FDIC Vice Chair Blames Low Bank Profitability on Debt/Equity Ratio

The FDIC released a semi-annual report of the Global Capital Index. FDIC Vice Chair Thomas Hoenig described the results, noting that equity capital ratios increased at most of the largest U.S. banks.

Vice Chair Hoenig maintained that, while the report reveals improvements in capital ratios, the banking sector remains highly leveraged and provides the lowest return on equities when compared with other major U.S. industries. He expressed concern that capital ratios at the largest U.S. banks “remain too low,” which is “undermining long-term economic growth.”

Lofchie Comment: The notion that banks would improve their return on equity if they had a higher percentage of equity seems counterintuitive. The “proof” that Vice Chair Hoenig offers for this assertion is that other industries that have higher ROEs are less highly leveraged. The argument that a bank would make the same profits as a consumer/discretionary company if only it had the same debt/equity ratio does not seem compelling. There are reasons other than high leverage why banks’ ROE might be low: for example, heavy regulatory costs and being forced out of existing business activities; e.g., the Volcker Rule. Perhaps Vice Chair Hoenig’s theory is correct, but other possible theories should be considered.