The Federal Reserve’s point man on bank regulation, Daniel Tarullo, is calling for big banks who rely on the debt markets for financing to hold more capital, adding to the growing pressure to rein in megabanks.
Tarullo’s proposal comes a week after Sens. Sherrod Brown (D-Ohio) and David Vitter (R-La.) introduced legislation to impose higher capital requirements on megabanks to make them safer and less dependent on government bailouts.
The ultimate goal of both proposals is the same, but Tarullo is zeroing in on a niche segment of the industry and can move on his plan without congressional action.
Regulators grew concerned during the financial crisis about banks’ dependence on “wholesale funding” — debt used to purchase assets and manage operations. The debt markets froze up during the 2008 financial crisis, forcing banks to sell off assets amid falling prices.
In a speech at the Peterson Institute for International Economics on Friday, Tarullo said the financial system remains vulnerable to the risks of short-term funding shortfalls as megabanks continue to depend on the market. The prominent regulator said the more wholesale funding a bank uses, the more capital it should hold as a buffer against losses.
“Where a firm has little need of short-term funding to maintain its ongoing business, it is less susceptible to runs,” Tarullo said. “Where, on the other hand, a firm is significantly dependent on such funding, it may need considerable common equity capital to convince market actors that it is indeed solvent.”
Banks say they no longer heavily rely on short-term wholesale funding and have bolstered liquidity since the crisis. Any additional capital requirements, they say, would only hamper lending in the midst of a tepid economic recovery.
But the nation’s biggest banks continue to face a barrage of criticism from lawmakers, economists and academics who say their unwieldy operations still pose a threat to the financial system.
To curb some of that risk, the Brown-Vitter bill aims to force banks with more than $500 billion in assets — JPMorgan Chase, Bank of America and Citibank— to have capital equal to 15 percent of their assets. Analysts suspect that many large banks would shed assets to reduce their size, rather than tangle with the capital requirements.
Banking industry groups have railed against the legislation, and political analysts suspect it has little chance of passing both chambers. But where Brown-Vitter may fall short, Tarullo’s proposal could succeed in curbing risks in the financial system.
“The strength of this proposal is that it doesn’t have to go through Congress; regulators can do it on their own,” said Jaret Seiberg, a senior policy analyst at Guggenheim Securities. “The beauty of this approach is that regulators get to both raise capital levels and encourage banks to avoid short-term wholesale funding.”
Tarullo did not indicate when the Fed would act on the issue. But other senior Fed leaders, including William C. Dudley and Chairman Ben S. Bernanke, have raised the issue during the past month. This has led some analysts to suspect that the central bank could act soon.