Background on the Federal Reserve and Its Role
The Federal Reserve (Fed) of the United States, led by Chairman Jerome Powell, plays a crucial role in maintaining the stability and efficiency of the U.S. financial system. As part of its ongoing efforts to adapt to changing economic conditions, the Fed recently proposed adjustments to a key capital requirement for major banks.
The Proposed Changes to Capital Requirements
On Wednesday, the Fed voted 5-2 to propose amendments to a post-2008 global financial crisis measure that mandates banks to hold a certain amount of capital relative to their assets to withstand economic shocks.
The proposed changes aim to lower the “enhanced supplementary leverage ratio,” which is the ratio of own capital to assets, currently set at 5% for the largest banks.
Rationale Behind the Proposed Changes
Powell explained that the original rule was designed as a “safety net,” but over the past decade, banks have significantly increased their holdings of relatively safe and low-risk assets. He argued that, based on this experience, it is prudent to reconsider the initial approach.
“We want to ensure that the leverage ratio does not become a rigid constraint discouraging banks from engaging in low-risk activities, such as intermediation in the Treasury bond market,” Powell stated.
Support and Concerns
Vice President for Supervision at the Fed, Michelle Bowman, believes that the proposal will help strengthen resilience in Treasury bond markets.
However, Fed Governors Michael Barr and Adriana Kugler have expressed reservations about the plan.
Concerns Raised by Fed Governors
Barr warned that the proposal significantly reduces bank capital, thereby increasing risks associated with a large bank failure.
Kugler, on the other hand, questions whether the benefits to the Treasury bond market justify the proposed reductions in capital requirements, “especially considering the potential increase in financial stability risks.”
Industry Response
Rob Nichols, President of the American Bankers Association, hailed the initiative as a crucial step towards strengthening the financial system and reducing banks’ financing costs.
“We urge regulators to move swiftly to finalize these much-needed reforms,” Nichols added.
Key Questions and Answers
- What is the proposed change? The Fed proposes to lower the enhanced supplementary leverage ratio, which is the own capital to assets ratio for major banks from 5%.
- Why is this change being proposed? The original rule was established post-2008 financial crisis as a safety net. However, banks have increased their holdings of safe and low-risk assets over the past decade, prompting a reconsideration of this approach.
- What are the potential benefits? The proposal aims to encourage banks to participate in low-risk activities, such as intermediation in the Treasury bond market, thereby strengthening market resilience.
- What are the concerns raised? Critics argue that this change could increase risks associated with bank failures and may not justify the proposed reduction in capital requirements given potential financial stability risks.
- How has the banking industry responded? The American Bankers Association supports the proposal, viewing it as a crucial step towards strengthening the financial system and reducing banks’ financing costs.
