US and European regulators have been advancing the idea that big banks should hold more capital than Basel III proposes.
Over the course of May regulators from around the world offered their opinion that capital requirements for the world’s biggest financial institutions – so-called systemically important financial institutions or SIFIs – weren’t strong enough.
So far buffers or surcharges have been suggested, bringing the final requirement well above the 7 percent called for by Basel III. One proponent of increasing bank capital is the FDIC’s Sheila Bair, who said in May that banks should be required to hold more capital until they prove they have a viable workout plan. She also said that an increase would have only a modest impact on the cost of credit.
But Friday US Federal Reserve Governor Daniel Tarullo topped them all by suggesting SIFIs doing business in the US should go 20 to 100 percent over Basel III. The Basel III requirements were offered up as a way to prevent another financial crisis by improving the big banks’ ability to absorb financial or economic shocks.
In Fed Governor Tarullo’s view, however, the Basel Committee – which wrote the Basel III accords – based their estimates on microprudential considerations – i.e. they were firm-specific. But this needs to be enhanced by taking a broader, macroprudential approach that takes into account the impact of the firm’s failure on the system.
“A post-crisis regulatory regime must include a significant macroprudential component, one that addresses two distinct, but associated, tendencies in modern financial markets: First, the high degree of risk correlation among large numbers of actors in quick-moving markets, particularly where substantial amounts of leverage or maturity transformation are involved,” Mr. Tarullo said in a speech to the Peter G. Peterson Institute for International Economics. “Second, the emergence of financial institutions of sufficient combined size, interconnectedness, and leverage that their failures could threaten the entire system.”
As the current Basel III requirements stand “a SIFI has no incentive to carry enough capital to reduce the chances of such systemic losses,” Mr. Tarullo said, because “the microprudential approach of Basel III does not force them to do so. Making it a macro approach doesn’t give them a choice.
Banks are certain to fight this, as they have already. JP Morgan Chairman Jamie Dimon has been the most vocal, saying Basel III would “put a nail in the coffin” of big US banks. And on Friday according to Bloomberg he told an investor conference that costs will likely increase – and that was just for a 10 percent capital requirement. That 10 percent, he said, “will have ramifications on what people pay for credit, what banks hold on balance sheets.”
Recently International Treasurer wrote that so far there has been no Basel III credit crunch (see story here). However, chances are a credit crunch could ensue if the Basel III is doubled. So far there has been no reported comment from Dimon or others on the impact of Mr. Tarullo’s new calls.