Regulators plan to require the nation’s large banks to boost capital.
This morning The Federal Reserves Vice Chair for Supervision, Michael S. Barr went before the members of the Bipartisan Policy Center. To report on his holistic review of capital requirements for banks.
Akin Investments takes a quick look at his
presentation of the report. We touch on key takeaways and feature a link to the full text of the report.
Thank you to the Bipartisan Policy Center for the opportunity to speak today. I'm here to report on my holistic review of capital for large banks and to outline steps that I believe are appropriate to update our capital standards so that banks can continue to serve our communities, households, and businesses.
The review was a top priority because capital is fundamental to safety and soundness. I approached the task with humility. We need to be skeptical about the ability of bank managers or regulators to anticipate all emerging risks. Events over the past few months have only reinforced the need for humility and skepticism, and for an approach that makes banks resilient to both familiar and unanticipated risks.
Our dynamic financial system is complex and constantly evolving. Regulators and bank managers are limited in our ability to comprehensively identify risks and to measure them. We cannot fully appreciate how a specific vulnerability can interact with other vulnerabilities to amplify and propagate risk in the face of a shock, or multiple shocks. It is extremely difficult to identify shocks in advance. And we also cannot fully predict how firms and markets adapt to changes in the environment or to the behavior of regulators or other participants.
So, instead of trying to design rules to address every conceivable risk, regulators must focus broadly on resilience—ensuring that banks and the financial system can withstand challenges, wherever they emerge and however they are transmitted through the system. Fortunately, there is a component of bank funding—equity capital—that is well suited to building resilience.
Banks rely on both debt and capital to fund loans and other assets, but capital is what allows the bank to take a loss and keep on operating. The beauty of capital is that it doesn't care about the source of the loss. Whatever the vulnerability or the shock, capital is able to help absorb the resulting loss and, if sufficient, allow the bank to keep serving its critical role in the economy. Higher levels of capital also provide incentives to a bank's managers and shareholders to prudently manage the bank's risk, since they bear more of the risk of the bank's activities.
Holistic Review of Capital Standards
I initiated a review of capital standards as one of my first actions as Vice Chair for Supervision. This review was focused on capital requirements for large banks with more than $100 billion in total assets. Capital requirements are multi-layered with different components. A holistic approach is important because the requirements function as a system—each component treats risks and associated capital needs differently, but all components together result in a certain amount of capital required. Banks manage their operations with an eye on the entire system, and as such, adjustments to one part of the regime may imply adjustments to another.
To that end, over the last nine months, I have engaged with a wide range of parties: policymakers and staff from the Federal Reserve and other agencies, banks and financial sector groups, public interest groups, members of Congress, and academics to get a broad perspective on how the Fed's capital standards interact with each other and the result they together achieve. In the midst of this review, we once again learned the importance of resilience when a sudden bank run and contagion caused three large banks to fail and we experienced significant stress in the banking system, stemmed only by invocation of the systemic risk exception and creation of an emergency lending facility.
This should make us very humble indeed.
I reviewed whether changes would be appropriate to better align capital requirements with risk-taking, to help ensure that our banking system is sufficiently resilient to serve its vital role in our economy. Any proposed changes would go through the standard notice-and-comment rulemaking process, allowing all interested parties ample time to weigh in on the proposed changes. Any final changes to capital requirements would occur with appropriate transition times.
I will be pursuing further changes to regulation and supervision in response to the recent banking stress, including how we regulate and supervise liquidity, interest rate risk, and incentive compensation, as well as improving the speed, agility, and force of the Federal Reserve's supervision. I expect to have more to say on these topics in the coming months
Additional topics covered in the report include:
Multiple Measures of Risk
Conclusion of the Holistic Review
Basel III Endgame
Changes to the Stress Test to Improve Risk Capture
Minimal Adjustments to the G-SIB Surcharge to Improve Precision
Continuous Assessment of Capital Needs and the CCyB
Calibration of the Enhanced Supplementary Leverage Ratio
Long-Term Debt
Conclusion
The comprehensive set of proposals that I have described here today would significantly strengthen our financial system and prepare it for emerging and unanticipated risks, such as those that manifested themselves in the banking system earlier this year. The holistic review began well before then, of course, and the steps proposed here address shortcomings in capital standards that did not begin in March of 2023. But in an obvious way, the failures of SVB and other banks this spring were a warning that banks need to be more resilient, and need more of what is the foundation of that resilience, which is capital. Some industry representatives claim that inadequate capital had nothing to do with those bank failures. I disagree. It was an unsuccessful attempt by SVB to raise capital that caused uninsured depositors to look more closely at how the bank was capitalized.
Some industry representatives have claimed that SVB's problems were really related to poor management and shortcomings in the Federal Reserve's supervision. Indeed, those failings were thoroughly documented in a report I released in May, and steps by the Fed to address those issues will be announced in coming months. But 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.
Some industry representatives have claimed that raising capital requirements will push activity outside of the regulated financial sector. As I discussed in my speech on capital last December, we need to worry, a lot, about nonbank risks to financial stability. The answer, however, is not lower capital requirements for banks, but more attention to those nonbank risks. Further, as stress in nonbank financial markets is often transmitted to the banking system, both directly and indirectly, it is critical that banks have enough capital to remain resilient to those stresses.
For the reasons I have outlined today, we need to strengthen capital standards for large banks. That process will be deliberative and open to public participation and implementation of any changes agreed to will take a least several years, which is why it is so important to begin now. Everyone in America depends on a safe and stable financial system. By strengthening capital standards, we are ensuring that businesses have credit to grow and hire workers, and deal with the ups and downs in the economy. Stronger capital standards mean workers can depend on getting their paychecks and families can save and borrow to plan for the future. Our goal is a financial system that works for everyone, and having strong capital rules is essential for that.
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