Time is tight for the Federal Reserve’s effort to redraw US bank capital rules, but they shouldn’t rush the job. The better course would be to take a step back and delay a set of proposals that have nowhere near enough support from the industry, politicians or even many regulators themselves.
Tuesday was the deadline for feedback on the rules, which are meant to implement for US banks the final post-2008 global standards, nicknamed the Basel III Endgame. But the version written by the Fed and other US regulators is tougher in many ways than what other countries are adopting. In turn, the complaints and objections from people, businesses, banks and pressure groups that have been filed to the Fed this month are much stiffer, too.
The US proposals are certain to be tweaked regardless of arguments about how much extra capital they demand at big banks. The rules as drafted contain too many deficiencies, errors that have been fixed elsewhere and overlaps with other US regulation. But rushing to make changes just to meet regulators’ own July deadline would be a mistake and could prove costly to both the industry and its overseers.
There are two big traps ahead. First, banks are preparing to fight the regulators in court, a highly unusual strategy that could drastically upset working relations between the two sides for years to come. The Bank Policy Institute, a trade association, is working on the legal options on behalf of banks. Jeremy Barnum, JPMorgan Chase & Co.’s chief financial officer, told reporters last Friday that it’s never banks’ preferred option to sue their regulators, but it had to remain on the table for rule changes with such a significant impact as these.
The second trap is this year’s elections. A Republican president would very likely move quickly to change, or ditch, the rules again. Playing Hokey-Cokey with regulations only adds costs and uncertainties to banks, their customers and the Fed, while helping no one.
So, how can regulators avoid these pitfalls? They could withdraw the proposal, rewrite the rules and re-propose them later. The BPI and others such as David Solomon, chief executive officer of Goldman Sachs Group Inc., have called for this. “My view is the rule was not proposed appropriately, and it should be withdrawn and re-proposed,” he said on the bank’s earnings call Tuesday.
Michael Barr, the Fed’s vice-chair for supervision who is leading the overhaul, has said repeatedly that he would listen to feedback and be open to changes. But scrapping the project and starting again may be too much of a climbdown for him and his team to bear.
Still, there is another way. One solid objection behind calls to withdraw the proposal, which came up several times in Senate committee hearings last year, is that there was no proper review of the costs and benefits to banks, financial markets or the wider economy. Other countries have done comprehensive impact studies to assess how the final Basel rules would affect individual banks and their business lines — and what that would mean for the wider world. These analyses helped tailor the regulations to ensure that their purpose could be preserved while overly costly consequences were avoided.
US regulators could hit pause on their plans and do assessments, not only of these proposals, but also of the ways in which they might interact with capital markets or double-up the capital demands derived from annual stress tests, for example.
It’s entirely possible to mend this process, and some leading industry complaints are easily fixable. For instance, it wouldn’t take much to remove disincentives for funding green infrastructure, or to cut the punitive costs of dealing with companies or pension funds that don’t issue public securities. European regulators fixed something very similar to the latter example.
UK and European regulators also already found a workable answer to the US problem of how historic fines and legal costs should be used to help calculate potential future losses from things like fraud and computer failures — also known as operational risks. The currently proposed US method is significantly more costly but could be changed quite simply.
However, there are bigger problems with the US approach to operational risk — these have to do with measuring the size of the businesses based on charging fees rather than making loans or trading. And there’s an even bigger problem with the double-counting of risks between these proposals and the US’ unique use of stress tests to set a large chunk of big banks’ capital requirements each year.
After some adjustment, the Fed’s proposals might still be the right answer for US bank capital, but the current stress test regime might then have to be completely overhauled or scrapped. The lack of a comprehensive analysis of the pros and cons across the US financial system leaves everyone flying blind and gives the industry an easy route to suing the rule makers, too.
Regulators should pause and reflect. Getting this right is far more important than getting it done.
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