U.S. regulatory agencies are moving forward with plans to regulate big banks and establish rules meant to prevent another crisis like the financial disaster that began in fall 2008.
The Federal Reserve’s Board of Governors voted Tuesday morning to finalize a rule that would require big banks in the U.S. to keep plenty of capital on hand in case of a panic. The rule, first proposed by the Fed a year ago, fulfills the United States’ commitment to improve capital standards under the 2010 Basel III agreement among advanced nations. Other U.S. financial regulatory bodies are expected to approve the rules in coming weeks.
Chairman Ben Bernanke called strong capital requirements “a core element of the Federal Reserve’s regulatory response to the financial crisis.” He also said at the meeting in Washington that “the rule would put in place a comprehensive regulatory capital framework” that “requires banking organizations to hold more and higher quality capital, which acts as a financial cushion to absorb losses, while reducing the incentive for firms to take excessive risks.”
The rule would institute higher minimum requirements for the quantity and quality of capital held by banks. It also would revamp the criteria used to assign levels of risk to different kinds of assets in banks’ portfolios for the purpose of establishing the requirements.
One purpose of the new rule is to prevent smaller community banks, which engage in fewer risky activities than the biggest banks, from straining to comply with capital requirements, according to Fed officials. The Fed received more than 2,600 comments on the proposed rule, with the majority coming from community banking organizations. Fed Governor Elizabeth Duke said she believes that the central bank has “maintained the objective of strengthening capital requirements but without the more onerous regulatory burden.” The Fed’s analysis showed that 90 percent of banks with less than $10 billion in assets currently have enough capital to meet the new requirements, even before the rules begin phasing in.phase-in of the rules begins.
The rule, if adopted by other regulators including the FDIC and Office of the Comptroller of the Currency, would apply to big, internationally active banks starting Jan. 1, and then to others starting in 2015. The entire package of rules is not expected to fully take effect until 2019.
Fed officials emphasized that the implementation of the Basel III capital requirements was only one part of a larger plan to avoid future market panics and bailouts that will include Fed stress tests of big banks. Sarah Bloom Raskin, appointed by President Obama to the Fed’s Board of Governors in 2010, warned that capital requirements were not a “panacea” that could prevent further crises.
Daniel Tarullo, the governor tasked with overseeing the Fed’s regulatory efforts, also gave notice that the Fed will propose a leverage ratio requirement higher than that included in the Basel III framework, saying that the leverage ratio included in the plan “seems to have been set too low to be an effective counterpart to the combination risk-weighted capital measures that have been agreed internationally.” A leverage ratio threshold would be stricter than other capital requirements because it would require banks to hold a certain percentage of their total assets as capital to protect against shocks regardless of the perceived riskiness of those assets.
Tarulllo did not suggest what the proper leverage ratio requirement would be, but recent reports have suggested that regulatory officials are pushing for 6 percent, twice as high as required by Basel III. A bill introduced in the Senate by Sherrod Brown, an Ohio Democrat, and David Vitter, a Louisiana Republican, would set the ratio at 15 percent. Thomas Hoenig, the vice chairman of the FDIC, has proposed a 10 percent leverage ratio. Hoenig made headlines in June for saying that Deutsche Bank was “horribly undercapitalized.”