The Federal Reserve has proposed new rules that would allow eight of the biggest Wall Street firms to collectively lower by about $121 billion the capital cushions their banking subsidiaries are required to hold against a collapse, according to federal banking regulators.
Critics of the plan say it would dangerously weaken a rule put in place after the global financial crisis and intended to ensure that banks have big enough stockpiles of safe capital to survive a panic. The banks say the new rule would give them greater flexibility and would not lead to riskier investment decisions.
This month, the Fed unveiled a plan to modify rules on what capital banks must hold on reserve in case their assets fail. The proposal would weaken one capital requirement tailored specifically to ensure the solvency of the eight Wall Street companies deemed most essential to the world financial system — the institutions whose sudden failure could do severe damage to the economy as a whole.
The rule acts as an additional safeguard above the other capital requirements that apply to a much broader range of Wall Street banks and that would not be weakened by the Fed's new proposals. The eight institutions it covers — the six biggest Wall Street banks and two “custodian banks,” responsible for holding safe assets — have pushed for the rule to be loosened. They say other banking rules ensure that they have adequate cushions against collapse and argue that the restriction limits lending that would help private-sector growth.
The proposed rollback of this capital requirement — called the “enhanced supplementary leverage ratio” — comes as lawmakers move in multiple other ways to overhaul the banking oversight rules that President Barack Obama helped install after the 2008 banking crisis helped trigger a global recession.
Last month, the Senate passed a bipartisan banking plan, over the objections of progressive Democrats, that would exempt banks with assets between $50 billion and $250 billion from the highest levels of scrutiny by the Fed. It also would repeal or pull back other regulations created by the Dodd-Frank Wall Street Reform and Consumer Protection Act. House Republicans are now negotiating changes to a companion measure passed in the House.
Meanwhile, the Fed is moving forward with a new proposal that would revamp the “stress tests” banks face to periodically ensure that their assets are safe. Both rule changes, which now move to a public comment period expected to take 30 to 60 days, can be enacted by the Fed without congressional approval.
In announcing the proposal, the Fed estimated that the “required” capital for the eight critical companies' banking subsidiaries would fall by $121 billion, a number that would be much higher without other capital requirements left in place.
Experts disagree about the significance of reducing these banks' capital requirements, with liberal critics contending it would increase the likelihood of a banking crisis and industry officials pointing to other capital constraints that would remain in place.
“This is bad and risky,” said Sheila Bair, who served as the chair of the FDIC under Obama and President George W. Bush. “There’s no reason to reduce the capital requirements.”
The change would reduce the capital requirements for the Wall Street firms' holding companies by only $400 million, or .04 percent, meaning they would have the flexibility to plow capital back into the banking subsidiaries in the event of a crisis, Fed officials said in announcing the plan. The Fed said the current rules act as a “binding constraint” at a time when banks have already increased their capital stockpiles. (The top banks now hold $1.2 trillion in capital, up from the $700 billion they held in 2009.)
“It is quite a small amount, given the overall level of capital that would actually be released,” Randal K. Quarles, vice chairman for supervision at the Fed, told lawmakers at a hearing last week.
But critics say the relevant metric is not the holding companies but the banking subsidiaries, since their failures could spread to the rest of the company. In an op-ed titled “The Fed's capital mistake,” the Wall Street Journal editorial page warned that eight banks' subsidiaries would see their leverage ratios drop, on average, by 20 percent under the plan.
“All of this seems short-sighted, not least for the banks,” the Journal said. “The banks want less regulation and less capital, which will set them up for Senator Elizabeth Warren's tender mercies when the next panic strikes.”
Opponents also say the banking rule targeted the subsidiaries for a reason, since their failures could have catastrophic consequences for the world economy. “This will significantly increase the likelihood of a bank subsidiary failing, leaving taxpayers on the hook,” said Gregg Gelzinis, a banking expert at the Center for American Progress, a left-leaning think tank. “With bank profits high and businesses taking on a lot of debt, now is the time that we should be strengthening requirements for a future downturn in the economy.”
A separate analysis from Goldman Sachs last week found that the Fed's plans would lower the capital requirements faced by the holding companies by $2 billion but did not analyze how the changes would affect companies' banking subsidiaries.
In its earnings call, Citibank Chief Financial Officer John Gerspach welcomed the change but said he did not expect it to significantly affect the bank's business practices.
The eight banks that could benefit from the new Fed rule all received taxpayer-funded bailouts after the 2008 crash.