Big US banks look to be getting their way in the fight over tougher capital rules. The Federal Reserve is talking to other regulators about changes to the updated standards that were proposed last July, according to Bloomberg News, which could mean capital demands increasing by less than one-third of what was originally envisaged.
Such a climbdown would be galling to campaigners for safer banks, but a boost to shareholders who want a restart of their generous stock buybacks. This has been a bruising battle for the regulators, and with a presidential election looming, the worry is they will concede too much ground to the industry and the fears it has stirred up just to get an agreement done.
The so-called Basel III Endgame has been a surprisingly prime-time event for a dry and technical process to strengthen the complicated calculations of risk exposures that banks use to work out how much capital they need to absorb potential losses. Eight of the biggest banks led by JPMorgan Chase & Co. formed a group to sponsor TV adverts full of solemn threats that ordinary Americans would struggle to get all kinds of loans if the new rules were adopted. The “Endgame” nickname added a suitably apocalyptic tone.
The claims were overblown but were taken to heart by senators and representatives from both parties on congressional banking committees who almost unanimously demanded reassurances from Fed Chairman Jerome Powell and vice chairman for supervision, Michael Barr, among others. Powell ended up promising “broad and material changes” to the rules in his most recent appearances.
Michelle Bowman, one of two Fed governors who unusually voted against the proposal when it was launched, laid out some potential changes that would win the rules more support in a speech in London on Tuesday. Much of her focus was on the measurement of operations risks (which relates to fines, frauds and other foul-ups) and market risks, the two areas that have the biggest effect on how much capital big banks would need. They were the same areas highlighted for fixes in the Bloomberg News piece.
Changes to the rules were needed regardless of the political maelstrom. The collapse of Silicon Valley Bank and a few others early in 2023 lead to the proposed rules being hastily expanded, which left them with inconsistencies and massive overlaps with the capital already demanded by the Fed’s stress-testing regime.
There were also some odd differences with how Europe and the UK were interpreting the Basel standards, which made the US version significantly tougher. These included how to measure operational risks and the riskiness of counterparties who don’t themselves issue public securities.
The rules are meant to bring the US in line with the latest version of the global minimum standards drawn up after the 2008 crash, which have forced banks to raise more capital and lessen the chances that taxpayers will have to rescue them in the future. Europe is already expected to delay the parts of its own update related to trading desks as a result of the slow progress of US wrangling, Bloomberg News reported this month. The bloc doesn’t want its own banks left at a competitive disadvantage if the American rules fail to get agreed for an extended period. Banks were meant to be implementing the rules from the start of next year.
Risks linked with trading desks were behind the biggest increases in capital requirements in Europe as well as in the US. Big banks get to use their own sophisticated models to assess trading risks and set their own capital needs, but regulators have long been worried that this approach is too clever for its own good and prone to being gamed by banks.
Lenders in the US were unhappy about the limits on how low they could go on risk judgments in their models and about the loss of diversification benefits, which allow them to recognize that some exposures can naturally offset each other. US regulators also want to approve every model used by each trading desk, which banks feared would be a slow and costly process that might not ever get finished.
The floors on risk judgments make sense, whereas approving every desk’s model probably does not. As far as possible, regulators should try to set boundaries within which banks can make choices, not try to micromanage their risk-taking.
For all US banks, the original rule proposal was expected to mean a 16% rise in the common equity they needed to back their assets. The biggest banks estimated their own capital requirements would be greater: JPMorgan and Goldman Sachs Group Inc. expected 25% hikes, and Bank of America Corp. and Wells Fargo & Co. 20%.
The changes being circulated by the Fed could end up leading to an overall rise of just 5% instead, according to Bloomberg News. The biggest banks would likely see stronger demands than that, but they would also easily have the capital to cover those.
For the regulators, despite the battering they’ve taken from politicians and the mistakes they’ve made in writing the rules, they still need the fortitude to ensure they capture the right risks and in a way that is internationally consistent as far as possible.
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