Earlier this week, we sent clients an assessment of all of the capital requirements dictated by the Dodd-Frank Act. The new law comes, of course, in tandem with final action on Basel III. Each of these capital ideas on its own makes a fair amount of sense. But, piled together, the overall new capital regime can only be called a hodge-podge – and we’re being polite. Harkening back to what passed for our training in organization theory, the emerging global policy on regulatory capital bears all the hallmarks of a “synoptic” solution – that is, an attempt at a giant, total answer without clear thinking about the sum total of all aspects of a complex, untried policy. History has not treated other synoptic solutions kindly.
Is smiting the capital rules with the sobriquet “synoptic” unfair? A run-down of all the capital and comparable rules to come in the U.S. tells the tale. Bear with us – it’s a long list:
new resecuritization rules (final in Basel);
- new trading-book rules (also final in Basel and of particular note because of how big a punch they pack);
- a new leverage standard for global banks and a far tougher one for U.S. banks under Dodd-Frank;
- a total rewrite of all the Basel III risk-based capital rules, stiffening them up from what went before even if not to the total satisfaction of capital hawks;
- a still higher set of capital rules for large banks in the U.S. under the “minimum” capital criteria in Dodd-Frank;
- a systemic-risk surcharge, now agreed upon in theory by global regulators, but mandated in practice for U.S. banks (Dodd-Frank strikes again);
- a capital-conservation buffer (proposed in Basel III);
- a counter-cyclical capital charge ( again, proposed in Basel, but required for all banks in Dodd-Frank);
- a “contingent” capital charge, under consideration everywhere these days;
- risk retention for asset securitizations (mandated in Dodd-Frank, but also applicable in the EU);
- still tougher risk-retention requirements proposed by the FDIC;
- “activity-based” capital charges, which are stipulated in Dodd-Frank for any activity or practice fingered by the FSOC;
- new capital and margin requirements for derivatives and similar activities (including credit default swaps), required under Dodd-Frank and pending in the EU: and
- an overall requirement going forward that financial holding companies be “well-capitalized,” which means that U.S. firms must always hit the capital ball out of the park.
And, of course, there’s the new set of liquidity rules that plays into the capital ones in ways as yet untold. But, just listing all the capital standards has tired us out. It’s a formidable list, as of course evident on its face.
What could this new capital regime do? Without careful calibration – and that means more than just the number set to be sent out from Basel this month – U.S. banks – especially the largest of them – will bear a crushing capital burden when all of the parts of the capital rules are totaled up. Because capital is the sine qua non of line-of-business decisions within each bank and for investment decisions, the rules on their own and in their synoptic entirety will redefine banking as we know it.
Unless great care is taken – and little is evident so far – this sum total will power up the shadow-banking system as never before. Not exactly what the capital hawks want, of course, but history is littered with examples of well-intentioned, over-ambitious policies gone horribly wrong. Without careful consideration now of all of the capital charges and how they relate to each other, Basel and Dodd-Frank capital rules could join a sorry list.