Adding to the already intense regulations in the banking sector, the Federal Reserve intends to impose new stricter norms on the U.S. banking giants. On Tuesday, Fed Governor Daniel K. Tarullo released a statement, giving an update on the Fed’s advancement towards the Dodd-Frank Act that started over four years back and outlined some important forthcoming “regulatory and supervisory priorities” to act upon the concerns arising from the “too big to fail” banks and systemic risk. The testimony was prepared for a hearing before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate.
Of the 29 global systemically important banks (‘GSIBs’) identified by the Financial Stability Board ('FSB'), there are 8 U.S. banks – The Goldman Sachs Group, Inc. (GS), Citigroup Inc. (C), Bank of America Corp. (BAC), Wells Fargo & Company (WFC), JPMorgan Chase & Co. (JPM), Morgan Stanley (MS), The Bank of New York Mellon Corp. (BK) and State Street Corp. (STT). An updated list will release on Nov 2014.
Higher Capital Surcharges
Among the imminent rules, Tarullo outlined the imposition of common equity risk-based capital surcharges on U.S.-based GSIBs. This considers the fact that as a firm becomes more systemically important, it calls for tougher capital requirements.
The objective of the reform is to make banks capable of protecting themselves from severe scenarios. The reform might also induce large banks to trim down their ‘systemic footprint’ and risks. Notably, the Fed’s capital surcharges for the U.S. GSIBs will be stricter than the international standards set by the Basel Committee on Banking Supervision (‘BCBS’).
Short-term Wholesale Funding
Furthermore, the Fed is concerned of the banks reliance on short-term wholesale funding as it believes that such funding poses a risk to the firm’s solvency and affects the broader financial system as well.
In the normal period, short-term wholesale funding aids investors in making safe and liquid investments, decreases borrowers’ funding costs and helps in overall functioning of the markets. However, such funding has an adverse impact during a stressed period. The testimony stated “the runs by providers of short-term wholesale funding and associated asset liquidations can result in large fire sale externalities and otherwise undermine the financial stability. A dynamic of this type engulfed the financial system in 2008.”
Though several steps have been taken by the Fed to address the risks from short-term wholesale funding, it is presently focused on the following three proposals:
- It proposes to include short-term wholesale funding in the above mentioned surcharge pertaining to U.S. GSIBs
- Amendment in the BCBS’s net stable funding ratio (‘NSFR’) standard to boost liquidity requirements in the event a bank serves as a provider of short-term funding to other market participants
- Setting floors for collateral haircuts in securities financing transactions (SFTs)
Long-Term Unsecured Debt
Tarullo also outlined that the Fed in association with the Federal Deposit Insurance Corporation ('FDIC') is mulling over a proposal that would require the U.S. GSIBs to maintain a minimum amount of long-term unsecured debt at the parent holding company level. The objective of this proposed reform is to ensure that in the event the equity base of a firm gets exhausted, the long-term unsecured debt would aid in ”successful resolution” without involving taxpayers’ money.
Among others, the Fed is expected to finalize a rule which restricts a financial institution from merging with another firm if the merged entity’s liabilities exceed 10% of the total consolidated liabilities of all financial institutions. Regarding community banks, Tarullo also highlighted the fact that the Fed is ‘supportive’ and has taken several actions to “avoid unnecessary regulatory costs” for such banks.
Bottom Line
Last week, regulators came out with several rules for the U.S. Banks, regarding liquidity, swap margin and supplementary leverage ratio. The latest revelation further compounds the regulatory woes for the banks, which are already combating challenges including a competitive environment, escalating costs and a persistent low environment.
Though imposition of further restrictions will weigh on the banking business to some extent, in the long term, their sustainability and growth should be safeguarded.
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