Federal Reserve Vice Chair of Supervision Michael Barr offered a preview of stronger capital standards for banks with more than $100 billion in assets, arguing the adjustments would make the industry more resilient following the failures of several mid-sized lenders in the spring.
"Our recent experience shows that even banks of this size can cause stress that spreads to other institutions and threatens financial stability," Barr said in a 16-page speech released Monday.
"The risk of contagion implies that we need a greater degree of resilience for these firms than we previously thought."
The changes, which are expected to be proposed this summer, follow a nine-month-long "holistic" Fed review that began before the panic triggered by regulatory seizures of Silicon Valley Bank, Signature Bank, and First Republic this year. All had more than $100 billion in assets at the time of the failures.
The proposals will surely face pushback from the banking industry, which argues that lenders are much more resilient than they were during the 2008-09 financial crisis and that higher requirements could restrict lending.
Barr said the proposed changes from the Fed would principally raise capital requirements for the largest, most complex banks. The biggest institutions could be asked to hold an additional 2 percentage points of capital — or an additional $2 of capital for every $100 of risk-weighted assets.
He said that most banks already have enough capital to meet the new standards and estimated that banks would be able to build the required capital through retained earnings in less than two years — even while maintaining their dividends.
Barr said he will not recommend fundamental changes to three capital ratios that apply to the nation’s largest banks — a surcharge as well as a countercyclical capital buffer and enhanced supplementary leverage ratio.
One change that could affect regional banks is that any with more than $100 billion in assets would have to count any unrealized available-for-sale securities losses against their regulatory capital.
Years ago, US supervisors decided most small and mid-sized institutions could opt out of deducting paper losses on bonds from key regulatory capital levels.
In essence, these banks were allowed to report assets that were stronger in theory than they would be in practice. As Silicon Valley Bank — and the broader investing public — found out in March.
“If the bank had already been required to include those losses in its reported capital, it is less likely that the market and depositors would have reacted the same way,” Barr said Monday.
Only banks with more than $700 billion in assets are currently required to count these unrealized losses against their regulatory capital levels. That includes giants like JPMorgan Chase (JPM), Bank of America (BAC), Citigroup (C), and Wells Fargo (WFC).
Capital, also known as "equity," is what allows a bank to absorb any changes in the value of its assets and survive unexpected shocks. Regulators require banks to keep key capital ratios above certain thresholds. These ratios go up if a bank earns more profits and down if it loses money on loans or investments.
If these ratios aren't high enough, the thinking goes, a bank could run into serious problems during times of stress.
Barr on Monday also called for another change that could affect regional banks: a long-term debt requirement for institutions with more than $100 billion in assets. That would also expand the group of institutions that have to follow those rules.
“Long-term debt improves the ability of a bank to be resolved upon failure because the long-term debt can be converted to equity and used to absorb losses,” said Barr.
Barr is also proposing ending the practice of relying on banks’ own individual estimates of their own risk, noting that banks tend to underestimate their credit risk.
The rules would also adjust the way that banks measure market risk — the risk of losses from movements in interest rates, stock prices, foreign exchange, and commodities risk.
Banks would also be required to model risk at the level of individual trading desks for particular asset classes, instead of at the firm level, acting to raise capital used to protect against market risks.
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