March 20, 2023

DealBook: Fed Wants U.S. Banks to Adhere to Stiffer International Rules

The Federal Reserve proposed on Thursday that the country’s banks adopt a broad package of international regulations aimed at making the global financial system more resilient to shocks.

The proposal, drafted by a group of central banks and national bank regulators, would require banks to hold sturdier buffers against losses. The Basel Committee on Banking Supervision devised the rules, known as Basel III, after the 2008 financial crisis revealed the frailty of global banks.

“It is a faithful implementation of the global agreement,” said Stefan Walter, a principal at Ernst Young, and a former secretary-general of the Basel committee. “This is a major step forward.”

The proposal focuses on capital, which banks must hold to protect themselves against potential losses. The critical requirement compares Tier 1 common capital with a measure of a bank’s assets. Thursday’s proposal would require Tier 1 common capital that amounted to 7 percent of assets by the end of 2018, when the phase-in period for the regulations would end. The Fed’s proposed rules will be open to public comment for 90 days.

Many of the requirements have been known for months, and the banks are already fortifying their balance sheets in preparation. For instance, Citigroup, which was severely undercapitalized when it entered the financial crisis, said it had an estimated Basel III ratio of 7.2 percent at the end of March. JPMorgan Chase, under scrutiny because of a multibillion-dollar loss in a derivatives trade, has not publicly disclosed its current estimated Basel III ratio.

The largest global banks are likely to be required to have capital levels higher than 7 percent. Regulators are expected to demand that the largest banks hold extra capital to reflect the risk their size presents to the financial system. Such banks might be need as much as 2.5 percentage points of additional capital, bringing the total to 9.5 percent.

Despite the stricter requirements, the Federal Reserve would allow many banks to pay out their capital in the form of dividends and share buybacks. A Federal Reserve official said that recent bank stress tests took into account whether the banks could still meet minimum, interim Basel III requirements after paying out capital. The banks will have more than six years to fully comply with the new rules, with the phase-in period starting next year.

The Basel III standards have plenty of critics. Some bankers say they are overly burdensome, arguing that even a slow introduction could crimp lending.

Under Basel III, banks would have to hold more capital against certain types of mortgages, which could deter banks from making home loans. A Federal Reserve official responded that the Basel III rules were intended to give banks incentives to write sound mortgages, not hamper lending.

Some analysts say they think the rules are too weak and could lead to dangerous unintended consequences.

Through a practice known as risk-weighting, Basel III allows banks to hold less capital against assets that the rule makers assume are less risky, like government bonds. The European sovereign debt crisis shows the potential danger of this approach.

“When you give something a low risk-weight, that’s where the risk tends to build,” said Anat R. Admati, professor of finance and economics at Stanford University.

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