Federal Reserve approves final Basel rules requiring banks to set aside capital


An open meeting of the Federal Reserve Board on Tuesday in Washington. (Michael Reynolds/European Pressphoto Agency)
July 2, 2013

The Federal Reserve Board on Tuesday ordered banks to set aside more capital as a cushion against losses, bringing the United States in line with developing international standards and opening the door for a set of tougher rules for the nation’s biggest financial institutions.

Almost all banks already meet the requirements the board unanimously approved Tuesday, but the new capital rules are only the beginning. Fed governor Dan Tarullo said the board plans to issue four proposals in the coming months to ratchet standards up even higher for banks deemed “systemically important,” including JPMorgan Chase and Goldman Sachs.

Those proposals, coupled with the new capital rules, could force mega-banks to reduce their size and complexity to remain profitable. The Fed’s approach gets to the heart of the “too big to fail” problem by limiting the risks big banks can pose to the financial system, and ultimately taxpayers, if they collapse.

Financial-industry officials have argued that the new standards could work against government efforts to promote economic growth, with banks potentially pulling back on lending, exiting certain lines of business or passing along the costs of increased capital to consumers. The big bank trade groups did not return calls for comment.

The Fed’s vote Tuesday brings the United States closer to enforcing an international agreement struck in 2010 by a committee of central bankers and regulators operating out of Basel, Switzerland. The Basel committee’s recommendations were meant to make the global banking system more resilient in times of financial upheaval by forcing banks to sock away more money.

Former Federal Deposit Insurance Corp. chairman Sheila Bair talks about financial regulation and U.S. banks' exposure to an increase in interest rates. (Bloomberg)

Instituting those proposals, however, has been a slow process as regulators have scaled back or revised some elements in the face of a pushback from the banking industry. The Fed’s final plan for implementing the Basel proposals reflects the tension in the United States between the financial stability that regulators are trying to achieve and their desire not to disrupt the economic recovery.

Chief among the final rules is a requirement that all banks hold a minimum of 7 percent of assets in the form of common equity, considered the best buffer against a downturn. The Fed also limited what can count as capital and changed the risk calculation used to determine how much a bank must set aside against different types of assets.

The Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency are scheduled to vote on the final draft next Tuesday. Banks would have to start phasing in the rules in January but have five years to complete the transition.

“This framework requires banking organizations to hold more and higher-quality capital . . . while reducing the incentive for firms to take excessive risks,” said Fed Chairman Ben S. Bernanke. “Banking organizations will be better able to withstand periods of financial stress, thus contributing to the overall health of the U.S. economy.”

The rules represented a win for regional and community banks, which lobbied for exemptions with the argument that they did not cause the financial crisis and are a critical source of funding for small businesses.

Regulators capitulated by chucking an extensive mortgage proposal that would have forced community banks to raise more capital. Fed staffers said they backed off the proposal to examine the impact of other new mortgage rules on the industry.

Small and midsize banks also can opt out of having to count certain types of income in capital calculations.

“The new standards will mollify community banks and, with them, congressional critics of this aspect of the U.S. standards,” said Karen Shaw Petrou, managing partner of Federal Financial Analytics, an independent banking consulting firm. “Those advocating for far higher leverage rules for the biggest U.S. banks will remain dissatisfied, but not for long.”

Tarullo’s pending proposals would place pressure on big banks to raise more capital. The Fed’s point man on banking regulation said banks will face a tougher leverage standard, a measure of equity to total assets that some regulators say is a better way to judge a bank’s ability to withstand stress.

Tarullo said his team is also working on a proposal to force banks to hold a minimum amount of debt that could be converted to equity in the event of a crisis, an idea he has been pitching for months. Regulators also intend to address risks in short-term wholesale funding by requiring firms that rely on the debt markets for financing to hold more capital.

“These measures would round out a capital regime of complementary requirements that focus on different vulnerabilities and together compensate for the inevitable shortcomings in any single capital measure,” Tarullo said.

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