Wall Street Faces Higher Capital Demands Under Fed Proposal
A pedestrian carrying an umbrella passes a U.S. flag on Wall Street in front of the exterior of the New York Stock Exchange (NYSE). (Photographer: Scott Eells/Bloomberg)

Wall Street Faces Higher Capital Demands Under Fed Proposal

(Bloomberg) -- Wall Street banks could face higher capital hurdles under a Federal Reserve proposal that would mark the most significant rewrite of requirements put in place after the 2008 financial crisis.

The new “stress capital buffer” announced by the Fed Tuesday is meant to streamline competing regulatory demands on lenders and better tailor standards to each bank’s specific business. The central bank’s proposal would also relax parts of its annual stress tests.

For financial firms anticipating a deregulatory wave under President Donald Trump, it’s a mixed bag. The proposal could make capital requirements a bit tougher for megabanks but the industry’s overall demands may fall by tens of billions of dollars.

The Fed said the overhaul could “somewhat increase” capital minimums for the largest lenders, though the regulator added that it believes the firms already have enough of a cushion to clear the proposed hurdle. Meanwhile, less systemically important banks would see modest reductions in the capital they need to maintain, according to the Fed.

‘Strength Maintained’

“This proposal significantly simplifies our capital regime while maintaining its strength,” Fed Vice Chairman for Supervision Randal Quarles said in a statement. “It is a good example of how our work can be done more efficiently and effectively.”

Though Quarles and Fed Chairman Jerome Powell were appointed by Trump, the move demonstrates their commitment to much of the sweeping regulatory regime imposed on banks after the crisis. In fact, the idea originated in 2016 with former Fed Governor Daniel Tarullo, an appointee of former President Barack Obama. Tarullo wanted to better integrate two of the Fed’s key demands -- its stress tests and its risk-based capital regime.

After the 2008 meltdown, global regulators implemented much tougher capital standards to limit the industry’s reliance on debt so that lenders could better withstand losses. But Trump administration officials have argued the rules are unnecessarily curtailing lending and holding back economic growth.

In a concession to banks, the Fed indicated it wants to ease some aspects of its stress tests by changing assumptions it has made about how the firms would behave in another crisis. An important revision would be removing the expectation that lenders would grow their balance sheets and continue to pay out dividends when facing severe economic headwinds.

Reducing Tensions

The proposed rule, open for a 60-day public comment period, would tie the new capital buffer to each company’s performance in the Fed’s stress tests and scrap what’s currently known as the “capital conservation buffer.”

That would marry the stress tests to the industry’s risk-based capital requirements, reducing long-standing tensions between day-to-day capital demands and the annual stress-test minimums that firms have to clear.

The Fed estimated the change could increase capital requirements for the biggest and most complex banks by tens of billions of dollars. For smaller banks, capital would decrease by about the same amount. Using last year’s tests as a guide, the overall demand for the entire industry would have been about $30 billion less, the Fed indicated.

Since the Fed implemented its stress tests in 2009, they’ve been the most significant constraint on banks’ payouts to shareholders. And the industry has repeatedly complained that it has to comply with too many competing ratios -- a concern that the Fed’s proposal tries to address by removing almost half of the different thresholds lenders have been expected to clear.

Harder Tests

Still, lenders had been hoping for a more straightforward easing of the stress tests that would allow them to increase shareholder dividends and buy back more stock.

In February, the Fed actually toughened the economic scenarios it uses in its exams to calculate firms’ hypothetical losses. That could hamper banks’ plans to boost dividends and repurchase shares. The results from this year’s tests will be announced in June.

©2018 Bloomberg L.P.

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