Say It’s Simple
Our most recent analysis of the inter-agency capital proposal focuses on significant changes to the rules for securitization and credit-risk transfer positions. In short, super-traditional securitizations have an easier path to the secondary market, but GSEs still beat banks. Complex ABS face often-formidable obstacles, as does CRT given or taken by banks.
Based on our analysis of the inter-agency capital proposal’s framework and its credit-risk provisions, FedFin turns now to the proposed approach to equities as well as to that for securitization exposures (i.e., those that are tranched rather than simple secondary-market issuances of packages of loans or other assets backed as needed by a single credit enhancement). The proposal in some cases liberalizes the current, “general” standardized approach (SA), but more often toughens it to account for elimination of the advanced approach…
The full report is available to retainer clients. To find out how you can sign up for the service, click here and here.…
Equity and Securitization Capital Standards
Based on our analysis of the inter-agency capital proposal’s framework and its credit-risk provisions, FedFin turns now to the proposed approach to equities as well as to that for securitization exposures (i.e., those that are tranched rather than simple secondary-market issuances of packages of loans or other assets backed as needed by a single credit enhancement). The proposal in some cases liberalizes the current, “general” standardized approach (SA), but more often toughens it to account for elimination of the advanced approach. This will have particular bearing on significant aspects of category III and IV bank activities (e.g., credit-card securitizations, MMF funding), but all covered banking organizations will see significant capital increases as many activities now permitted within the banking book would need to move to the trading book under the new market-risk rules. Securitization-related capital standards are generally brought closer to those for underlying assets in simple securitizations, giving banks more balance-sheet flexibility and credit-risk mitigation opportunities if investors accept these structures. The treatment of equity exposures is generally tightened, sometimes so much as to effectively prohibit certain activities – e.g., non-traditional equity investments in covered funds and BHC subsidiaries. The new treatment of investment funds will also have significant implications for banks that fund themselves through prime MMFs or sponsor investment funds through equity positions.
A Crushing Capital Burden
No, we’re not talking about the proposals – enormous, complex, and in some cases ill-drafted and confusing though they are. We’re talking about how much work it’s taking to go beyond the top-line analyses and section-by-section repeats we’re seeing in so many releases to give you in-depth, strategy, and market-focused analyses of what key parts of the rules say and how they’ll redefine banking as we and the financial system know it. There’s much not to love about the current construct, but the complexity of the new capital framework makes it stunningly difficult not just for us, but we fear also for the regulators, to know if the new framework will prove a Frankenstein. When we finish our read of all the proposals’ sections and that for GSIBs, we’ll release a final, bottom-line strategic conclusion. Until then, it’s critical to understand each key part of the rule and how it defines individual business lines and the markets that depend on them.
In this report, we proceed from our assessment of the proposed regulatory capital framework to an analysis of the rules governing credit risk. In addition to eliminating the advanced approach, the proposal imposes higher standards for some assets than under the old standardized approach (SA) via new “expanded” requirements. As detailed here, many expanded risk weightings are higher than current requirements either due to specific risk-weighted assessments (RWAs) or definitions and additional restrictions. This contributes to the added capital costs identified by the banking agencies in their impact assessment, suggesting that lower risk weightings in the expanded approach reflected the reduced risks described in the proposal for other assets and will ultimately have little bearing on regulatory-capital requirements and thus ….
The full report is available to retainer clients. To find out how you can sign up for the service, click here and here.…
Credit-Risk Capital Rewrite
In this report, we proceed from our assessment of the proposed regulatory capital framework to an analysis of the rules governing credit risk. In addition to eliminating the advanced approach, the proposal imposes higher standards for some assets than under the old standardized approach (SA) via new “expanded” requirements. As detailed here, many expanded risk weightings are higher than current requirements either due to specific risk-weighted assessments (RWAs) or definitions and additional restrictions. This contributes to the added capital costs identified by the banking agencies in their impact assessment, suggesting that lower risk weightings in the expanded approach reflected the reduced risks described in the proposal for other assets and will ultimately have little bearing on regulatory-capital requirements and thus on the overall ability of banks to expand into lower-risk areas and compete more effectively with nonbanks and foreign banks. Big banks forced to abandon certain activities may expand others receiving capital discounts in the new rules, increasing their footprint in traditional banking in ways that may increase industry consolidation.
Few Surprises, Much Consternation
There is little in the new capital framework we did not forecast for new capital rules after the March bank failures (see Client Report REFORM219) and what we missed was later presaged in Vice Chair Barr’s recent speech (see Client Report CAPITAL228). However, as we’ve also said many times, many devils lurk in regulatory-capital details. We know the agencies’ capital-impact bottom line because the FDIC and Fed each outlined this at contentious meetings approving the proposal for public comment. We also know that Republicans really don’t like the rule even if they haven’t read it and that key decision-makers – most notably Chair Powell – are hedging their affirmative votes for releasing the proposal with careful caveats of what they want to see in a final rule. Thus, careful analytics are essential to effective assessments of winners and losers as a result of this complex package, especially if one looks – as FedFin will – at big-picture implications – i.e., those for the economy, financial system, and economic equality – as well as at sector- and institution-specific provisions not just in key asset classes based on specific risk weightings.
FSB Tries to Calm CoCo Confusion
Doubtless responding to the CoCo chaos when Credit Suisse failed, the FSB today issued a report laying out how cross-border crisis-management groups are to handle unallocated TLAC (UTLAC) such as the “alternative Tier 1” bonds popular in the EU.
FDIC 3-2 Vote Presages Knock-Down Basel Battle
As anticipated, the FDIC today voted 3-2 to issue a sweeping rewrite of U.S. regulatory capital requirements.
Divided, Cautious Fed Advances End-Game, GSIB Rewrites
As anticipated, Gov. Bowman today voted against the new capital framework, as did Gov. Waller; as a result, the vote was 4-2.
Stablecoin Bill Advances, Compromises to Come
At a fiery HFSC markup today, Chairman McHenry (R-NC) announced that bipartisan negotiations had broken down largely due to the White House, choosing to proceed to a final package as he remains open to amendment before floor action.
House Republicans Skewer Basel Rules
Hill comment so far in response to the new capital rules is sparse.
FedFin Assessment: What to Watch in the Regulatory-Capital Rewrite
As promised, we plan in-depth coverage of the Fed and FDIC meetings tomorrow as well as of the capital rewrites they are set to propose no matter all the warning shots from Congressional Republicans. In this report, we provide an overview of each of the rules the agencies will propose based on key issues in the Basel end-game standards they will finally advance. We do not focus on details or how the U.S. may adapt these rules except where public releases have provided advance insight. Instead, we highlight key issues to provide vital background and context of tomorrow’s actions as well as key decision points on which comment and political advocacy are sure to center.
40 Percent!?
Reuters is reporting today and other sources are echoing three regulatory sources saying that the impending capital rewrite will propose risk weighted assessments (RWAs) between 40 and 90%, up from the minimum 20 and 70% Basel standards. The rationale according to Reuters is a desire not to set big-bank RWAs lower than those applicable to smaller banks. However, the rule could also amend smaller-bank RWAs if regulators are or become so inclined.