Major banks are on the verge of a significant regulatory shift, the largest since the financial crisis. This change could lead to disagreements with Wall Street over the capital reserves required to endure financial instability.
Michael Barr, the Federal Reserve’s chief banking regulator, advocates for banks to use a standardized method for estimating credit, operational, and trading risks. He also suggests that the Fed’s annual stress tests need to be adjusted to better identify potential risks. These changes aim to align U.S. regulations with international standards, known as Basel III.
These proposals follow a comprehensive review of capital requirements for banks, a politically sensitive topic, particularly after the collapse of several lenders earlier this year. Barr’s review concluded that the current system is sound, but it necessitates several modifications that will lead to banks setting aside more funds as a buffer against losses.
Barr emphasized that these changes would primarily increase capital requirements for the largest, most complex banks. He assured that any changes would be implemented with an appropriate phase-in period and that most banks already have sufficient capital to meet the new requirements.
Barr has indicated his general support for stricter restrictions for larger, systemically important lenders. In response, large banks have adopted a relatively cautious approach when announcing payouts after passing the Fed’s annual stress test exam last month.
As part of the proposed plan, the largest banks would be required to hold an additional 2 percentage points of capital, equating to an extra $2 of capital for every $100 in risk-weighted assets.
Barr clarified that these changes would only be implemented if 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 early as this month, but actual changes would likely not take effect for months or years. The industry will also have the opportunity to provide input.
He further suggested 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.
Barr emphasized that setting aside more capital is not about destruction but about building resilience in the financial system, enabling banks to lend to the economy.
The proposed Basel III reforms to bank capital levels are part of an international overhaul of capital rules that began over a decade ago in response to the 2008 financial crisis. The issue became more prominent and political this year with the collapse of several banks.
In response to the plan, Tim Adams, head of the Institute of International Finance, expressed concerns that higher capital standards could dampen the economy, describing them as “puzzling and counterproductive.” He argued that the financial system has proven its resilience and is well-capitalized.
Barr acknowledged these concerns but reiterated that most banks already have sufficient capital to meet new mandates. 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.
Although his review began before the banking crisis in March, Barr stated that his plans would address some of the issues exposed by the collapse of Silicon Valley Bank and others.