Fed’s Bowman says capital reforms are missed opportunity to review leverage ratio

In July of this year, the federal banking agencies — the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) — proposed significant reforms to capital requirements for banks with more than $100 billion in assets. Although many banks would not be directly affected based on their asset size, the proposal could have a significant impact on the US banking market and economy.

The proposal would increase total risk-weighted assets across bank holding companies subject to the rule by an estimated 20%. These impacts would vary based on firm-specific attributes-but not by asset size. This proposal, said Michelle Bowman, member of the Board of Governors of the Federal Reserve System, is not designed to address identified regulatory deficiencies and shortcomings and gives insufficient attention to the potential unintended consequences and harm that could result if finalized and implemented in its current form.

In drafting the Basel III capital proposal, it seems clear that the agencies made broad assumptions that the current capital framework is insufficient to support bank and financial market activity. The agencies have received substantial initial public feedback, and in response, have extended the comment period into mid-January 2024. The agencies have also engaged in a parallel effort to gather more information about the potential impact of the proposal’s approach and calibrations. These actions reflect an important recognition of the proposal’s length and complexity and are certainly a positive step. While it would be impossible to highlight all the issues in the proposal that raise concerns in her remarks Bowman noted several areas that will be necessary to address:

  • Redundancy in the Capital Framework. The proposal does not include an analysis of the appropriate aggregate level of capital requirements. This consideration is important since many of the existing enhanced capital standards that apply for US banks were contemplated and finalized while the prudential regulation framework, including capital and liquidity rules, were still under development. For example, there are known overlaps and redundancies among the new market risk and operational risk requirements, and the stress capital buffer.
  • Calibration of the Market Risk Capital Rule. The revisions to the market risk rule alone will increase risk-weighted assets from $430 billion to $760 billion for Category I and II firms, and from $130 billion to $220 billion for Category III and IV firms. These increases are significant, with broad-based impacts, affecting business and municipal financing, risk management, hedging of foreign exchange and interest rate risk, or managing the risks of fluctuating commodity prices through hedging activities.
  • Inefficiency of Two Standardized Capital Stacks. Firms subject to the new risk-based capital rule would remain subject to the standardized approach applicable to all firms, resulting in a “dual-stack” capital calculation, with the firm required to use the lower capital ratio. This approach will add complexity to the capital calculation for all firms, but it will be especially cumbersome for Category III and IV firms, applying a one-size-fits-all approach for these smaller firms despite the variation in their risk, size, business models, and complexity, likely resulting in costs that outweigh the benefits of this provision.
  • Punitive Treatment of Fee Income. The proposal adopts a punitive treatment for noninterest and fee-based income through the proposed operational risk requirements, coupled with an internal loss multiplier. Imposing this type of capital charge for operational risk can deter banks from diversifying revenue streams, even though this can enhance an institution’s stability and resilience.
  • Missed Opportunity to Review Leverage Ratio Requirements. The proposal does not address or propose changes to leverage requirements, including the 5 percent leverage ratio that applies to U.S. global systemically important banks, commonly referred to as the enhanced supplementary leverage ratio (or eSLR). Treasury market intermediation can be disrupted by constraints imposed by the eSLR, as occurred during the early days of market stress during the pandemic. It seems prudent to address this known leverage rule constraint before future stresses emerge that would likely disrupt market functioning.

“Policymakers may disagree about the best choices to further supervisory goals, but we have an obligation to understand and assess the true cost of reform, going beyond the direct costs to banks and their customers to include the potential harm to US bank competitiveness in the global economy. As I have noted previously, unless we consider reforms with a thorough understanding of their combined and aggregate impact on the institutions subject to the revised regulatory framework, we create a significant risk of arriving at a capital end state that is inefficient, contradictory, and potentially harmful to banks, their customers, and the broader economy,” she said.

Read the full speech

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