RPC Reg Spotlight June 21, 2011

 

Regulatory Action in the Spotlight:

 

Risk-based capital requirements for large banks.

 

 

Adverse Effects:

 

  • Less capital available to lend.
  • Undermines international competitiveness.

 

 

Response of the Obama Administration:

 

The stated aim of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) is to promote the financial stability of the United States.  Under Section 171 of Dodd-Frank, three federal banking regulatory agencies adopted a final rule on June 17, 2011, that establishes a floor for the risk-based capital requirements applicable to the largest, internationally active banking organizations.  The rule, by the Federal Reserve Board (FRB), the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC), would require the nation’s largest banks to be subject to the same minimum capital requirements as smaller institutions.  Financial institutions with assets at or above $250 billion would be required to evaluate their capital requirements not only with an advanced approaches formula, but also by a general risk-based formula.  The banks would then comply with the more stringent interpretation.  The standards apply to banks, bank holding companies, and any other Federal Reserve supervised financial institution.

 

 

Impact on the United States:

 

The advanced measurement approach (advanced approaches) is a set of operational risk measurement techniques under the Basel II capital adequacy rules for banking institutions.   With approval of regulators, certain large banks are allowed to develop their own empirical models, tailoring risk weight to an individual asset, and set capital requirements for operational risk.  The general risk-based capital rules assign a risk weight for different types of balance sheet asset classifications only.  This provides limited flexibility in establishing appropriate capital requirements, and usually leads to higher capital retention.  Larger institutions would be required to calculate their risk-based capital requirements utilizing both methods and using the general risk-based rules as a floor.  This portion of the rule imposes significant economic costs in personnel and equipment as an institution has to essentially keep two sets of detailed books.  This may cause pressure on U.S. banks’ financial performance.  As a result, the banks may have to pass along costs to consumers in the form of higher fees or interest rates, or even curtail lending to keep their balance sheet in compliance.

 

Although adhering to the Basel framework for advanced approaches capital adequacy rules, non-U.S banks will not be subject to the capital requirements of Dodd-Frank.  Significant competitive disadvantages may arise from the uneven implementation of the capital requirements, with non-U.S. banks being allowed to hold lower minimum capital requirements than U.S. banks.  While a U.S. subsidiary of a foreign bank would be subject to the Dodd-Frank capital requirements for U.S. assets only, worldwide assets of U.S. banks would not be able to take advantage of advanced approaches rules for their non-U.S. assets, placing U.S. institutions in a position of competitive inequity.   

 

 

In Closing:

 

The new risk-based capital standards will force banks to retain additional capital, preventing funds which could have been made available for lending to enter the economy.  Furthermore, these large financial institutions will now have to bear the expense of essentially keeping two sets of books, and the added personnel and equipment expenses, to calculate both capital requirements.  In a statement on behalf of the American Bankers Association at a Senate hearing on June 15, 2011, Thomas P. Doyle cautioned, “In an effort to deal with the aftermath of the financial crisis, the response by Congress and the regulators has been to drive out allthe risk from the system in the name of safety and soundness.  The pendulum has swung too far in favor of tighter regulation, micro-management, and second-guessing.”

 

 

Relevant Action:

 

The Committee on Financial Services held a subcommittee hearing on June 14, 2011, entitled “Does the Dodd-Frank Act End 'Too Big to Fail'?"  A Senate hearing was held on June 15, 2011, by the Committee on Banking, Housing and Urban Affairs.