Fed Attempts to Boost Bank Capital as Lenders Expect Weak Results

Federal Reserve Board Vice Chair for Supervision Michael S. Barr speaks during a hearing with the Senate Banking Committee on Capitol Hill in Washington on May 18, 2023. (Anna Moneymaker/Getty Images)

Federal regulators launched an effort that would force major lenders to set aside billions in more capital to guard against risk this week.

The Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), and Office of the Comptroller of the Currency agreed on July 27 to put the new proposal out for public feedback.

The banking industry is fiercely critical of the plan, and tepid support from Fed Chairman Jerome Powell has raised questions about how it would work before it is launched.

It comes after Fitch Ratings released a July 25 report showing that large and regional U.S. banks in the second quarter saw weak results on a sequential-quarter and year-over-year basis.

The industry expects weaker results to persist, amid lower growth and high inflation.

Banks Could Increase Funding as Cushion Against Losses

This marks the first extensive effort to tighten bank oversight, following the spring bank crisis that saw three regional lenders collapse.

The move would raise the overall capital banks hold as a cushion against a crisis by 16 percent and would overhaul how the institutions measure the riskiness of their behavior.

Banks have already witnessed rising deposit costs, an uptick in provisions, and continued inflationary pressure on non-interest expenses, reported Fitch.

Mr. Powell said he supported putting the proposal forward for review, but also had many questions and noted that regulators have a “difficult balance” to make.

“Congress and the American people rightly expect us to achieve an effective and efficient regulatory regime that keeps our financial system strong and protects our economy, while imposing no more burden than is necessary,” said the Fed chair.

The regulatory agenda at the Fed is normally set by Vice Chair for Supervision Michael Barr, who led the proposal, but Mr. Powell’s support is crucial in a system that favors consensus among policymakers whenever possible.

A handful of Fed officials have said they are willing to receive feedback on the proposal and suggested changes would be forthcoming.

Mr. Barr said he would listen to comments on the proposal, but said that the need for additional capital was essential.

“Neither regulators nor bank managers can anticipate all risks, or how risks may be amplified and propagated,” said Mr. Barr.

Regulators said that comments would be open until Nov. 30 and that new rules are expected to be in force by mid 2028.

SVB (Silicon Valley Bank) logo and decreasing stock graph are seen in this illustration taken on March 19, 2023. (Dado Ruvic/Reuters)

Safeguarding Against Catastrophic Failure

The changes would implement a 2017 agreement from the Basel Committee on Banking Supervision, to overhaul how lenders assess their risks and how much reserves they should keep as a cushion against losses.

The proposal will particularly change risk assessments for bank lending, trading activities, and internal operations.

The new plan would reduce the use of internal models employed by the banks to measure various types of risk, in favor of a standardized approach.

Federal regulators in favor argued that this would produce more consistent results and raise overall capital.

Meanwhile, previous relief for banks with over $100 billion in assets will be reversed in the wake of the spring financial crisis.

From now on, regional banks will have to account for unrealized gains and losses on available-for-sale securities, along with obeying tougher leverage requirements.

The effects will mostly be felt by banks that maintain $100 billion to $250 billion in assets.

The central bank also announced several technical adjustments to the surcharge it assesses for the nation’s eight biggest lenders and will impose on them an additional $13 billion in capital requirements.

Banks Oppose Proposal as Misguided

The new proposal faced opposition from Republicans and other officials at the Fed and the FDIC, who argued that the changes are misguided and would backfire.

Members of Congress and bank executives have been skeptical of the plan, which could block the overhauls.

The Securities Industry and Financial Markets Association (SIFMA) stated that any capital charge on operational risks would penalize lenders’ fee-based wealth management and investment banking activities.

“Imposing a punitive capital charge on businesses that provide steady fee income is misguided,” said SIFMA President and CEO Kenneth E. Bentsen, Jr. in a statement.

The bank sector has already warned that the new rules would lead to a massive hike in operational costs, that could force them to pull back from services, raise fees, or both.

Some analysts say it could take years of retained earnings for banks to comply with the proposal, limiting their ability to boost dividends or buy back shares.

However, regulators responded by saying that most banks already had enough liquidity to accept the proposal and that they would need at most two years of retained earnings to comply.