- Key insight: Federal regulators issued a suite of proposals that would reduce bank capital requirements for banks with more than $100 billion of assets.
- 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 article 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
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 and proposed changes to the stress test, the total cumulative Tier 1 capital reduction for the G-SIBs would be close to 6%, or $60 billion. A Fed official told reporters ahead of the meeting that the Fed estimates the total Common Equity Tier 1 capital reduction, not including stress testing changes or the eSLR, would 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 approved the rules during open meetings Thursday morning. The FDIC, with only three members, approved the proposals unanimously; the Fed approved the proposals by a 6-1 vote, with Barr providing the lone dissent.
Basel III proposal
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 G-SIBs 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."
G-SIB surcharge
The G-SIB surcharge proposal makes significant adjustments to fixed coefficients in the "Method 2" formula for calculating a G-SIB's surcharge, which is based on size, interconnectedness, reliance on short-term wholesale funding, complexity, and cross-jurisdictional activity.
Method 1 is the formula banks must use to determine whether they are a G-SIB for the purposes of the rule, whereas Method 2 is an alternate formula that banks designated as G-SIBs under Method 1 must calculate to account for exposure to wholesale funding. Method 1 has a "substitutability" component — which is meant to capture the extent to which a bank's activities could be taken up by other institutions should it fail — in place of the wholesale funding component. G-SIBs must use the larger of the capital requirements between the two methods to calculate their G-SIB surcharge.
Those coefficients were established when the G-SIB surcharge rule was passed in 2015 and arrived at based on aggregate global averages of each of the indicators (except wholesale funding for Method 2) and is meant to ensure that an individual bank's systemic risk is being judged on its own merits rather than based on the aggregate risk in the financial system. The proposal notes that because those coefficients are fixed, broader economic factors like economic growth and inflation would have banks retain ever-more capital even when risks have not accumulated to the same degree.
To combat this, the proposal would reduce the coefficients for the size, interconnectedness, complexity, and crossjurisdictional activity components of G-SIB Methods 1 and 2 by a factor of 1.2 and annually index those coefficients — as well as the wholesale funding metric in Method 2 — with nominal gross domestic product. The proposal said it would also take comment on whether the coefficients should be indexed to inflation rather than GDP growth.
Federal Reserve Gov. Lisa Cook, who expressed support Thursday for the proposals' goals, said during the Fed board meeting that she is concerned that the board is setting itself up to have to address these issues again if the fixed coefficients no longer reflect economic realities down the road.
"Today's proposal tries to solve this problem by doing a one-time calibration of the original coefficients and periodically adjusting them using GDP growth instead of directly relevant measures of financial system growth," Cook said. "I am concerned that we are setting ourselves up to have the same conversation in five to 10 years about Method 2 surcharges veering off their intended course."
Standardized approach to risk-weighted assets
The proposal to create a standardized approach to risk-weighted assets adjusts the calibration of certain risk weights in an effort to better capture a bank's risk profile.
The proposal — which, unlike the G-SIB surcharge and Basel III proposals, would apply to all banks, large and small — revises the risk weight for corporate exposures from 100% to 95% and reduces the risk weight for other exposures not categorized elsewhere from 100% to 90%. The proposal would also remove a threshold-based deduction for mortgage servicing assets, or MSAs, and replace it with a 250% risk weight for all MSAs. The change would "promote mortgage origination and servicing by banking organizations in a risk-appropriate manner," according to the proposal.
The standardized approach proposal would also instruct Category III and IV banks to include accumulated other comprehensive income, or AOCI, in their Common Equity Tier 1 capital calculations — a practice already required for Category I and II banks — with a five-year phase-in period.
The proposals would have different capital impacts on affected banks. The Basel III proposal, for example, would raise capital requirements on Category I and II firms by 1.4% on average, while the G-SIB surcharge would reduce those banks' capital requirements by an average of 3.8%. The revised standardized approach, meanwhile, would reduce required capital levels for Category III and IV banks by an average of 6.1% and by 7.8% for small banks. The AOCI requirement of that proposal, by contrast, would raise capital requirements for Category III and IV banks by 3.1%.
When not accounting for the proposed changes to the stress testing regime, the proposals would reduce Category I and II banks' capital requirements by 2.4%, Category III and IV banks capital requirements by 3% and smaller banks by 7.8%.
Maria Volkova and Ebrima Santos Sanneh contributed to this report.
