“To avoid huge accounting losses, which cut into capital, the effect would be to not lend, or to lend less,” said Joshua Ronen, an accounting professor at New York University. That could “paradoxically” hit the most cash-strapped borrowers, he said, since they are often the worst credit risk.
Strains to the financial system could come at a particularly bad time. Big financial firms outside the banking sector remain largely out of regulatory oversight, including asset managers, hedge funds, private equity firms and big insurers.
And the rules governing regulated institutions have become gradually less stringent. The Fed implemented a regulatory change last week, which one official — Gov. Lael Brainard, an Obama administration pick — warned could significantly reduce capital at the biggest banks. Last year, the Fed adjusted the structure of its annual stress tests, changes that could make it easier for banks to get regulatory approval to pay higher dividends or buy back their own shares.
Fed officials had already expressed concern in January that banks might be returning too much of their profits to shareholders, leaving them exposed if there is another big downturn. “Planned increases in dividend payouts by large banks and the associated decline in capital buffers might leave those banks with less capacity to weather adverse shocks,” according to minutes of the meeting.
Banking regulators have also been working to relax the Volcker Rule, which prohibited banks from making risky bets with their customers’ deposits. Banks took major losses on their derivatives holdings in the 2008 crisis, helping to exacerbate financial system strains. Proposed changes would allow banks to invest in some credit funds and sponsor or take ownership stakes in venture capital funds, which pool ultrarich investors’ money to bet on start-ups.
“We are in a much more fragile situation than we should be because the regulators haven’t been on the job,” said Marcus Stanley, policy director for Americans for Financial Reform. “This is a real economic crisis we’re facing.”
Mr. Stanley noted that bank capital has been steadily declining during Mr. Trump’s time in office while corporate debt has been piling up. That combination, he said, could turn out to be a “recession accelerator” if companies experience sharp revenue declines and are forced to lay off workers.