Fed tweaking post-'08 rules for U.S. banks

Slow, steady changes raise critics’ fears of backsliding

Federal Reserve Chairman Jerome Powell speaks during a news conference following a two-day Federal Open Market Committee meeting in Washington, Wednesday, July 31, 2019.
Federal Reserve Chairman Jerome Powell speaks during a news conference following a two-day Federal Open Market Committee meeting in Washington, Wednesday, July 31, 2019.

WASHINGTON -- A decade after big banks needed government support to dig out of the financial crisis, the Federal Reserve is slowly, but steadily, making a series of regulatory changes that stand to chip away at new requirements put in place to prevent a repeat of the 2008 meltdown.

Some of the changes, seemingly incremental and technical on their own, are seen as adding up to a weakening of capital requirements installed in the wake of the crisis to prevent the largest banks from suffering the kind of destabilizing losses that imperiled the U.S. economy. Another imminent change will soften a rule intended to prevent banks from making risky bets with customer deposits.

Fed officials and others who support the changes, including big banks, say the Fed is engaging in what they call "tailoring" -- a regulatory correction that will bring greater efficiency to standards written in the heat of a meltdown. They say the tweaks will not weaken the ability of banks to withstand financial losses but will reduce burdensome regulations that could have unintended consequences, like encouraging risk-taking.

But some current and former Fed officials worry that the central bank and its fellow regulators are giving large banks, which are making big profits, an unnecessary gift that could leave the economy exposed in the next downturn. They say the overseers should be forcing banks to maintain or even build up their defenses given the strong economy, which is in its longest expansion on record, rather than eroding those buffers.

"No individual thing jumps out, but if you look at the sum total, the direction of travel is not entirely encouraging," Jeremy Stein, a Harvard professor and former Fed governor, said on a recent panel. "You need to be incredibly vigilant, and really understand this stuff very well. It's very opaque, in many ways."

The Fed is expected to soon approve bank-friendly changes to the Volcker Rule, which was aimed at preventing banks from trading for their own profit with depositors' money and other funds. The revised rule, approved by the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency on Tuesday, eases restrictions on how banks invest for their own gain.

The Volcker Rule previously forced banks to prove that their short-term trades -- those held for fewer than 60 days -- were allowable under the law. Banks complained that the provision was burdensome and restricted legitimate trading. That practice is now scrapped. Regulators proposed replacing it with a test based on accounting standards, which would have determined what kind of trades are banned. But big banks criticized the proposal, and the industry slammed the new approach as overly broad. It also was eliminated in the final rule. The end result is that a portion of bank financial activities will no longer be captured and judged by regulators.

Martin Gruenberg, a member of the FDIC board of directors, dissented against the rule, saying "the Volcker Rule will no longer impose a meaningful constraint on speculative proprietary trading by banks and bank holding companies benefiting from the public safety net."

Other agencies, including the Fed, probably will approve the measure within weeks, said Ian Katz, an analyst with Capital Alpha Partners.

Other changes to regulation, some put into place and others still under consideration, range from making it easier for big banks to pass the Fed's annual "stress test" of their financial health to allowing some to borrow more. One idea being floated could quietly reduce capital levels at the biggest American banks over the course of the business cycle.

The tinkering is being driven by Randal Quarles, the Fed's vice chairman for supervision, whom President Donald Trump nominated in 2017, and the effort has earned the consideration of Jerome Powell, the Fed chairman. At a news conference last month, Powell said the Fed was weighing a proposal that might have the effect of reducing average capital levels at big banks over time.

Bankers acknowledged that capital needed to be higher after the 2008 crisis, but increasingly say enough is enough. Big banks have complained of measures that might increase capital from current levels or that could make year-to-year requirements fluctuate more, and have criticized U.S. rules for being more demanding than international standards.

Bank lobbying groups like the Bank Policy Institute have pushed back on calls to lift capital requirements, saying that stricter regulations "would harm economic growth with little benefit to the safety and soundness of the financial system." And the country's large banks have been working for more than a year to persuade the Fed to avoid putting more stringent capital rules in place.

Representatives from each of the biggest banks have met several times with Fed officials to talk about the stress capital buffer, a measure that would condense and streamline capital requirements, according to two people familiar with the matter. Each bank also used a public-comment period in 2018 to send letters detailing specific suggestions for changes the Fed could make when it enacts the new standard.

Some Fed officials say capital requirements are already on the low side and should be beefed up, and careful watchers of financial regulation warn that current regulatory tweaks could bite into capital over time.

Lael Brainard, a Fed governor who was appointed by President Barack Obama, has now dissented on six regulatory matters, and has said that the Fed must be "especially vigilant to safeguard the resilience of our financial system in good times when vulnerabilities may be building."

The president of the Federal Reserve Bank of Dallas, Robert Kaplan, and Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, have warned against making changes that reduce capital requirements.

Fed research shows that bank capital should be in a range of 13% to more than 26% of a bank's assets, adjusted for risk, to best balance threats that emerge during downturns against costs to economic activity during times of expansion. Overall capital ratios at big banks stood at about 14% at the end of last year.

"The biggest banks need substantially more capital," Kashkari said in an interview, calling changes that could weaken requirements "concerning."

A proposal already underway will lower capital slightly, while making a hard cap on how much the biggest banks can borrow more flexible. Known as the "enhanced supplemental leverage ratio," the measure was put in place to ensure that the eight largest U.S. banks did not overextend themselves with borrowed money, as some did in the lead-up to the financial crisis. The changes would give banks more room to borrow and bring U.S. rules in line with global standards.

Quarles has called it a "modest recalibration" that will ensure that banks' capital requirements better reflect the risks to which they are exposed. Bank executives support the change, which could free $400 million of bank holding company capital -- 0.04% of the total -- for dividend payouts and buybacks, according to staff estimates.

Not all of the tweaks act on capital directly. For example, the Fed has begun disclosing more information about its stress tests, which critics equate to giving banks the answers before the test. Quarles takes objection to that characterization, saying the point of stress testing is to encourage strong capital standards, not to punish banks.

"Like a teacher, we don't want banks to fail. We want them to learn," he said in a July speech.

The Fed also has cut a qualitative component from most banks' tests, one that checks in on their processes, rather than assessing numbers alone. Brainard voted against the move.

A Section on 08/21/2019

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