A series of capital proposals were given by the Federal Reserve yesterday aimed at guaranteeing that the U.S. banks maintain a solid capital position and become resilient in stressful times.
These rules would put into practice the Basel III accords as well as changes required by the Dodd Frank Wall Street Reform and Consumer Protection Act in the United States.
Per the proposal, the rule would apply to all depository institutions, bank holding companies with total consolidated assets of $500 million or more, and banking organizations.
These proposals were voted 7-0 by the Fed governors and are subject to discussion. Comments on them can be put forward until September 7. The rules will be finalized after that. The proposal is likely to be approved by the Federal Deposit Insurance Corp and the Comptroller of the Currency in the coming week.
Banks are expected to adhere to these rules, which are scheduled to be implemented in a phased in manner starting 2013 through 2019.
The Proposed Rules
The proposed rules suggest that U.S. banks would need to set aside more capital as buffer in times of unexpected losses. Banks would need to maintain a new minimum common equity tier 1 ratio of 4.5% of risk-weighted assets and a common equity tier 1 capital conservation buffer of 2.5% of risk-weighted assets. This comes to a total of 7%, which is well above the current requirement of around 2%.
Moreover, per the proposals, banks would be compelled to not depend on credit ratings for assessing their assets’ riskiness. Instead, they need to base their evaluation on the categorization of risk offered by the Organization for Economic Cooperation and Development.
This is to comply with the requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Under this financial overhaul, all federal agencies must remove from their regulation references to, and requirements of reliance on, credit ratings.
The other proposed rule is related to banks with consolidated total assets of at least $250 billion or consolidated total on-balance sheet foreign exposures of at least $10 billion. It would also apply to banks with aggregate trading assets and trading liabilities equal to at least 10% of quarter-end total assets or $1 billion.
This includes Wall Street’s major players, such as Bank of America Corp. (BAC), Citigroup Inc. (C), Goldman Sachs Group Inc. (GS) and JPMorgan Chase & Co. (JPM).
These banks would be required to hold more capital as a buffer against their trading books. Such capital cushion would help address the risks associated with complex financial products. The final rule in this context would be effective January 1, 2013.
In Conclusion
These rules might limit the flexibility of the banks with respect to their investments and lending volumes. Moreover, such strict capital norms may somewhat reduce the pace of a worldwide economic recovery in the short term.
Moreover, elevated capital requirements are a significant cause of concern for the smaller banks, which are already finding it difficult to navigate through the current environment of tepid economic growth and increased regulatory actions. While larger banks can counter such situations with their scale, smaller banks whose business model has already been questioned might be challenged while adhering to such capital norms.
However, the rules are still in the proposal phase and comments are welcome. These might lead to the development of regulations that address concerns of all. In fact, we believe that eventually, such norms will serve as building blocks for the economy. It would check bank failures and involve less of taxpayers’ money for bailing out troubled financial institutions.
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