The Federal Reserve’s top regulator on Thursday reviewed changes to key capital requirements for banks that would reduce their cash cushions by a small amount while still keeping them above levels set for 2019.
This is a move aimed at promoting lending while still maintaining the strength of the banking system.
Fed Vice President Michel Baumann, who is expected to make a formal proposed regulatory framework known as Basel III next week, said it would lead to a small increase in requirements for large US banks – similar to the level required in the UK – but that a capital surcharge would apply to large banks such as JPMorgan Chase and Goldman Sachs. The reason, she said, is that the increase was higher than the banks’ risk appetite.
Together, the two changes will reduce the amount of cash the Fed needs to keep banks with “minimum amounts.”
“Continuously increasing the level of capital without a specific purpose creates a real economic cost,” Bowman said in a speech at the Cato Institute in Washington, D.C. “When capital needs become excessive, it undermines the basic function of the banking system to provide credit for the real economy.” The price is paid in lost economic growth, reduced job creation and lower living standards.
Bowman said the changes to the capital framework are designed to eliminate mutual requirements, rework accounts to match real risk, and address long-standing gaps in regulators’ oversight.
“The result is more effective regulation and banks that are better positioned to support economic growth while maintaining safety and soundness,” she said.
Currently, banks are required to use two different calculations to show that they comply with capital requirements, which is a very heavy burden. The proposal would reduce this so that banks would only have to use a single method to calculate compliance with their requirements.
The proposal also adds that investments protect banks against their commercial activities. Bowman said the new method would better capture losses under market stress and better account for less liquid positions. It introduces a standardized accounting that is consistently applied to companies while reducing the burden on banks with simple business activities.
The aim of the changes is to start mortgage lending in banks, which have largely shifted to non-banks.
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These changes include removing any requirement for a bank to deduct mortgage servicing assets from regulatory capital. Instead, Bowman would assign a 250% risk weight to these assets so that banks, in turn, would need capital to cover any losses on these mortgages. Bowman said he thinks banks are encouraged to originate and service mortgages and reduce the migration of mortgage activity to non-banks over the past 15 years.
