Federal Reserve to Propose Higher Capital Standards for Large Banks to Boost Resilience

The Federal Reserve Board is set to propose an increase in capital standards for large banks and holding companies, aiming to strengthen the resiliency of the banking system against unexpected market shocks.

In a speech on Monday, Michael Barr, the Fed's vice chair for supervision, outlined the proposal that would require large and complex banks and holding companies with over $700 billion in assets to reserve an additional two percentage points of capital. This translates to an extra $2 of capital for every $100 of risk-weighted assets.

Barr emphasized the importance of enhancing the financial system's resilience, stating, "While this increase in requirements could lead to some changes in bank activities, the benefits of making the financial system more resilient to stresses that could otherwise impair growth are greater." He reassured that most large banks covered by the new rule already possess the necessary capital to meet the increased requirement.

For banks that currently fall short, Barr estimated that they would be able to build the required capital through retained earnings in less than two years, without compromising dividend payments. However, he acknowledged that implementing the proposed changes would take several years.

The proposed capital standards aim to fortify the financial system and prepare it for unforeseen and emerging risks, such as those that contributed to the failures of Silicon Valley Bank (SVB), Signature Bank, and First Republic Bank earlier this year.

Barr also outlined other proposed changes to capital standards, including those for mid-sized banks with over $100 billion in assets. These changes involve standardizing credit and operational risk estimates and eliminating the practice of relying on banks' individual risk estimates in these areas.

In addition, the proposal suggests adjusting the way banks measure market risk by raising model quality standards. However, banks would still be allowed to calculate their own market risk. The rules would also require banks with assets of $100 billion or more to account for unrealized losses and gains in their available-for-sale (AFS) securities when calculating their regulatory capital.

While Barr affirmed that the current stress testing framework remains sound, he indicated the need to review its effectiveness in measuring a firm's response to a global market shock and its ability to assess operational risk.

Barr did not specify whether mid-sized banks would be required to conduct annual stress tests, a requirement currently imposed on larger and more complex banks with over $700 billion in assets. Further adjustments to supervisory requirements are expected to be unveiled at a later date.

The proposed increase in capital standards aims to ensure businesses have access to credit for growth, job creation, and economic stability. Barr emphasized the goal of creating a financial system that works for everyone, stating, "Our goal is a financial system that works for everyone, and having strong capital rules is essential for that."

The Federal Reserve's proposed changes to capital standards for large banks will undergo a period of public comment and further analysis before any final rules are implemented.

By fLEXI tEAM