What You Don’t Know About the Big Bank Capital Surcharge

By Rob Blackwell

For every answer international regulators give on a requirement for a large bank capital surcharge, it just feels like more questions pop up. The Group of Governors and Heads of Supervision agreed over the weekend to force certain banks to hold between 1% to 2.5% in extra capital depending on their size, riskiness and complexity. But left unclear, among other things, was exactly which institutions will face that charge, and where in the range they will fall. We offer the following frequently asked questions in an effort to explain what’s going on. So regulators agreed to what? In a nutshell, regulators want to force the largest, most complex, internationally active banks to hold extra capital, between 1% to 2.5% in common equity. These requirements would be on top of basic Basel III requirements, which require all institutions to hold 7% in common equity by 2019. For those keeping score, that means the largest banks would have to hold between 8% to 9.5% in common equity by 2019. Could any of them face even higher capital requirements? Yes, although that’s not likely in the short term. Regulators warned they could assess a 1% extra surcharge if big banks continue to grow bigger. Will they actually make do on that threat? Some are skeptical, but the uncertainty makes some bankers nervous. It’s clearly intended as a message. Greg Lyons, a partner at Debevoise & Plimpton LLP, called it a “Sword of Damocles over the big banks,” while Karen Shaw Petrou, managing partner of Federal Financial Analytics, called it a “penalty box.” So this makes the system safer, right? Well, we could debate the relative merits of higher capital versus tougher supervision, but what should worry you is this: these requirements do not touch globally significant nonbanks. So, for example, had this surcharge been in place 10 years ago, it would not have applied to Fannie Mae or Freddie Mac, institutions that the government had to save because they were so economically critical. Going forward, the new requirements do not apply to hedge funds or other big market players that do not technically fall under the definition of bank. “The backward looking exclusive focus on banking is a significant failure,” said Petrou. “It ignores the origins of systemic risk in the past like Fannie and Freddie and those looming now as the shadow system continues to outpace traditional banking in size and scope.”