Fed’s Basel climbdown leaves foot on rules ladder

Meeting in the middle. The U.S. banking industry’s worst nightmares have been allayed, but its wildest dreams remain out of reach for now. On Tuesday Michael Barr, the Federal Reserve’s top regulator, substantially softened proposed rules that would tighten capital requirements for the United States' biggest lenders. It’s a reasonable change that addresses many real pain points, but still codifies some thorny philosophical shifts.

The Fed, along with its fellow watchdogs, has been pushing new rules known as the “Basel Endgame” for over a year. It’s a U.S. interpretation of global regulations agreed in the Swiss city and designed to complete the overhaul that began after the global financial crisis of 2008.

Yet bank executives and their lobbyists argued furiously that the Fed was being too harsh. If implemented as originally designed, the largest U.S. institutions known as global systemically important banks, or GSIBs, would have seen their required capital buffer expand by 19%.

This is a huge rise. The eight U.S. GSIBs together had just shy of $1 trillion in common equity Tier 1 capital at the end of June. Though banks generally hold more equity than the required minimum, increasing the collective buffer by one percentage point would therefore roughly require them to retain an extra $10 billion of equity. Barr’s announcement that the rejigged rules for GSIBs like JPMorgan and Bank of America would increase their combined capital by just 9% therefore amounts to a roughly $100 billion saving.

Even this obscures the scope of the change. Barr promised tweaks to ease the burden posed by a new measure of operational risk which tries to capture the threat posed to banks’ financial stability by, say, cybersecurity breaches or human error. This measure, which effectively was set to scale with bank size, would have fallen hard on institutions like Morgan Stanley that prize steady, fee-generating businesses.

Barr also backed away from other industry concerns which drove a frenzied opposition campaign. The Fed has nixed a proposal to penalize dealing with certain non-publicly traded companies; it softened risk calculations involving residential real estate and it fine-tuned the treatment of smaller banks to focus on unrealized losses.

Nonetheless, the philosophical changes embedded in items like operational risk charges remain in place, despite being questioned by members of the Fed’s own board of governors. And the likes of JPMorgan will probably still chafe at the idea of facing higher capital requirements even when regulators insist major lenders are resilient. There’s still a long way to go, and Barr was at pains to say everything is still on the table. For now, though, his climbdown is far from total.

Context News

Michael Barr, vice chair of supervision for the U.S. Federal Reserve, on Sept. 10 announced a set of changes to proposed new banking capital rules commonly known as the Basel endgame. In a speech at the Brookings Institution, Barr announced that forthcoming revisions would lead to common equity tier 1 capital requirements for the largest U.S. banks increasing by around 9%, from 19% previously. In addition, the risk-weighting for loans secured by residential real estate will be lowered, the treatment of fee income will be normalized with other forms of revenue when calculating operational risk, and calculations of credit risk with certain non-publicly traded firms will be changed.