Michael S. Barr, the Federal Reserve’s vice chair for supervision, outlined a sweeping initiative to bolster capital requirements for the nation’s largest banks to enhance the resilience of the U.S. banking system.
The main proposal is mandating the largest banks to hold an extra two percentage points of capital, or an additional $2 of capital for every $100 of risk-weighted assets. Other suggestions include forcing banks with $100 billion or more in assets to account for unrealized losses, expanding and broadening annual stress tests, and installing a global bank capital agreement.
“We need to be skeptical about the ability of bank managers or regulators to anticipate all emerging risks,” he said in a speech at the Bipartisan Policy Center on July 10. “Events over the past few months have only reinforced the need for humility and skepticism, and for an approach that makes banks resilient to both familiar and unanticipated risks.”
The proposal emanates from Mr. Barr’s holistic review of big-bank capital requirements, efforts that he started when he arrived at the Fed in July 2022. The full plan is expected to be released this summer.
Following the failures of Silicon Valley Bank, Signature Bank, and First Republic, Mr. Barr believes regulators must put forward plans that would mandate larger banks to maintain stricter oversight requirements and transfer more capital to reserves. While Mr. Barr is not advocating transforming the national bank capital framework, the central bank’s chief regulatory official wants to contribute more to these measures to facilitate a buoyant environment.
“The risk of contagion implies that we need a greater degree of resilience for these firms than we previously thought,” Mr. Barr stated.
It is challenging for financial institutions and regulators to identify every risk and measure the threat, but this should not prevent regulatory entities from designing systems that “can withstand challenge, wherever they emerge and however they are transmitted through the system,” he noted.
At the same time, Mr. Barr does not believe these ideas will wreak havoc on the financial system because most financial firms possess enough capital to meet these new standards. However, banks needing to increase capital could do so in less than two years.
Barr explained that he would pursue additional regulation and supervision changes in response to the banking stress. This would consist of regulating and supervising liquidity, incentive compensation, and interest rate risks, as well as the speed and agility of Fed regulation.
Critics Question Need for More Capital
Since the banking turmoil this past spring, many leading U.S. officials have assured lawmakers and the public that the financial system is safe, sound, resilient, and liquid.At a May meeting with the Bank Policy Institute, Treasury Secretary Janet Yellen “reaffirmed the strength and soundness of the banking system, noting that it remains well-capitalized with strong liquidity.”
During his semiannual hearing before the House Financial Services Committee on June 21, Fed Chair Jerome Powell told the House Financial Services Committee that the largest U.S. banks and lenders were “very well capitalized.”
According to the results of the Fed’s latest June 28 stress tests, the largest U.S. banks are well-capitalized and could endure massive economic and financial market shocks. The annual stress testing of the banks shows that large institutions could handle a deep recession, an enormous drop in commercial and residential real estate prices, and a 10 percent unemployment rate.
“Today’s results confirm that the banking system remains strong and resilient,” Mr. Barr said in a statement. “At the same time, this stress test is only one way to measure that strength. We should remain humble about how risks can arise and continue our work to ensure that banks are resilient to a range of economic scenarios, market shocks, and other stresses.”
In recent weeks, Republican lawmakers have sought clarity on this issue because they believe there has been mixed messaging emanating from the current administration and the central bank.
Rep. Patrick McHenry (R-S.C.), who also heads the House Financial Services Committee, noted that Barr’s holistic review of bank capital requirements would pose risks to the economy since they would limit bank lending and impact small businesses’ access to capital and add to a potential credit crunch.
“Uncertainty from Fed supervision and regulation is the last thing the well-capitalized banking system needs now,” Chair McHenry said in his opening remarks at Powell’s monetary policy address to the House. “Following numerous supervisory failures, and a new vice chair for supervision at the Fed injecting politics into policy, it is becoming clear that Congress may need to examine separating supervision and regulation out of the Fed and gaining greater oversight and control.”
Earnings Season Arrives
Investors have become jittery ahead of the second-quarter results that begin this week.The big banks are expected to record the largest increase in loan losses since the beginning of the coronavirus pandemic amid rising interest rates. It has been estimated that the biggest entities, from Bank of America to Wells Fargo, have written off a collective $5 billion associated with defaulted loans.
There are also concerns surrounding regional banks because, according to Ian Lapey, the portfolio manager at Gabelli Funds, these institutions’ underlying problems persist, including substantial unrealized losses.
“Many U.S. banks have significant unrealized losses on their securities portfolios that will only increase if rates keep going up,” said Mr. Lapey in a research note. “The banking sector has been under pressure this year primarily because of the sharp increase in interest rates that caused bank runs at a few U.S. regional banks and the forced takeover of Credit Suisse by UBS.”
Bank shares and funds have held steady during the July 10 trading session.
The iShares US Regional Banks ETF was up about 0.3 percent, while the SPDR S&P Regional Banking ETF climbed as much as 1 percent. The Financial Select Sector SPDR Fund, which includes the largest bank stocks, rose roughly 0.5 percent.
