End Discrimination in Bank Lending
Containing access to capital for politically unpopular businesses distorts markets and disenfranchises voters.
The opposition to “discrimination” by political activists has not prevented them from applauding constrained access to capital by such politically unpopular businesses as producers of fossil fuels and firearms or operators of for-profit colleges and private prisons. The list of disfavored economic sectors will only grow over time as government engages in ever-more economic favoritism. This problem has become sufficiently acute for some industries that the Office of the Comptroller of the Currency has proposed a “Fair Access to Bank Services, Capital and Credit” rule that would compel national banks and federal savings associations to make lending decisions based only upon creditworthiness and related criteria, rather than such politicized standards as “reputation risk.”
In reality, the proposed rule is targeted at the vast bureaucracy that regulates the everyday operations of banks. Many of these regulators are quite willing to impose their political preferences upon the institutions they oversee; they are all too happy to pretend that they are the legislature, which, having failed to enact the measures preferred by the regulators, must be circumvented.
Regulators monitor lending institutions constantly across many dimensions, sifting through their complex operations to find violations of rules small and large, whether accidental or not. Are lenders free in such an environment to make lending decisions driven solely by considerations of creditworthiness? The question answers itself.
Moreover, the negative favoritism and punitive efforts aimed at particular businesses is not limited to the whims of the bureaucracy. Remember Operation Choke Point? That was the concerted effort by the Obama administration to exclude a number of legal businesses from the financial system — essentially because the White House did not like them — a blatant attempt to politicize the allocation of capital, a process that the proposed rule attempts to blunt. It is worthy of strong support.
It is consistent with the central purpose of a private-sector capital market: allocation of capital to the most productive (highest economic return) uses possible, as perceived by market forces ex ante on the basis of expected market prices. Those prices in most cases reflect the aggregated preferences of individuals, which drive economic decisions in a free society. Accordingly, the proposed rule would further the larger social objective of maximizing the aggregate value of all production by reducing the scope of political factors in lending decisions, and thus increasing economic growth.
One standard objection is that the presence of externalities and collective goods requires government action to achieve allocational efficiency. I shunt aside here the issue of whether government policies driven by political competition can improve resource allocation. The more important point is that in a constitutional republic governed by the rule of law, it is the legislature that is vested with the power to promulgate policies designed to deal with such problems. Political pressures exerted by interest groups are not consistent with any such allocational improvements; the proposed rule recognizes that reality by requiring implicitly that constraints on lending behavior be enacted through democratic institutions.
One prominent argument in support of lending discrimination is the presence of “reputational risk that ethically questionable companies run.” This justification is circular, in that the purported “reputational risk” depends on the definition of “ethically questionable” business behavior. The latter term can be applied to any business without any independent underlying principles at all.
Instead, purported political unpopularity, created by political attacks, has been redefined as reputational risk that supposedly reduces the creditworthiness of a given borrower. But market prices for the outputs of those borrowers presumably reflect any such reputational risks, which means that the expected return to lending to such borrowers already reflects them.
Moreover, the reputational risk and the supposed political unpopularity of the borrowers are inconsistent with the reality that the interest groups exerting pressures for lending constraints have been unable to enact their policy preferences through congressional action. Is that political outcome consistent with an assertion of political unpopularity? Why else would it be necessary to pressure the banks and savings associations directly?
Political pressures to choke certain sectors are explicitly anti-democratic, in that the investment activities to be disfavored are legal, whether authorized explicitly in law (e.g., investment in fossil-fuel exploration and production activities on the Arctic National Wildlife Refuge coastal plain) or not proscribed by law at either the state or federal level. If there exists a compelling policy rationale for lending discrimination against particular industries, it is unclear why such policies should be imposed through means independent of the democratic institutions that define the American system of governance.
Moreover, there is no obvious limit to the range of industries that might be targeted. The interest groups favoring such discrimination have powerful incentives to expand their abilities to influence resource allocation. The proposed rule represents a bulwark against a long-term process of increasingly politicized resource allocation that would hamper the economy.
Distortions in lending decisions by banks and other institutions benefiting from federal deposit insurance and other policy instruments must yield a reduction in the lenders’ financial soundness, whether large or small, an outcome inconsistent with the central goal of federal financial regulation. The “reputation risk” justification for politicized lending ignores this obvious risk created for the financial system writ large. Because there exists no natural limit to the lending behavior to be subjected to discriminatory pressures, the inefficiency of lending decisions would expand over time in the absence of the proposed rule, threatening ever-more industries and the banking industry and savings associations themselves. It is not difficult to envision a downward spiral in terms of the allocation of capital and the productivity of the economy.
The “stranded asset” argument for discrimination against producers of conventional energy can be summarized as follows: Future climate (and other) policies around the world will reduce the value of energy resources sharply, and thus the credit-worthiness of the borrowers owning such assets, making lending to those sectors more risky than it appears. This argument is incorrect: The market price of such assets reflects the market evaluation of the effect of future policies and other relevant factors. If the “stranded asset” problem is real, precisely why is the Paris climate agreement not stronger than it is as negotiated?
In the aggregate, labor and capital are complements. An increase in the economic value of the capital stock can be predicted to yield a rise in the productivity of labor and thus in market wages. Lending discrimination will reduce the aggregate returns to investment by distorting the allocation of capital, thus yielding over time a capital stock less productive and valuable, and reduced wage growth.
The argument that lenders ought to be allowed to lend to whomever they choose is sheer hypocrisy: Lenders choosing not to do business with, say, fossil-fuel producers are merely exercising their rights, but lenders making the opposite choice are destroying the planet. Without such political pressures, the banks and savings associations would be left to maximize their own risk-adjusted returns from lending decisions; a failure to do so would be unlikely to survive the market for corporate control. And the “lend to whomever they choose” argument shunts aside the fact that such lenders cannot ignore regulatory pressures.
By imposing a nondiscrimination constraint upon lenders, the proposed rule would constrain the political imperatives of the bureaucracy, stabilize the industrial structure of the capital market, improve the allocation of capital, and yield a wealthier economy over time. It deserves our support.