The conventional wisdom in banking circles is that the pandemic of 2020 has vindicated the post-2008 drive to make lenders more robust. Institutions like HSBC, and JPMorgan entered the pandemic with large capital buffers, allowing them to absorb loan losses while keeping credit flowing to lockdown-hit firms and households. It’s a comforting story, but only the first part is true. Banks indeed started 2020 with higher levels of capital. The 20 largest North American and European lenders had average common equity Tier 1 capital equivalent to just under 12.9% of risk-weighted assets at the end of 2019. That’s a far cry from the single-digit ratios that were the norm before 2008. It has left banks well-placed to soak up bad-debt charges, which will this year average 1.1% of total loans using Refinitiv estimates. On the lending side, however, reality hasn’t conformed to regulators’ expectations. True, the total stock of U.S. commercial and industrial loans was 12% higher in November 2020 than a year earlier, Federal Reserve data shows. In France, Germany, Italy, Spain and the United Kingdom, total loans to domestic non-financial firms rose 7% on average between February and October. But much of that lending was underwritten by governments, not banks. About 95% of UK small and medium-sized business lending in the year up to mid-November carried a state guarantee, according to estimates by Huw van Steenis of UBS. He also calculates that, after excluding the government’s Paycheck Protection Program, U.S. commercial and industrial lending was lower as of Nov. 18 than a year earlier. Euro zone banks benefitted from similar programmes, and better-than-free funding from the European Central Bank linked to hitting lending targets. Meanwhile, supervisors bent over backwards to protect bank balance sheets. They banned dividend payouts, encouraged banks to ignore some loan moratoria when forecasting credit losses, and tweaked leverage and capital requirements to flatter capital ratios. The striking result is that banks’ combined capital levels have risen this year. The 20 big lenders on average reported a more than 13.5% average CET1 ratio in the most recent quarter - 0.7 percentage points higher than at the start of the year. This data calls into question a key pillar of the regulatory regime: banks’ willingness to dip into their buffers in a crisis. That’s what supervisors expected them to do. Post-2008 rules specify that banks must maintain a minimum CET1 ratio of 4.5% of risk-weighted assets. On top of that sits a so-called capital conservation buffer of 2.5%, which the Federal Reserve recently replaced with a stress capital buffer of at least the same size. The idea was that banks can dip into that reserve without being deemed insolvent. A lender with $500 billion of risk-weighted assets would therefore in theory have at least $12.5 billion of surplus equity to draw on - enough to absorb hefty losses, and to support hundreds of billions of dollars in loans. This approach reflects bank regulators’ two big priorities: to make banks safer, but also to ensure they keep lending. While it may be rational for one lender to shrink its balance sheet in a crisis, that approach would make the situation worse if pursued by everyone. A 2018 study estimated that the post-2008 credit crunch explained about 35% of the shortfall in U.S. GDP by the end of 2010 compared with the long-run trend. The Bank of England estimated this May that banks’ capital ratios would on aggregate be 0.8 percentage points lower if they all cut lending. Yet, as the rise in capital ratios shows, no major Western lender came close to using its buffers in the pandemic. The benign interpretation is that policymakers’ rapid action meant they didn’t have to. The pessimistic version, however, is that governments had to step in because banks would otherwise have proved too risk averse. Regulators are already mulling possible changes to the buffers. Bank of England Deputy Governor Jon Cunliffe in October floated the idea of focusing more on countercyclical buffers: variable capital requirements which supervisors can increase when they fear the economy is in danger of overheating, and relax in a downturn. Such a shift would have the advantage of reducing the penalties banks face when they dip into the capital conservation buffer, such as restrictions on bonuses and dividend payments. Even then, however, chief executives might be reluctant to accept lower capital ratios for fear of spooking customers, counterparties and credit ratings agencies. The depressing conclusion may be that there’s little regulators can do to force lenders to use their buffers in a crisis. The implication is that all the emergency help governments and central banks provided in 2020 may be needed to keep credit flowing when the next downturn arrives. Banks may no longer be the problem. But policymakers will still have to provide the solution.