- Key insight: Federal regulators issued a suite of proposals that would reduce bank capital requirements for all banks.
- Supporting data: The Federal Reserve estimates that the proposals would reduce Common Equity Tier 1 capital requirements for Category I and II banks by 4.8%, for Category III and IV banks by 5.2%, and by 7.8% for smaller banks.
- Expert quote: "The result will be more efficient regulation and banks that are better positioned to support economic growth, while preserving safety and soundness and financial stability." — Federal Reserve Vice Chair for Supervision Michelle Bowman
UPDATE: This story includes additional details regarding the proposed rules.
WASHINGTON — The Federal Reserve, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. issued a suite of proposed rules Thursday that would cumulatively reduce the amount of capital banks will have to retain by billions of dollars.
The agencies, led by the Federal Reserve, published three separate proposals; one implementing remaining elements of the Basel III accords, which concern risk-based capital requirements for the largest banks or those with significant trading activity; another to adjust the Global Systemically Important Bank capital surcharge; and a third to modify the U.S. standard approach to calculating capital requirements.
The cumulative impact of the proposals — combined with proposed changes to the Fed's stress testing regime — would be a 4.8% reduction in common equity tier 1 capital requirements for the largest banks, known as Category I and II banks, a 5.2% CET1 reduction for Category III and IV firms, and a 7.8% capital reduction for smaller banks.
In a statement ahead of the Federal Reserve's board meeting, Fed Vice Chair for Supervision Michelle Bowman said the proposals, taken together, would "meaningfully improve the bank capital framework by addressing duplicative overlaps, matching requirements to actual risk, and comprehensively addressing long-standing gaps in our framework."
"The result will be more efficient regulation and banks that are better positioned to support economic growth, while preserving safety and soundness and financial stability," Bowman said. Bowman was joined by Fed Govs. Christopher Waller, Stephen Miran and Board Chair Jerome Powell in offering support for the rule.
Powell, in his statement, said that it is prudent to reexamine our regulatory frameworks at "regular intervals" and align them with international standards. He added that he supports "seeking public comment on all three of these proposals."
Fed Gov. Michael Barr, who had previously served as Vice Chair of Supervision when the Fed issued its prior Basel III proposal, said in a statement that he does not support the regulatory package and said that, when combined with the recently implemented changes to the enhanced Supplemental Leverage Ratio, the total cumulative capital reduction for the GSIBs would be closer to 6%, or $60 billion. By contrast, a Fed official told reporters ahead of the meeting that the Fed estimates the total capital reduction to be between $20 and $21 billion across banking organizations.
"These significant reductions in capital requirements are unnecessary and unwise," Barr said. "The capital surcharge for G-SIBs could be refined and the Basel III reforms could be adopted in the United States without materially weakening the capital framework. Today's proposals, if adopted, would harm the resilience of banks and the U.S. financial system."
The Fed and the FDIC are slated to vote on the proposals Thursday morning at 10 a.m.
The Fed separates banks with more than $100 billion of assets into four categories based on size and risk. Category I firms are the eight GSIBs subject to the most stringent standards; Category II firms are those with $700 billion or more of assets or with more than $100 billion of assets and more than $75 billion in cross-jurisdictional activity; Category III firms are those with more than $250 billion of assets or more than $75 billion in nonbank assets, short-term wholesale funding or off-balance sheet exposure; and Category IV firms with between $100 billion and $250 billion of assets, generally subject to the least stringent rules.
Bowman has telegraphed some of the driving innovations in the Basel proposal for some time. Importantly, the proposal replaces the dual risk-based capital ratios, both standardized and advanced, with a single "expanded risk-based" capital ratio for Category I and II firms.
The rule also introduces standardized methodologies for credit, operational and market risk, and makes important changes to each.
For credit risk, the proposal would include additional metrics, including loan-to-value assessments in certain real estate transactions and vary the existing credit conversion factors for off-balance sheet exposures — that is, the risk weights assigned to off-balance sheet exposures to quantify the likelihood that those risks become assumed by the bank.
The rule also introduces an operational risk requirement — an amorphous risk category that encapsulates risks to ongoing business operations, which can be anything from a cyberattack to rogue trading to a natural disaster.
The proposed rule notes that losses associated with operational risk "typically do not result in substantial credit or market risk-weighted assets, such as certain fee-based activities" and thus are not captured via credit or market risk considerations. The risk-weighted assets for operational risk are set at 12.5 times the "business indicator component," which will "serve as a proxy for a banking organization's business volume and would be based on inputs compiled from a banking organization's financial statements." The 12.5 factor was selected because it is "the amount by which the measure of operational risk exposure needs to be multiplied so that the risk-weighted assets it generates are equivalent to an 8% total capital requirement," the proposal said.
FDIC Chair Travis Hill expressed some misgivings about the operational risk component during the FDIC open board meeting Thursday morning, saying that precisely applying a regulator-determined risk weight to such an unquantifiable universe of risks seems difficult.
"I continue to have some skepticism that regulators can accurately measure operational risk through a complex, standardized formula, and am interested in comments on the merits of exploring a simpler approach," Hill said.
The proposal also replaces the stressed Value-at-Risk measure for market risk with what it calls a "simple, transparent, and risk-sensitive standardized methodology" for assigning market risk, consistent with the Basel III standards, as well as a models-based methodology. The proposal said the new measures would introduce an "expected shortfall-based measure that better accounts for extreme losses."
This is a developing story. Check back for more updates.
Maria Volkova and Ebrima Santos Sanneh contributed to this report.
