Dodd-Frank, Economic Policy Uncertainty, and Bank Lending

bank lending, credit channel, Dodd-Frank, GDP Growth, Great Recession
Copies of the Cato Institute Research Brief, "Economic Policy Uncertainty and the Credit Channel in the United States."

Research-Briefs RotatedMichael Bordo, John Duca, and Christoffer Koch recently produced a Cato Institute Research Brief on how policy uncertainty affects bank lending.  The Cato Research Briefs in Economic Policy series allows economic researchers to write an accessible 2,000 word summary of an academic article that cuts through the required literature review, regression explanations, etc., required in the full version.  Bordo, Duca, and Koch based their Research Brief on an NBER article they published in February, entitled, “Economic Policy Uncertainty and the Credit Channel: Aggregate and Bank Level U.S. Evidence over Several Decades.”

The authors find that, holding other macroeconomic and regulatory factors constant, policy uncertainty “significantly slows U.S. bank credit growth.”  To measure uncertainty, Bordo, Duca, and Koch use an economic policy uncertainty (EPU) index based on newspaper article wording.  The EPU index shows consistently higher uncertainty in the four years after the Great Recession compared to four years after the five prior recessions.  What has caused elevated uncertainty post ’08 relative to comparable time periods?  Bordo et al. argue that Dodd-Frank accounts for at least part of this relatively high uncertainty.  Dodd Frank not only vastly overhauled financial regulation, but did so in a way that left a uniquely large and substantive amount of rulemaking authority to administrative agencies.  Three years after Dodd-Frank’s passage only half of the rules the law mandates had been finalized.  Even now, regulators have still not implemented twenty-five percent of the rules required by the law.

Just what has the increased uncertainty, caused at least in part by Dodd-Frank, meant for bank lending?  Examining data from 1961-2014, Bordo, Duca, and Koch show that uncertainty has a highly significant effect on real per capita bank loan growth.  This significance is robust across various macroeconomic and regulatory variables, like changes in GDP growth, the fed funds rate, and bank capital rules.  The authors also delineate their results by bank size, noting that uncertainty has a greater adverse impact on smaller banks.

The connection that Bordo, Duca, and Koch show between policy uncertainty and depressed bank lending is surely an important consideration for policymakers charged either with evaluating the legacy of Dodd-Frank, or with thinking about the reasons for slow post recession growth in general.

  • Benjamin Cole

    You know what is puzzling? Go to the American Bankers Association website. You will find almost nothing that is adversarial in regards to Dodd-Frank.

    I would say the industry, at least as represented by its major lobby group, has made peace with Dodd-rank. Frank

    • George Selgin

      Talk to more bankers, Benjamin: I would say that certain parts of the industry have captured the ABA!

  • Dodd-Frank is not Basel. Dodd-Frank should only be implemented to protect consumers and stop rampant speculation. It should not be implemented in order to destroy the GDP. Question for the author, how can both these be balanced? Look at China, which has avoided Basel and the banks don't crash there.

  • John

    On the front line Dodd-Frank implementation and the CFPB enforcement is a nightmare. You cannot win. The regulatory interpretations are poorly written and often conflict. The regulators will tell you they will not penalize you on the final interpretation of conflicting language but will not grant safe harbor. Nobody trusts enforcement by the CFPB which apparently has no oversight and self-funds by the fines it levels. Once a bank gets stung by this it has a chilling effect on lending. I guess it protects consumers by making it harder for them to get money. One solution is to fix pricing on loans for everyone. You buy a loan like you buy a cheeseburger at a fast food restaurant. This is already happening, especially in consumer auto lending. Pricing for risk is seen as discriminatory and you will get in trouble. Private hard money lenders who are not subject to this nonsense are thriving.