Recently, the Federal Reserve released a long-awaited proposal. This new initiative would relax capital requirements for large, Wall Street banks while increasing their operational flexibility. The draft regulation would require a 1.4% reduction in the highest-level capital that banks should have to hold. This proposed change would save these holding companies an estimated $13 billion. This change is part of a broader effort to align U.S. banking standards with the Basel guidelines, which set international benchmarks for capital adequacy.
As for foreign banks, the proposed rule would create a pretty big loophole in their favor, reducing their capital requirements by $210 billion. Yet, the parent institutions will continue to hold onto this capital. Today, the capital requirements for these large banks are between 5 and 6 percent. If finalized in their proposed form, the new regulations will reduce the requirements for holding companies to between 3.5% and 4.5%. This amendment will bring subsidiaries more in line with these new, higher numbers.
As Federal Reserve Chair Jerome Powell stated at the time of the proposal, This is a real shift in the banking landscape.
“This stark increase in the amount of relatively safe and low-risk assets on bank balance sheets over the past decade or so has resulted in the leverage ratio becoming more binding,” – Jerome Powell
The recent changes are taking place against the backdrop of increasing worry about liquidity in Treasury markets. Federal reserve officials and Wall Street executives are on a campaign to roll back existing capital requirements. They hope that this step would relieve some stresses on the markets and reduce the prospect for future dysfunction.
Governor Adriana Kugler and former Vice Chair of Supervision Michael Barr have expressed opposition, highlighting potential risks associated with the rule change.
Barr noted that while there may be some improvement in Treasury market intermediation under normal conditions, the proposed adjustments are unlikely to provide relief during times of financial stress.
“Even if some further Treasury market intermediation were to occur in normal times, this proposal is unlikely to help in times of stress,” – Michael Barr
Current Vice Chair for Supervision, Michelle Bowman, supported most of the proposed changes. She does think they’ll increase resilience in U.S. Treasury markets.
“The proposal will help to build resilience in U.S. Treasury markets, reducing the likelihood of market dysfunction and the need for the Federal Reserve to intervene in a future stress event,” – Michelle Bowman
The Federal Reserve’s proposal reflects a complex balancing act as it seeks to address both operational flexibility for banks and the need for robust safeguards within the financial system. As bank reserves have built up significantly in recent years, this proposal aims to provide banks with more room to maneuver while addressing liquidity concerns in the Treasury market.