The Federal Reserve’s principal regulator of the banking industry, Michael Barr, on Thursday reiterated plans to study capital requirements and other safeguards to protect lenders and consumers in a downturn, and said more specific proposals from the central bank would come early in 2023.
The U.S. Federal Reserve will soon launch a holistic review of its full range of regulations as part of Barr’s effort to adapt the banking system to address emerging risks. That review could include consideration of higher capital requirements, counter-cyclical buffers and other measures, Barr said.
“We are looking not only at how capital standards are working today, but also how they may work in the future, when conditions are different,” said Barr, who took the job in July as vice chair of supervision for the U.S. Federal Reserve.
Items on the table include surcharges for the U.S.’s six global systemically important banks, or G-SIBS, which include JPMorgan Chase & Co.
Goldman Sachs Group Inc.
Bank of America Corp.
and Wells Fargo & Co.
The Fed is also taking a look at supplementary leverage ratios, stress testing, consideration of higher capital requirements, the introduction of counter-cyclical buffers and other measures, Barr said.
Asked about the impact of volatility in the digital currency sector, Barr said turmoil in the crypto markets after the collapse of crypto brokerage firm FTX “is a good example of what happens with firms that set themselves up to avoid a regulatory structure.”
While regulators must avoid stifling innovation, rules on fraud, custody and co-mingling customer funds with trading activities would have minimized some of the risks that are currently roiling the crypto world, he said.
His remarks came in a talk entitled, “Assessing the Federal Reserve’s Capital Framework: A Conversation with Federal Reserve Vice Chair Michael Barr,” hosted by the American Enterprise Institute.
If the government fully backs lenders no matter what, banks will be inclined to take on more risk. Instead, bank regulators need to strike a balance to protect consumers against another severe downturn such as the global financial crisis that upended the economy after the collapse of Lehman Brothers in 2008.
“Capital regulation — requiring a bank to operate with what is deemed to be an adequate level of equity based on its asset size and its risks — is a useful tool to strengthen the incentives for banks to lend safely and prudently,” Barr said. “We have to be humble about our ability to forecast the future.”
The COVID-19 pandemic was unexpected and took the banking system by surprise, but the government stepped in with the PPP loan program, he said.
Instead of relying on taxpayers to bail out banks through an act of Congress, Barr supports requiring capital requirements to allow banks to handle economic upheaval on their own, he said.
The American Enterprise Institute invited Barr to speak after the banking chief has been highlighting efforts by the Fed to study a variety of capital requirements, which regulators require to protect banks and consumers from systemic risks.
Banks have argued that they are already safe and that increased capital requirements will divert money away from loans that could help stimulate the economy.
JPMorgan Chase & Co. CEO Jamie Dimon said at an appearance in Congress in September that increased capital markets “raise the cost of lending and damage markets.” The capital requirements, he said, will restrict lending “at precisely the wrong time” as the economy weakens.
Also Read: Bank CEOs push back on capital requirements in Capitol Hill hearings
Meanwhile, others continue to spot vulnerabilities in the banking system.
Christopher Whalen, the chairman of Whalen Global Advisers, recently made the bold case that banks were short by more than $1 trillion in capital at the end of the second quarter, and that it’s only going to get worse as the Fed keeps hiking interest rates.
Also Read: Banks are short more than $1 trillion in capital, says this analyst, who fears the shortfall will only get worse
The U.S. Federal Reserve has been studying increased capital requirements not only for the seven U.S. megabanks but also upping its total loss absorbing capacity (TLAC) requirements for large regional banks with $250 billion or more in assets.
Also Read: Federal Reserve studying new capital requirements for regional banks amid merger parade
Thursday’s speech by Barr comes about two weeks after he said market volatility and other headwinds “may also reveal pockets of excess leverage and liquidity risk in the non-bank financial sector, which risks spillovers to the banking system and the real economy,” according to remarks on Nov. 16 to the Committee on Financial Services at the U.S. House of Representatives.
Also Read: Fed’s Barr expects ‘significant softening’ in economy and rising unemployment
At that time, Barr said the collapse of FTX and price drops in the crypto market, “have highlighted the risks to investors and consumers associated with new and novel asset classes and activities when not accompanied by strong guardrails.”
Also Read: CFTC chief calls for ‘comprehensive’ rules to head off another FTX collapse