#capital rules

3 07, 2023

Karen Petrou: The Unintended Consequence Of Capital Hikes Isn’t Less Credit, It’s More Risk

Eliza Allen2023-07-03T12:08:54-04:00July 3rd, 2023|The Vault|

As was evident throughout Chairman Powell’s most recent appearances before HFSC and Senate Banking, conflict between capital and credit availability characterizes what is to come of the “end-game” capital rules set for imminent release. The trade-off is said to be between safer banks and a sound economy, but this is far too simple. As we’ve seen over and over again as capital rules rise, credit availability stays the same or even increases. What changes is who makes the loans and what happens to borrowers and the broader macro framework, which in the past has been irrevocably altered. The real trade-off is thus between lending from banks and the stable financial intermediation this generally ensures and lending from nonbanks and the risks this raises not just to financial stability, but also to economic equality.

As post-2008 history makes clear, banks do not stop lending when capital requirements go up; they stop taking certain balance-sheet risks based on how the sum total of often-conflicting risk-based, leverage, and stress-test rules drives their numbers. That all these rules push and pull banks in often-different directions is at long last known to the Fed based on Vice Chair Barr’s call for a “holistic review”. Whether it plans to do anything about them and their adverse impact on the future of regulated financial intermediation remains to be seen. Until something is done, banks will look across the spectrum of capital rules, spot the highest requirement, and then figure out how best to remain profitable …

24 04, 2023

Karen Petrou: The Price of Higher FDIC Protection and How to Prevent It

Eliza Allen2023-04-24T10:40:22-04:00April 24th, 2023|The Vault|

Last week’s memo stirred up a lot of comment about ways to provide at least some private-sector deposit insurance. The consensus is that, while nothing is easy about a private-sector backstop for federal coverage, the concept warrants careful consideration because all the other reform ideas on their own are still more problematic. This isn’t just because proposals for expanded federal coverage – my own included – extend the federal safety net at resulting moral hazard. In some cases, as I said, this risk is worth taking because some depositors warrant protection. Still, there’s sure to be a price for more federal coverage – super-costly premiums and/or more bank regulation – that argue for market-based solutions to the greatest extent compatible with social welfare and stable finance.

This trade-off was most recently addressed last week by John Vickers, a former U.K. regulator. Commenting on proposals across the pond akin to those in the U.S. to expand the sovereign deposit backstop, Mr. Vickers cautioned that added coverage should come with higher regulatory capital to ensure that banks do not take undue advantage of the comfy quilt into which the current, porous safety net would be transformed.

The U.K. deposit insurance system is different than that in the U.S., most notably by the absence of costly, ex ante bank premiums for the privilege of deposit-insurance coverage. However, the U.S. risk-based premium system that sets bank premium payments is asset – not insured deposit – based. As a result, coverage could go up considerably …

20 03, 2023

Karen Petrou: Three Fast, Urgent Fixes to U.S. Bank Supervision and One Major Change to End Bailouts

Eliza Allen2023-03-20T11:35:24-04:00March 20th, 2023|The Vault|

In the wake of recent bank failures, much has rightly been said about how supervisors failed to act even though warning claxons blared. Nothing that happened to Silvergate, SVB, or Signature is due to forces beyond supervisory control, but there are deep, structural weaknesses in how banks have long been supervised. How long? I went back to my 2001 Senate Banking testimony about what was then the largest-ever failure to find that many of the lessons that should have been learned never sunk in.

Given that this hearing was in 2001, a good deal of what I said about bank capital requirements was about Basel I and is thus long out of date. However, one key point isn’t: the capital triggers used to spark prompt corrective action (PCA) were and are an unduly-simplistic way to identify the need for rapid supervisory intervention.

Silvergate, SVB, and Signature were all “well” capitalized right up to the brink of collapse because each of the banks in its own way arbitraged the capital rules to enormous – and obvious – advantage. Nothing in law or rule bars bank supervisors from stepping in well before PCA ratios sink but nothing seems to stir supervisors to do so. 1991’s PCA requirements were an important advance at the time, but it was outdated only a decade later. Now, it’s a dangerous supervisory distraction.

What else noted in 2001 remains an urgent fix? Over two decades ago, I urged the FDIC to reinstate the high-growth early-warning system it …

17 03, 2023

FedFin Assessment: Future of U.S. Bank Capital, Liquidity, Structural Regulation

Eliza Allen2023-03-17T16:50:38-04:00March 17th, 2023|The Vault|

In this report, we continue our policy postmortem of SVB/SBNY and, now, so much more. Prior reports have assessed the overall political context (see Client Report RESOLVE49) and likely changes to FDIC insurance (see Client Report DEPOSITINSURANCE118), with a forthcoming Petrou op-ed in Barron’s focusing on specific ways to reform federal deposit insurance to protect only the innocent. In this report, we look at some key regulatory changes likely as the banking agencies reevaluate the regional-bank capital, liquidity, and the IDI/BHC construct. As noted in our initial assessment and thereafter, we do not expect meaningful legislative action on the Warren, et. al. bill to repeal “tailoring” requirements, but we do expect bipartisan political pressure not just for supervisory accountability (see another forthcoming report), but also regulatory revisions.

The full report is available to retainer clients. To find out how you can sign up for the service, click here and here.…

27 02, 2023

Karen Petrou: How the SEC Turned Custody Reform from a Righteous Cause to Jihad and Why it Matters

Arezou Rafikian2023-02-27T09:57:44-05:00February 27th, 2023|The Vault|

As we finalized our new in-depth analysis of the SEC’s rewrite of the nation’s custody rules, I asked some of the best-informed people I know if they had ever heard of a financial custodian. All they could come up with is the name of their elementary-school custodian and, in some ways, this is apt. Custody is among the services often called market “plumbing” because one only notices its importance when something goes wrong or realizes how risky poor maintenance is when everything gets wet. The SEC is right to retool custody services – their abuse was all too evident in the Madoff affair and even more costly to hapless investors in the course of crypto chaos. However, as seems often the case with the Commission, it has taken a righteous cause and turned it into a jihad.

When my question about custody services doesn’t outright kill conversation, I often explain the importance of this obscure financial service as follows: when you give an investment adviser your money to buy stock or other assets, he or she does so on your behalf. The adviser takes a bit – okay, maybe a big bit – for his or her trouble, but the assets purchased are yours, not the adviser’s. If the investment is poor because the asset loses value, that’s your bad. But, if the asset loses value or, worse, disappears due to malfeasance or insolvency on the part of the adviser, you’ve quite literally been robbed. To prevent this, custodial …

6 02, 2023

Karen Petrou: It’s Game-On for End-Game Capital Regulation

Arezou Rafikian2023-02-06T10:56:45-05:00February 6th, 2023|The Vault|

Many rules determine the terms of combat in key financial markets, but none is as fundamental as bank-capital standards because every decision a bank makes first factors capital costs or benefits. These are axiomatic because, even if every other business assumption a company makes is good, a financial product or service will still prove unprofitable if capital requirements are high enough to doom returns sufficient for insatiable investors. Said by some only to be a tidy Basel III clean-up, the Basel IV “end-game” capital rules set to come in the next month or so are actually a substantive recalibration of which businesses make banks how much money compared to all the competitors empowered over the years by the happy – if highly risky – absence of like-kind requirements. It’s thus no wonder that it’s already game-on for the future of the end-game regulations.

As we’ve noted in recent client updates, Rep. Andy Barr (R-KY) now chairs the HFSC subcommittee with power over both financial-institution regulation and monetary policy. Although one of his first bills in this Congress deals only with loosening capital rules for de novo banks (H.R. 758), he has made it very clear that he fears that the new big-bank capital construct will prove unduly costly and anti-competitive. Senate Banking Ranking Member Tim Scott (R-SC) said the same thing in more guarded tones when he released his priorities, making it clear that the GOP has its eyes on the new capital rules.

No coincidence, conservative critics are …

1 09, 2022

FedFin on: Centenarians Get a Face Lift

Arezou Rafikian2022-12-20T16:22:39-05:00September 1st, 2022|The Vault|

As seems always the case, FHFA Director Thompson is as good as her word to Congress earlier this summer, announcing yesterday a review of the extent to which the Home Loan Banks and their System meet the mission assigned to them and, regardless, if that mission still makes sense. Building on our initial assessment of FHFA’s plans, we here turn to what the System, its allies, and reformers are likely to say and what FHFA and/or Congress will then do about it.

The full report is available to subscription clients. To find out how you can sign up for the service, click here.…

11 07, 2022

Karen Petrou: Holistic-Capital FAQs and Some Priority Answers

Arezou Rafikian2023-01-24T15:15:17-05:00July 11th, 2022|The Vault|

Late last week, we released a new issue brief laying out how to quickly take Michael Barr’s suggestion of a holistic regulatory-capital regime from rhetoric to reality. The American Banker did a fine job summarizing the paper and putting it into the policy context, generating a lot of questions to which I’ll turn in this memo. By far the most common assertion is that this paper is a stealth big-bank campaign to cut regulatory capital. If it is, that’s news to all of them, as they saw the paper about the same time the Banker article appeared. More to the point and as I’ll discuss below, a holistic-capital regime wouldn’t come cheap, it would just be better honed and more effective.

The paper was sparked by what might have been an offhand comment from Mr. Barr at his Senate confirmation hearing for the Fed’s supervision vice chair. He was asked his views on the “Basel IV” package of regulatory-capital rewrites and said that he favored thinking about capital as a whole rather than finalizing individual standards in the absence of a broader vision. Or that’s what he seemed to mean because, sensible man that he is, the less said at a confirmation hearing, the better, and talk quickly turned to other matters. Assuming he meant what we thought he said, FedFin did our best to give it legs.

We did so in part by providing a short taxonomy of key capital requirements showing how they relate to other capital requirements …

5 05, 2022

FedFin Analysis: Global Climate-Risk Disclosures and Standards

Arezou Rafikian2023-03-01T14:37:09-05:00May 5th, 2022|The Vault|

The FSB’s report is aimed at establishing global standards that prevent fragmentation along national or regional lines as well as ensuring that regulatory and supervisory actions mitigate climate risk to the greatest extent possible in the face of an array of data and measurement challenges. Although the FSB proposes no specific requirements….

The full report is available to retainer clients. To find out how you can sign up for the service, click here and here.…

2 05, 2022

Karen Petrou: Why the Basel Capital Construct is Broken and How to Fix It

Arezou Rafikian2023-03-01T14:46:14-05:00May 2nd, 2022|The Vault|

Last week, the head of Britain’s key financial-regulatory agency, Sam Woods, stunned his Basel colleagues by suggesting that the entire edifice of Basel I, II, II.5, III, and what is rightly called IV should be tossed out in favor of something far more elegant and considerably less procyclical than the thousands of pages of Basel minutiae. Mr. Woods calls the alternative the “Basel Bufferati” in honor of the concept-car approach to auto innovation and it’s hard not to like something with such a cute name that might also achieve these essential goals. But, Mr. Woods’s Bufferati drives on the power of regulatory discretion over key considerations such as when there’s systemic risk and how susceptible to it each bank is likely to be. Been there, done that, it didn’t work.

The key features of the Bufferati are a minimums standard that’s a single number comprised only of common equity Tier 1 capital set by each supervisor’s judgement and a buffer for good measure set by “macroeconomic cost-benefit analyses.” The buffer could be released under stress and the minimum doesn’t necessarily bind even if there isn’t stress, making it unclear what either of these thresholds is other than ratios that might be useful cushions against undue risk-taking if supervisors guess right about both the bank and the financial system.

Could they? The idea of leaving minimum ratios to supervisory judgment actually harks back to the world before Basel I, when each nation’s supervisors looked at each of its banks and set …