Michael S. Barr, the Federal Reserve’s vice chairman of supervision, announced Monday that he would push for sweeping changes to the way America’s largest banks are supervised to make them more resilient in times of trouble — in part through the amount of capital they have to get them through a rough patch.
The overhaul would require the largest banks to increase their holdings of capital – cash and other readily available assets that can be used to absorb losses in times of need. Mr Barr predicted his tweaks would be “equivalent to requiring the largest banks to hold two percentage points of extra capital”, if implemented.
“The beauty of capital is that it doesn’t care about the source of the loss,” said Mr. Barr in his speech previewing the proposed changes. “Whatever the vulnerability or the shock, capital can help cushion the resulting loss.”
Mr Barr’s proposals are not a foregone conclusion: they would have to pass a notice and comment period, giving banks, legislators and other interested parties a chance to express their views. If the Fed Board votes to enact them, their implementation will involve a transition time. But the sweeping set of changes he outlined meaningfully realigns both the way banks monitor their own risks and how oversight is conducted by government regulators.
“It’s definitely meaty,” said Ian Katz, an analyst at Capital Alpha who focuses on bank regulation.
The Fed’s vice chairman of oversight, nominated by President Biden, has spent months reviewing capital rules for America’s largest banks, and his results have been eagerly awaited: banking lobbyists have been warning for months about the changes he could propose . Medium-sized banks in particular have been vocal, saying any increase in regulatory requirements would be costly for them, limiting their ability to lend.
Monday’s speech made it clear why banks are concerned. Mr. Barr wants to update banking risk-based capital requirements “to better reflect credit, trade and operational risk,” he said in his remarks, delivered at the Bipartisan Policy Center in Washington.
For example, banks could no longer rely on internal models to estimate some types of credit risk – the likelihood of loan losses – or for market risks that are particularly difficult to predict. In addition, banks would be required to model risk for individual trading desks for certain asset classes, rather than at the corporate level.
“These changes would increase capital requirements for market risk by correcting gaps in the current rules,” said Mr Barr.
Perhaps in anticipation of more pushback from the banks, Mr. Barr also introduced existing rules that he had no intention of tightening, including special capital requirements that only apply to the very largest banks.
The new proposal would also try to address vulnerabilities that came to light early this year when a series of major banks collapsed.
One factor that led to the demise of Silicon Valley Bank — and sent a shock wave through the mid-market banking industry — was that the bank sat on a pile of unrealized losses on securities classified as “available for sale.”
The lender was under no obligation to include those paper losses when calculating how much capital he needed to get through a rough patch. And when it had to sell the securities to raise cash, the losses started to bite again.
The adjustments proposed by Barr would require banks with assets of $100 billion or more to account for unrealized losses and gains on such securities when calculating their regulatory capital, he said.
The changes would also tighten supervision of a larger group of large banks. Mr Barr said his stricter rules would apply to companies with $100bn or more in assets – lowering the threshold for tight supervision, which now apply the strictest rules to banks operating internationally or $700bn or more have assets. Of the country’s estimated 4,100 banks, about 30 have $100 billion or more in assets.
Mr Katz said the extension of strict rules to a wider range of banks was the most notable part of the proposal: such an adjustment was expected based on comments made by other Fed officials recently, he said, but “it’s quite a change .”
The bank blowouts earlier this year illustrated that even much smaller banks have the potential to unleash chaos if they collapse.
Still, “we won’t know how significant these changes are until the lengthy process of rule-making plays out over the next few years,” said Dennis Kelleher, the CEO of the nonprofit organization Better Markets.
Mr Kelleher said Mr Barr’s ideas seemed good overall, but added he was concerned about what he saw as a lack of urgency from regulators.
“When it comes to bailing out the banks, they act with urgency and decisiveness, but when it comes to regulating the banks enough to avoid crashes, they are slow and take years.”
Banking lobbyists criticized Mr Barr’s announcement.
“Fed Vice Chair for Supervision Barr seems to believe that the largest US banks need even more capital, without offering any evidence as to why,” Kevin Fromer, the CEO of the lobbying group the Financial Services Forum, said in a statement to the news media on Monday.
“Further capital requirements for the largest U.S. banks will lead to higher borrowing costs and less lending to consumers and businesses – slowing our economy and hitting those at the margin hardest,” said Mr. Fromer.
Susan Wachter, a finance professor at the Wharton School of the University of Pennsylvania, said the proposed changes are “long overdue.” She said it was a relief to know there was a plan to make them.
The Fed Vice Chairman hinted that additional banking supervisory adjustments are still coming, inspired by the March 2023 turmoil.
“I will pursue further regulatory and supervisory changes in response to the recent banking stress,” Mr Barr said in his speech. “I expect to be able to say more about these topics in the coming months.”