively strong position. Despite the reported cost of borrowing from Goldman, the near-zero main interest rate makes most corporate borrowing extremely cheap. As of the end of last month, U.S. companies held about $1 trillion in cash. Many of them are choosing to hoard, rather than spend, that cash, a defensive tactic that bolsters their position, to the detriment, experts say, of the larger economy.

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