Minneapolis Fed launches too-big-to-fail plan

The four-step plan proposes stricter capitalisation rules for big banks and looser regulation for smaller institutions
Neel Kashkari
Neel Kashkari

The Federal Reserve Bank of Minneapolis has put forward a plan to sharply increase the capital requirements of big banks, with the aim of eliminating the risk of a public bailout in the case of a financial crisis.

The document also calls for community banks to be unburdened from the more onerous regulations, as well as the imposition of a tax on the borrowing of non-bank lenders.

The Minneapolis Fed considers that leaving unchanged capital requirements for systemically important financial institutions exposes taxpayers to the risk of bailouts similar to the ones implemented in the wake of the financial crisis in 2008–09.

“We have repeatedly learned that it is almost impossible for governments to spot financial crises before they strike. But the data tells us that American taxpayers are still on the hook today,” says Neel Kashkari, president of the Minneapolis Fed, in the document.

“With today’s strong economy, now is the perfect time to act to strengthen our financial system. We must not wait, and we must not go backwards. If we wait until the next crisis to implement these reforms, it will be too late.”

The plan is the result of two years of consultations. In February 2016, the institution initially addressed the risk represented by the biggest banks in the US, and in November that year published a draft plan inviting public and expert feedback on it.

The final, four-step plan, published on January 10, 2018, proposes increasing the capital requirements for institutions with assets over $250 billion. These firms should issue common equity capital equal to 23.5% of risk-weighted assets with a leverage ratio of 15%. This measure would reduce the chance of a financial crisis to 39% from 67%, the regional Fed states.

Additionally, it proposes the US Treasury should certify that big banks have ceased to be systemically important, or subject them steadily rising capital requirements, up to a cap of 38% of risk-weighted assets: “If the Treasury secretary refuses to certify a large bank as no longer systemically important, that bank will automatically face increasing common equity capital requirements, an additional 5% of risk-weighted assets per year.”

The third step is the imposition of a tax on the borrowing of non-bank lenders – so-called shadow banks – that have assets over $50 billion. Institutions that are not considered systemically important would face a 1.2% rate, while important shadow lenders would have to pay a 2.2% tax rate.

Finally, the plan considers reducing the regulatory burden on community banks by simplifying the capital risk-weighting regime, creating a default method where supervisors would only review subject to an exception process, and repealing solvency and other noncompliance-related rules included in the Dodd-Frank Act that “do not have a strong link” to firms’ chance of failure.

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