Since the Fed released its proposal to rewrite big-bank risk-based capital rules and then did the same along with the OCC to the enhanced supplementary leverage ratio (eSLR), bank analysts have touted big capital savings and industry critics have lambasted the proposals said sharply to drop critical capital barricades against another financial crisis. The Fed fueled this debate by helpfully providing dollar totals in the rule for just how big the big banks would generally win. The problem here isn’t, though, that bank regulatory-capital ratios could go down. The problem is that no one – the Fed and OCC very much included – have a clue about what these rules would do first to big banks and then to borrowers, economic equality, financial stability, or much else. Here are eight reasons why the dollar totals in these proposals are meaningless and one more at the end saying why regulators should know before they go.
First reason, both the risk-based capital (RBC) and eSLR rewrites hinge results for GSIBs on the GSIB surcharge. I’ll leave for another day the merits of doing this and of the surcharge itself. The problem here is that the dollar totals for GSIBs in both NPRs are snapshots based on the current GSIB surcharge even though that’s set to change shortly both in the U.S. and then in the next year or so following a change in global standards. New GSIB surcharge, new regulatory impact.
Secondly, the RBC rules hinge for all large BHCs on the results of their CCAR tests. The numbers in the NPRs reflect prior CCARs, but the Fed’s 2018 scenarios are doozies. For the first time, CCAR includes a macroprudential element that makes the test a lot more costly at the height of the business cycle – i.e., now. New CCAR, new numbers.
Third, CCAR is about to go totally qualitative. The estimates in the NPR are based on quantitative results from prior tests. New judgments about each BHC could lead to wide variation in future results. More subjectivity, more uncertainty.
Fourth, the eSLR is founded on the current denominator for leverage-capital purposes. But Basel has just finished a total rewrite of the denominator. New denominator, new eSLR. Same goes for the stress leverage buffer, which will also be different from the current calculation.
Fifth, given that we’re at the height of the business cycle, FRB Gov. Brainard yesterday suggested that the Fed trigger the counter-cyclical capital buffer (CCyB) and/or do so if any of the proposed capital changes are finalized. New CCyB, new number
Sixth, there’s about to be expected-loss reserving sure to take a big bite out of capital ratios even though, in my view, it shouldn’t. The agencies have postponed this day of reckoning, but not averted it. So, new accounting, new capital ratios.
Seventh, with a new expected-loss accounting methodology, one would think CCAR’s models would change since the baseline scenario is intended to capture precisely the same forward-looking expected loss. Since there’s no reason in my opinion both to capitalize this risk and hold express reserves against it, stress-test models should change even if the basic requirements don’t. New CCAR methodology, new regulatory impact.
And my finale, the eighth reason why the quantitative estimates in these NPRs are nonsensical: possible changes to the liquidity coverage ratio (LCR). FRB Vice Chairman Quarles is clearly thinking about a significant revision that might apply only the modified LCR to all big BHCs but GSIBs, possibly even going farther to exempt all domestic-focused BHCs as Treasury recommended. Different or no LCR, very different balance sheets and, then, very different results.
Should the Fed and OCC have stayed their hand pending final action on all eight of these to-dos? If the agencies waited for such complete certainty, no rule would ever be promulgated. Much as some might like that, a lot of risk would then go untrammeled. However, to put out simple totals with all the gravitas of a Federal Register notice is to imbue these cost-benefit analysis with an authoritative air wholly belied by how closely these numbers resemble a wet finger stuck up in a swirling windstorm in hopes of forecasting the weather. The Fed and OCC need better data to tell what direction their going so we don’t all end up in Oz.