Federal Reserve Meeting on G -SIB Capital Surcharge
Federal Reserve Board of Governors
Open Meeting on G-SIB Capital Surcharges
Tuesday, December 9, 2014
Key Topics & Takeaways
- Proposal Approved: The Federal Reserve’s Board of Governors unanimously approved the proposed capital surcharges for G-SIBs.
- Higher Surcharges: The surcharges would be an estimated 1.8 times higher than the capital requirements set by the Basel Committee’s methodology.
- International Competitiveness: Governor Tarullo asked how the proposal might impact the international competitiveness of U.S. financial institutions. Staff commented that the Fed primarily focused on stability concerns, but said the proposal would make banks smaller than the G-SIBs more competitive, and that the G-SIBs may benefit from lower costs of financing as a result of holding more capital.
Speakers:
- Janet Yellen, Chair, Federal Reserve Board of Governors
- Stanley Fischer, Vice Chairman
- Daniel Tarullo, Governor
- Jerome Powell, Governor
- Lael Brainard, Governor
Opening Statements
Chair Janet Yellen
Janet Yellen, Chair of the Board of Governors of the Federal Reserve System, explained the Board of Governors’ (Board) proposal seeks to alleviate the potential risks that systemically important financial institutions pose to the financial stability of the U.S. economy. She noted that the proposed rule would require a risk-based capital surcharge for the most systemically important U.S. bank holding companies, and that the rule would provide incentives to these institutions to hold increased levels of high-quality capital as a percentage of their risk weighted assets. This would encourage firms to reduce their systemic footprint, Yellen explained, and lessen the threat of failure and its negative impacts on overall financial stability.
Governor Daniel Tarullo
Daniel Tarullo, member of the Board of Governors of the Federal Reserve System, explained that strong capital requirements are essential to ensuring a safe and sound financial system and commented that the proposed system of graduated capital surcharges would be a step towards implementing Section 165 of the Dodd-Frank Act. He continued that the proposed regulation is different from the international framework in two ways: (1) the calibration of surcharges would be higher than international standards; and (2) the formula used to calculate surcharges would take into account the reliance of short-term wholesale funding.
Tarullo explained that the surcharge levels agreed to by the Basel committee were “towards the low end,” and that the levels included in the Fed’s proposed rule were “more in the middle.” He continued that the surcharge would only apply to systemically important financial institutions, would increase as a bank’s systemic importance grows, and would decrease as bank reduces its systemic importance. He mentioned other countries have decided to increase capital standards above Basel levels to improve their financial stability.
Tarullo continued that the reliance on short-term wholesale funding was among the more important determinants systemic impact and said it was “unfortunate” that the Basel formula did not take short-term wholesale funding into account. He concluded that the proposed rule would strengthen the Basel standard in the U.S. by raising surcharges to levels that would create greater net economic benefits.
Staff Presentation
Michael Gibson, Director of Banking Supervision and Regulation said the Fed takes three approaches to reduce the risks posed to the financial system by G-SIBs: (1) use of the Large Institution Supervision Coordination Committee (LSCC); (2) stress testing; and (3) requiring resolution plans. He said the LSCC focuses on regular horizontal examinations of the largest banking organizations and called stress-testing a valuable tool for ensuring the resiliency of those firms. Gibson concluded that these efforts, combined with the proposed G-SIB surcharge, should better ensure that U.S. G-SIBs maintain strong capital levels and that the proposal would reduce the likelihood of economic disruptions resulting from problems at these firms.
Ann McKeehan explained that the proposed surcharge is based on the methodology and surcharge framework developed by the Basel Committee, which was based on size, interconnectedness, cross-border activity, substitutability, and complexity. She said the Fed proposal requires that U.S. G-SIBs determine their surcharge by two different methods: the Basel framework, and a second method that replaces substitutability with a measure of short-term wholesale funding. Firms would be subject to the higher of the two calculations, which McKeehan said will likely come from the second method.
Jordan Bleicher said the U.S. surcharges would be an estimated 1.8 times higher than Basel’s requirements. He stated that the staff believes that reducing the probability of crisis would provide a net benefit to the financial system, and that the calibration of surcharges is intended to maximize this net benefit. He noted that most of the U.S. G-SIBs already have adequate capital to meet the proposed surcharge. Bleicher said the proposal would phase in the G-SIB surcharge on a “straight line basis” from January 1, 2016 to January 1, 2019.
Questions and Answers
Yellen asked about the impact of the proposed surcharges on the decisions of affected G-SIBs, and whether it would create an incentive to rely on more stable forms of funding. Gibson answered that the inclusion of short-term wholesale funding in the calculation would indeed give an incentive to reduce reliance upon this type of funding, and noted that the proposal includes buckets of 50 basis points, which would give firms some predictability.
Yellen, noting that many of the firms already have capital levels in excess of the proposal’s requirements, asked if it would be necessary for the Fed to also change the threshold that has to be passed in stress tests in order to meaningfully increase capital levels. Gibson said the question of whether the proposed surcharge should be incorporated into the “post-stress minimum” for the purpose of stress tests is not addressed in the rulemaking, but that public comment would be welcomed and that the staff intends to revisit the issue in the future.
Vice Chairman Stanley Fischer noted that the second method for calculating the capital surcharge simply replaces substitutability with a measure of reliance on short-term wholesale funding. Presuming this conversation happened during the Basel Committee’s discussions, he asked if any arguments arose during the discussions on this approach. Gibson said Basel’s discussions happened several years ago when the U.S. regulators were still evaluating short-term wholesale funding, and so they were unable to convince others to retain it as part of the Basel formula. However, he pointed out that there will be a review of the Basel formula and that he hopes it will be considered then.
Fischer then asked if any other countries had similarly adopted surcharges different from Basel’s. Anna Lee Hewko, deputy associate director in the Division of Banking Supervision and Regulation, answered that most Basel Committee members have adopted the Basel G-SIB framework, but that “a few have done things differently,” including Switzerland, the Netherlands, and Sweden, albeit without incorporating short-term wholesale funding.
Tarullo asked about the impact the proposal would have on the abilities of U.S. banks to compete with foreign institutions that face lower surcharges. Mark Van Der Weide responded that the staff designed the framework with a primary focus on achieving financial stability goals. However, he commented that staff expects other countries to follow suit in installing requirements stronger than Basel’s. He further stated that while equity capital can be more expensive than debt capital, it can make financing less expensive, thus strong capital can be a competitive strength. He also mentioned that the proposal would make banks smaller than G-SIBs more competitive both domestically and internationally.
Next, Tarullo asked whether the Basel Committee has a scheduled reconsideration of its formula for determining systemic importance. A staffer responded that the Committee has a three-year review process that has just started.
Jerome Powell, governor of the Federal Reserve, explained that there was still a role for short-term wholesale funding even though it was problematic in the financial crisis, and that it can be appropriate if used “safely.” He asked how important financing markets, such as the Treasury market, may be impacted. Bleicher explained that impact on these markets can be reduced through different risk weighting of wholesale funding liabilities. He said the reason for including short-term wholesale funding in the surcharge formula was to capture a firm’s systemic footprint, continuing that including short-term wholesale funding is part of a “broader package” of reforms that include the liquidity coverage ratio (LCR) and margin requirements.
Lael Brainard, governor of the Federal Reserve, asked how the group traded off the desire to carefully target sources of risk against the desire to maintain a “fairly simple” system of requirements for financial institutions. Gibson explained that the proposal tries to balance complexity and effectiveness, noting a decision to use a small number of indicators for each firm.
Brainard then asked how institutions that may be large or complex, but do not hit the surcharge threshold, were taken under consideration. Gibson stated that “the line had to be drawn somewhere,” and noted in the U.S. there is a large gap between the smallest systemic bank and the next largest bank, which is not systemic, so there was no issue on changing the threshold slightly.
Fischer asked what minimum level of global activity must be reached for a bank to be subject to the surcharge. Gibson explained that Basel collects data from the largest banks in the world, and created a cutoff for determining who is systemic but that the formula is complicated and there is “no single number.”
Final Vote
Prior to the final vote, Powell voiced his support of the proposal and commented that the higher levels of capital will reduce the probability of default and encourage firms to reduce their systemic footprint. Brainard called the proposal “a significant step in tier-ing regulation” and said it is important to note that the enhanced standards will only apply to institutions well above the $50 billion floor designated by the Dodd-Frank Act. Yellen said financial institutions should hold more high-quality assets, and that the proposal imposes “meaningful additional capital requirements.” She commented that she was “pleased” that staff went beyond Basel, saying it was appropriate.
The proposal was approved in a unanimous vote.
For the meeting memoranda, Federal Register Notice and opening statements, please clickhere.
For the video of this event, please click here.
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Federal Reserve Board of Governors
Open Meeting on G-SIB Capital Surcharges
Tuesday, December 9, 2014
Key Topics & Takeaways
- Proposal Approved: The Federal Reserve’s Board of Governors unanimously approved the proposed capital surcharges for G-SIBs.
- Higher Surcharges: The surcharges would be an estimated 1.8 times higher than the capital requirements set by the Basel Committee’s methodology.
- International Competitiveness: Governor Tarullo asked how the proposal might impact the international competitiveness of U.S. financial institutions. Staff commented that the Fed primarily focused on stability concerns, but said the proposal would make banks smaller than the G-SIBs more competitive, and that the G-SIBs may benefit from lower costs of financing as a result of holding more capital.
Speakers:
- Janet Yellen, Chair, Federal Reserve Board of Governors
- Stanley Fischer, Vice Chairman
- Daniel Tarullo, Governor
- Jerome Powell, Governor
- Lael Brainard, Governor
Opening Statements
Chair Janet Yellen
Janet Yellen, Chair of the Board of Governors of the Federal Reserve System, explained the Board of Governors’ (Board) proposal seeks to alleviate the potential risks that systemically important financial institutions pose to the financial stability of the U.S. economy. She noted that the proposed rule would require a risk-based capital surcharge for the most systemically important U.S. bank holding companies, and that the rule would provide incentives to these institutions to hold increased levels of high-quality capital as a percentage of their risk weighted assets. This would encourage firms to reduce their systemic footprint, Yellen explained, and lessen the threat of failure and its negative impacts on overall financial stability.
Governor Daniel Tarullo
Daniel Tarullo, member of the Board of Governors of the Federal Reserve System, explained that strong capital requirements are essential to ensuring a safe and sound financial system and commented that the proposed system of graduated capital surcharges would be a step towards implementing Section 165 of the Dodd-Frank Act. He continued that the proposed regulation is different from the international framework in two ways: (1) the calibration of surcharges would be higher than international standards; and (2) the formula used to calculate surcharges would take into account the reliance of short-term wholesale funding.
Tarullo explained that the surcharge levels agreed to by the Basel committee were “towards the low end,” and that the levels included in the Fed’s proposed rule were “more in the middle.” He continued that the surcharge would only apply to systemically important financial institutions, would increase as a bank’s systemic importance grows, and would decrease as bank reduces its systemic importance. He mentioned other countries have decided to increase capital standards above Basel levels to improve their financial stability.
Tarullo continued that the reliance on short-term wholesale funding was among the more important determinants systemic impact and said it was “unfortunate” that the Basel formula did not take short-term wholesale funding into account. He concluded that the proposed rule would strengthen the Basel standard in the U.S. by raising surcharges to levels that would create greater net economic benefits.
Staff Presentation
Michael Gibson, Director of Banking Supervision and Regulation said the Fed takes three approaches to reduce the risks posed to the financial system by G-SIBs: (1) use of the Large Institution Supervision Coordination Committee (LSCC); (2) stress testing; and (3) requiring resolution plans. He said the LSCC focuses on regular horizontal examinations of the largest banking organizations and called stress-testing a valuable tool for ensuring the resiliency of those firms. Gibson concluded that these efforts, combined with the proposed G-SIB surcharge, should better ensure that U.S. G-SIBs maintain strong capital levels and that the proposal would reduce the likelihood of economic disruptions resulting from problems at these firms.
Ann McKeehan explained that the proposed surcharge is based on the methodology and surcharge framework developed by the Basel Committee, which was based on size, interconnectedness, cross-border activity, substitutability, and complexity. She said the Fed proposal requires that U.S. G-SIBs determine their surcharge by two different methods: the Basel framework, and a second method that replaces substitutability with a measure of short-term wholesale funding. Firms would be subject to the higher of the two calculations, which McKeehan said will likely come from the second method.
Jordan Bleicher said the U.S. surcharges would be an estimated 1.8 times higher than Basel’s requirements. He stated that the staff believes that reducing the probability of crisis would provide a net benefit to the financial system, and that the calibration of surcharges is intended to maximize this net benefit. He noted that most of the U.S. G-SIBs already have adequate capital to meet the proposed surcharge. Bleicher said the proposal would phase in the G-SIB surcharge on a “straight line basis” from January 1, 2016 to January 1, 2019.
Questions and Answers
Yellen asked about the impact of the proposed surcharges on the decisions of affected G-SIBs, and whether it would create an incentive to rely on more stable forms of funding. Gibson answered that the inclusion of short-term wholesale funding in the calculation would indeed give an incentive to reduce reliance upon this type of funding, and noted that the proposal includes buckets of 50 basis points, which would give firms some predictability.
Yellen, noting that many of the firms already have capital levels in excess of the proposal’s requirements, asked if it would be necessary for the Fed to also change the threshold that has to be passed in stress tests in order to meaningfully increase capital levels. Gibson said the question of whether the proposed surcharge should be incorporated into the “post-stress minimum” for the purpose of stress tests is not addressed in the rulemaking, but that public comment would be welcomed and that the staff intends to revisit the issue in the future.
Vice Chairman Stanley Fischer noted that the second method for calculating the capital surcharge simply replaces substitutability with a measure of reliance on short-term wholesale funding. Presuming this conversation happened during the Basel Committee’s discussions, he asked if any arguments arose during the discussions on this approach. Gibson said Basel’s discussions happened several years ago when the U.S. regulators were still evaluating short-term wholesale funding, and so they were unable to convince others to retain it as part of the Basel formula. However, he pointed out that there will be a review of the Basel formula and that he hopes it will be considered then.
Fischer then asked if any other countries had similarly adopted surcharges different from Basel’s. Anna Lee Hewko, deputy associate director in the Division of Banking Supervision and Regulation, answered that most Basel Committee members have adopted the Basel G-SIB framework, but that “a few have done things differently,” including Switzerland, the Netherlands, and Sweden, albeit without incorporating short-term wholesale funding.
Tarullo asked about the impact the proposal would have on the abilities of U.S. banks to compete with foreign institutions that face lower surcharges. Mark Van Der Weide responded that the staff designed the framework with a primary focus on achieving financial stability goals. However, he commented that staff expects other countries to follow suit in installing requirements stronger than Basel’s. He further stated that while equity capital can be more expensive than debt capital, it can make financing less expensive, thus strong capital can be a competitive strength. He also mentioned that the proposal would make banks smaller than G-SIBs more competitive both domestically and internationally.
Next, Tarullo asked whether the Basel Committee has a scheduled reconsideration of its formula for determining systemic importance. A staffer responded that the Committee has a three-year review process that has just started.
Jerome Powell, governor of the Federal Reserve, explained that there was still a role for short-term wholesale funding even though it was problematic in the financial crisis, and that it can be appropriate if used “safely.” He asked how important financing markets, such as the Treasury market, may be impacted. Bleicher explained that impact on these markets can be reduced through different risk weighting of wholesale funding liabilities. He said the reason for including short-term wholesale funding in the surcharge formula was to capture a firm’s systemic footprint, continuing that including short-term wholesale funding is part of a “broader package” of reforms that include the liquidity coverage ratio (LCR) and margin requirements.
Lael Brainard, governor of the Federal Reserve, asked how the group traded off the desire to carefully target sources of risk against the desire to maintain a “fairly simple” system of requirements for financial institutions. Gibson explained that the proposal tries to balance complexity and effectiveness, noting a decision to use a small number of indicators for each firm.
Brainard then asked how institutions that may be large or complex, but do not hit the surcharge threshold, were taken under consideration. Gibson stated that “the line had to be drawn somewhere,” and noted in the U.S. there is a large gap between the smallest systemic bank and the next largest bank, which is not systemic, so there was no issue on changing the threshold slightly.
Fischer asked what minimum level of global activity must be reached for a bank to be subject to the surcharge. Gibson explained that Basel collects data from the largest banks in the world, and created a cutoff for determining who is systemic but that the formula is complicated and there is “no single number.”
Final Vote
Prior to the final vote, Powell voiced his support of the proposal and commented that the higher levels of capital will reduce the probability of default and encourage firms to reduce their systemic footprint. Brainard called the proposal “a significant step in tier-ing regulation” and said it is important to note that the enhanced standards will only apply to institutions well above the $50 billion floor designated by the Dodd-Frank Act. Yellen said financial institutions should hold more high-quality assets, and that the proposal imposes “meaningful additional capital requirements.” She commented that she was “pleased” that staff went beyond Basel, saying it was appropriate.
The proposal was approved in a unanimous vote.
For the meeting memoranda, Federal Register Notice and opening statements, please clickhere.
For the video of this event, please click here.