Michael S. Barr, the Federal Reserve’s vice president of supervision, announced Monday that he will push for significant changes to the way America’s largest banks are supervised in a bid to make them more resilient in times of trouble, in part by increasing the capital amount they have to overcome a losing streak.
The reform would require the largest banks to increase their holdings of capital: cash and other readily available assets that can be used to absorb losses in times of trouble. Mr Barr predicted that his adjustments would be “tantamount to requiring the largest banks to have an additional two percentage points of capital”, if implemented.
“The beauty of capital is that it doesn’t care where the loss came from,” Barr said in his speech previewing the proposed changes. “Whatever the vulnerability or shock, capital can help absorb the resulting loss.”
Mr Barr’s proposals are not a done deal: They would have to go through a notice and comment period, giving banks, lawmakers and other interested parties a chance to express their views. If the Fed Board votes to institute them, their implementation will imply a transition time. But the broad set of changes he laid out significantly changes the way banks police their own risks and are overseen by government regulators.
“It’s definitely meaty,” said Ian Katz, an analyst at Alpha Capital who covers banking regulation.
The Fed’s vice president of supervision, who was nominated by Chairman Biden, spent months revising capital rules for America’s largest banks, and his results have been long-awaited: Bank lobbyists have been warning for months about the Changes you might suggest. Midsize banks, in particular, have been outspoken that any increase in regulatory requirements would be costly for them, limiting their ability to lend.
Monday’s speech made it clear why the banks have been worried. Mr. Barr wants to update the bank’s risk-based capital requirements “to better reflect credit, business and operational risk,” he said in his remarks, delivered at the Bipartisan Policy Center in Washington.
For example, banks could no longer rely on internal models to estimate some types of credit risk (the chance of loan losses) or for particularly hard-to-predict market risks. Beyond that, banks would be required to model risks for individual trading desks for particular asset classes, rather than at the company level.
“These changes would raise the capital requirements for market risk by correcting the loopholes in the current rules,” Mr. Barr said.
Perhaps anticipating more pushback from the banks, Barr also listed existing rules that he did not plan to toughen, including special capital requirements that apply only to the largest banks.
The new proposal would also try to address vulnerabilities that were exposed earlier this year when a number of major banks collapsed.
One factor that led to Silicon Valley Bank’s demise, and sent a shockwave through the midsize banking sector, was that the bank was sitting on a pile of unrealized losses on securities classified as “available for sale.”
The lender was not required to count those losses on paper when it was calculating how much capital it needed to weather a tough period. And when he had to sell the securities to raise cash, the losses hit again.
Mr Barr’s proposed adjustments would require banks with assets of $100 billion or more to factor in unrealized gains and losses on those securities when calculating their regulatory capital, he said.
The changes would also tighten supervision of a broader group of large banks. Barr said his stricter rules would apply to companies with $100 billion or more in assets, lowering the threshold for strict supervision, which now applies the stricter rules to banks that are internationally active or have $700 billion or more. more in assets. Of the nation’s estimated 4,100 banks, approximately 30 have $100 billion or more in assets.
Katz said the expansion of tough rules to a broader set of banks was the most notable part of the proposal: such an adjustment was expected based on comments from other Fed officials recently, he said, but “it’s a big change.” .
The bank explosions earlier this year illustrated that even much smaller banks have the potential to wreak havoc if they collapse.
Still, “we won’t know how significant these changes are until the long rule-making process takes place over the next two years,” said Dennis Kelleher, executive director of the nonprofit Better Markets.
Mr. Kelleher said that overall Mr. Barr’s ideas sounded good, but added that he was concerned about what he saw as a lack of urgency among regulators.
“When it comes to bailing out the banks, they act with urgency and decisiveness, but when it comes to regulating the banks enough to prevent bankruptcies, they are slow and take years.”
Bank lobbyists criticized Barr’s announcement.
“Fed vice chair of supervision Barr appears to believe that the largest US banks need even more capital, without providing any evidence as to why,” said Kevin Fromer, executive director of lobby group Financial Services Forum. , in a statement to the media on Monday.
“More capital requirements at the largest US banks will lead to higher borrowing costs and less lending for consumers and businesses, slowing our economy and hitting those on the margin the hardest,” Fromer said.
Susan Wachter, a finance professor at the Wharton School of the University of Pennsylvania, said the proposed changes were “long overdue.” She said it was a relief to know that a plan was being worked out to make them.
The Fed vice chair hinted that further bank supervision tightening inspired by the March 2023 turmoil is still on the way.
“I will seek further regulatory and supervisory changes in response to the recent banking stress,” Barr said in his speech. “I look forward to having more to say on these issues in the coming months.”