- Key Insight: Federal Reserve Vice Chair for Supervision Michelle Bowman highlighted upcoming changes to the Global Systemically Important Bank surcharge and Basel III endgame implementation rule, which primarily focus on adjusting input parameters and certain risk weighting mechanisms rather than overall capital levels.
- Expert quote: "These changes to the capital framework eliminate overlapping requirements, right-size calibrations to match actual risk, and comprehensively address long-standing gaps in our prudential framework." — Federal Reserve Vice Chair for Supervision Michelle Bowman.
- Forward look: Bowman said she is pushing for the proposals to be published next week, ahead of a long-telegraphed deadline of March 31 to publish the proposals.
WASHINGTON — Federal Reserve Vice Chair for Supervision Michelle Bowman outlined upcoming changes to the bank regulatory capital framework in a pair of upcoming regulations, saying the focus has been on making the capital framework more internally consistent and cohesive.
Speaking at an event at the Cato Institute Thursday morning, Bowman said the Federal Reserve and other regulators took a "bottom-up" approach in rethinking four pillars of the capital framework for the largest banks, namely stress testing, the supplementary leverage ratio, the Basel III risk-based capital rules and the global systemically important bank, or G-SIB, surcharge.
"These changes to the capital framework eliminate overlapping requirements, right-size calibrations to match actual risk, and comprehensively address long-standing gaps in our prudential framework," Bowman said. "The result is more efficient regulation and banks that are better positioned to support economic growth, while preserving safety and soundness."
The Fed issued a proposal to revise its stress testing process
Bowman said the revisions have been focused on whether the rules are properly calibrated to risk, achieve their intended purpose and avoid unintended outcomes. Some reforms implemented post-2008 have produced "unintended consequences," she said, including constraining credit availability, pushing activity into less-regulated nonbank sectors and adding complexity and cost without improving safety and soundness.
She said changes to the Basel III framework would streamline risk-based capital rules by using a single set of calculations and better aligning requirements with risk, rather than requiring banks to run their balance sheets through a standardized risk model as well as through their own internal models. Revisions to the GSIB surcharge, she said, are aimed at better capturing risk.
Bowman said the revisions to Basel III would improve the risk sensitivity of requirements for lending activities, including mortgages and credit cards.
"The proposal recognizes loan-to-value ratios in mortgage capital requirements and reflects repayment history in retail lending," Bowman said. "Importantly, it does not add new capital penalties for mortgages or consumer lending and seeks public feedback on the appropriate role of private mortgage insurance."
Bowman said the revised framework will allow banks to calculate their operational risks based on a standard calculation to align the requirements with international standards and will account for fee-based activities, such as credit card lending, on a net basis rather than independently, as is outlined in the Basel III framework. Regulators are also considering changes to risk-based capital requirements for all banks, Bowman said, adding that the forthcoming proposal would modify risk-based capital calculations for most banks, "moderately reducing requirements" for lending, including mortgages, consumer loans and business credit. The proposal will also introduce a "credit valuation risk" adjustment to capture bilateral counterparty risk for banks with significant derivative exposure, an element that she said would focus on financial derivatives transactions rather than end-users.
On mortgages, Bowman said regulators plan to
"This should reduce disincentives for participating in mortgage markets and servicing their mortgage originations, thereby addressing the migration of mortgage activity to nonbanks over the past 15 years," Bowman said.
Bowman said upcoming changes to the G-SIB surcharge will account for changes in economic growth and inflation. The proposal will adjust the "coefficients" that go into the GSIB calculation to "better [reflect] recent changes in the financial system." Bowman noted that the Fed is supposed to update these coefficients periodically, and the proposed rule would realign the U.S. GSIB surcharge with the international standard and index the coefficients to economic growth.
The proposal will also recalibrate the risk assumptions associated with short-term wholesale funding in the GSIB surcharge, changes that "would bring it into better alignment with other elements of the calculation," Bowman said. The proposal would also require banks to calculate some of their systemic risk indicators in the surcharge "as an average of their daily or monthly values, rather than the year-end value," which she said would preclude banks rushing at the end of the year to mitigate their risk exposures on their balance sheets.
During a question-and-answer portion of her appearance, Bowman said the proposals reflect a diversity of opinion on the Fed board and among stakeholders and a pragmatic effort to ensure that the regulatory capital framework is coherent all the way through.
"It's complicated and it's challenging to get different proposals through our Federal Reserve Board, because any change that we make ... through our regulation has to be voted on by our seven member board — so different views, different approaches," Bowman said. "The approach that we're taking here, as we started with that capital seminar that we did last last summer, was to ensure that we were thinking about all of these requirements together and we weren't publishing anything without understanding the implications for the rest of the capital framework. So hopefully we've taken an approach that makes sense."
When asked whether the changes might be viewed as loosening bank regulation in light of the high-profile failures of Silicon Valley Bank and other midsized banks in 2023, Bowman said the roots of that banking crisis were not in bank regulation, but rather diligent supervision.
"Let's be honest about what led to the failure of Silicon Valley Bank in 2023 — a lot of that was management and supervision failures," Bowman said. "We'll look forward to implementing those lessons once we've completed that review, but we certainly recognize that it wasn't capital or even necessarily liquidity that led to the failure of Silicon Valley Bank."
