The looming overhauls arrive amidst ongoing economic uncertainty.
Major banks are facing one of the biggest regulatory overhauls since the financial crisis, setting up a clash over the amount of capital that they have to set aside to weather tumult.
The Federal Reserve’s top banking regulator, Michael Barr, said he wants Wall Street banks to start using a standardized approach for estimating credit, operational and trading risks, rather than relying on their own estimates. He added that the Fed’s annual stress tests should be rejiggered to better capture dangers that firms can face. The changes stem from a months-long review to align US rules with a set of international standards known as Basel III.
Industry titans have long fought against higher capital requirements, and the issue became a political lightning rod after several lenders including Silicon Valley Bank collapsed this year. Barr said his examination found that the current system was sound, but several changes were needed that will result in banks setting aside more money as a cushion to protect against losses. The announcement arrived just days before the largest banks begin posting their second-quarter results, starting on Friday with JPMorgan Chase & Co., Citigroup Inc. and Wells Fargo & Co.
“These changes would increase capital requirements overall, but I want to emphasize that they would principally raise capital requirements for the largest, most complex banks,” he said in a speech at the Bipartisan Policy Center in Washington. “We intend to consider comments carefully and any changes would be implemented with an appropriate phase-in,” he said, adding that most banks already have enough capital to meet the new requirements.
Since taking the job last year, Barr has signaled that he generally supports tougher restrictions for bigger, systemically important lenders. Faced with that prospect, large banks sounded a relatively cautious approach for announcing payouts after they all passed the Fed’s annual stress test exam last month. Bank stocks were mostly higher on Monday, with the KBW Bank Index rising 0.2% in New York.
Analysts such as Kathleen Shanley at Gimme Credit have questioned the usefulness of the current setup of the Fed’s stress tests because most regional banks were exempted and the scenarios were designed before March’s sudden swoon. Some large regionals have already restrained stock buybacks and dividends in anticipation of new capital minimums, she wrote in a note to clients.
“The proposed rules would end the practice of relying on banks’ own individual estimates of their own risk and instead use a more transparent and consistent approach,” Barr said of his plans. The largest banks would also have to hold an extra two percentage points of capital — or an extra $2 of capital for every $100 in risk-weighted assets.
“We see this as consistent with our view that the proposed changes will result in modestly higher capital requirements,” Jaret Seiberg, a TD Cowen analyst, wrote in a note to clients.
Barr said the changes will only take effect if they’re proposed and approved by the Fed, Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency. An initial plan could be released as soon as this month, but actual changes would not likely take effect for months or years. Industry will also have a chance to weigh in.
He added that “enhanced capital rules” should apply to banks and bank holding companies with more than $100 billion in assets. Currently, such restrictions apply to firms that are globally active or have $700 billion or more in assets, he said.
“Setting aside more capital is not about smashing anything. It’s about building resilience in the financial system. It enables banks to lend to the economy,” Barr said during the question-and-answer portion of the event.
The long-awaited Basel III reforms to bank capital levels are part of an international overhaul of capital rules that started more than a decade ago in response to the financial crisis of 2008. The issue became more stark — and political — this year with the collapse of several banks. The top US banks are already subject to higher requirements than their European peers, according to the European Central Bank, which oversees lenders in the euro area. Despite that disadvantage, US securities firms were able to win market share from European competitors in previous years.
Tim Adams, head of the Institute of International Finance, said that the planned higher capital standards are “puzzling and counterproductive” because they could harm the economy. “The financial system has proven it is resilient and well-capitalized,” he said in a statement.
Barr acknowledged concerns that the changes in capital requirements could lead to banks altering their behavior, as well as the way that financial services are provided. But he said most banks already have sufficient capital today to meet new mandates. As for the rest, he estimates that they would be able to build enough capital through retained earnings in less than two years, “even while maintaining their dividends.” That assumes that they earn money at the same rate as in recent years.
Although his review began before this March’s banking crisis, Barr said his plans would deal with some of the issues that were exposed by the collapse of Silicon Valley Bank and others.
“Some industry representatives have claimed that SVB’s problems were really related to poor management and shortcomings in the Federal Reserve’s supervision,” Barr said. “It is not logical to argue that failings in supervision must mean that SVB was adequately capitalized — it wasn’t — or that supervision by itself can somehow assure safety and soundness throughout the banking system. It is not a choice between supervision and capital regulation — capital is and has always been the foundation of a bank’s safety and soundness.”