One of the key lessons learnt from the financial crisis was that a small number of big sized banks dominating the global financial system are so inter-connected that if one of these were allowed to fail, it would wreak havoc on the entire system like domino effect. While the reckless lending and risk management practices by these banks contributed greatly to the global financial crisis, many of these “too big to fail” institutions later had huge tax-payer funded bailouts.
Earlier this week, the Federal Reserve proposed a new set of rules aimed at strengthening the regulation of such large and systemically important financial firms. The measures are aimed at addressing issues such as capital, liquidity, credit exposure, risk management, and early remediation requirements, as mandated by the Dodd-Frank Act.
Among others, the proposals require largest U.S. banks to maintain a capital surcharge of between 1% and 2.5% above the base-line level, and set a limit of 10% for credit risk between the banks considered systemically important.
Higher capital buffer means lesser risk of failure of the banks and greater stability of the financial system in general. But holding more capital also means tighter and costlier credit for the clients and lower profitability for the banks. The limit on inter-bank exposures could affect the liquidity of the markets, shrink capital markets operations and securities lending. Overall the rules could mean smaller banks, focused on traditional banking activities.
Do you support stringent regulatory norms for the big banks? Or is over-regulation bad for the financial sector and the broader markets?
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