Fed's Brainard Makes Sharper Case to Turn on Bank Capital Buffer

(Bloomberg) -- Federal Reserve Board Governor Lael Brainard turned up the volume on her argument for activating a tool that requires banks to pile up more capital across the board, pointing to rapid growth and deteriorating conditions in high-risk corporate lending.

  • “At a time when cyclical pressures have been building and bank profitability has been strong, it might be prudent to ask large banking organizations to fortify their capital buffers, which could subsequently be released if conditions warrant,” she said Friday in remarks prepared for a speech at the Peterson Institute for International Economics in Washington.
  • Appetite for risky corporate debt -- often fueling mergers and acquisitions tied to highly indebted companies -- has “reached new heights amid rapid growth and deteriorating underwriting standards in riskier segments, such as leveraged lending,” she said.
  • Brainard was among the first officials to raise the possibility of turning on the Fed’s so-called countercyclical capital buffer to require an additional amount of capital in the banking system that would be flooded back when the industry is under stress.
  • She argued in April that cyclical vulnerabilities in the financial system were growing and might justify use of the capital buffer, a tool that many countries including the U.S. agreed to establish under an international accord. A handful of regional Fed presidents have also called for its use.
  • In sharpening her argument Friday, Brainard noted that “mutual funds that have built up exposure to some of this risky debt have liquidity mismatches that could contribute to market dislocations in stressed conditions.”
  • The buffer can only be imposed by the Fed’s board, and both Chairman Jerome Powell and Vice Chairman for Supervision Randal Quarles have suggested risks haven’t risen sufficiently to trigger the need. When activated, it forces big banks to set aside additional capital -- up to 2.5 percent of risk-weighted assets. It’s then meant to be released back to the banks in a downturn to keep credit flowing in the economy.
  • The Fed is scheduled to conduct its annual review of the buffer in January.

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