Fed’s vice-chair unveils watered-down capital requirements

The Federal Reserve’s vice-chair for supervision, Michael Barr, announced revised proposals for increasing banks’ capital requirements on September 10.

He recommended a 9% increase in requirements for the largest banks. The previous recommendation in July 2023 had been 19%.

In a question-and-answer session at the Brookings Institution in Washington, Barr said he expected the package to have “broad support” from the Federal Reserve board. He added he had “spent a lot of time working with my colleagues on the board developing this proposal”.

After the Fed’s original proposal was announced, banks and financial firms engaged in a concerted lobbying campaign against it. Barr said the complaints he received during the consultation period showed the proposal had not accounted for the trade-offs associated with higher capital requirements. This, he said, “led us to conclude that broad and material changes to the proposals are warranted”.

Barr said that “higher capital requirements can raise the cost of funding to a bank, and the bank can pass higher costs on to households, businesses, and clients”.

His new proposal concerns two sets of capital requirements: the Basel III endgame and the capital surcharge for global systemically important banks (G-Sibs).

In terms of credit risk, it reduces the risk weights for residential real estate and retail exposures, increases the scope of the reduced risk weight for some low-risk corporate debt, and eliminates the minimum haircut for securities financing transactions.

Concerning equity exposures, Barr said the proposal “significantly” lowers the risk weight for tax credit equity funding structures.

The proposal no longer calls for a firm’s operational risk charge to be adjusted based on its history of operational loss, as had been the case in the original proposal. It recommends changing fee calculations from being based on gross income to net revenue and reducing operational risk capital requirements for investment management.

The proposal gives banks more leeway to use internal models to capture market risk on derivatives trades. It has a longer implementation period for the profit-and-loss attribution tests that are used to confirm that banks’ own models are working as intended.

It also reduces the amount of capital required for the client-facing leg of a client-cleared derivative trade.

Barr emphasised that the amended proposal was still only an interim step and not indicative of the final rule.

He said he expected the Fed’s board to hold an open public discussion before voting on whether to approve the proposal. He also expected the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation to be involved in discussions over the final form the proposals would take. There would then be another consultation period, followed by further analysis from the Fed board, which would make a final ruling.

The vice-chair said commercial real estate was an area of financial risk that he was watching closely, as the changes brought about during the pandemic to the nature of work had put “enormous pressure” on city centre offices. He also pointed to cyber and interest rate risks as areas of concern.