8-8-18 12:35 PM EDT | Email Article

Systemic Risk Council Opposes Federal Reserve and OCC Proposals to Reform Leverage Ratio and Volcker Rule

On August 8, 2018, the Systemic Risk Council submitted a comment letter to the Federal Reserve Board of Governors and the Office of the Comptroller of the Currency on their proposals to relax the enhanced supplementary leverage ratio for big banks, and the so-called “Volcker Rule” constraints on using insured deposits to fund speculative trading and investments.

While in principle the Systemic Risk Council (SRC) supports the desire to simplify the current regulatory regime, the SRC believes the current proposals would make the US banking system materially less resilient and so expose the American economy and people to unnecessary risks. As such, the SRC is proposing an alternative way forward.

Leverage Ratio

The Federal Reserve (Fed) and Office of the Comptroller of the Currency (OCC) acknowledge that, while leaving capital in group holding companies broadly unchanged, this proposal would enable the large banking entities themselves to reduce their equity relative to total assets. The SRC’s letter offers four sets of reasons for not taking such action:

  • The reduced arsenal of the macroeconomic authorities, notably the Fed, is liable to exacerbate future recessions, so that banks need more rather than less equity if they are to maintain the standard of resilience desired after the crisis of 2008-2009;
  • Resilience is already being reduced by the recently-enacted legislative amendments to Dodd-Frank, the failure to implement the Net Stable Funding Requirement, and the proposed relaxations to the Volcker Rule;
  • Allowing dealers to lever up more would blunt the incentives of market participants to invest in necessary improvements to the trading infrastructure for fixed-income capital markets, as they could go back to relying on government-subsidized market making; and, crucially,
  • It is the resilience of operating banking subsidiaries that matters most, because it is they, not holding companies, that supply services to households and businesses. The current proposals are inconsistent with the policy behind earlier US legislation that requires operating banks to be subject to requirements enabling prompt corrective action.

The SRC has proposed an important mitigating measure if, despite those arguments, the Fed and OCC stick to their current course. It is that any reduction, relative to total assets, in the tangible common equity of operating banks should be offset by an equivalent increase in the amount of deeply subordinated bailinable debt issued by operating banks to their holding companies. The effect would be to leave unchanged the total amount of loss-absorbing capacity, while shifting its composition from equity to debt.

Volcker Rule

The principle underlying the Volcker Rule is that banks and dealers benefiting from access to Fed liquidity insurance and FDIC deposit insurance, backed ultimately by taxpayers, should not be in the business of speculative trading and investment; or, more generally, that such commercial activities should not have access to a government safety net.

The SRC has serious reservations about one aspect of the regulators’ proposals, which amount to giving more discretion to the management of banking groups to determine what are “market making” or “hedging” services provided to clients. This echoes the big mistake made by the Basel Committee when it allowed banks’ internal models to determine their capital requirements. Given the incentives banks face, the current proposal risks eroding the core substance of the Volcker Rule.

The SRC has urged the Fed and its fellow regulators to explore alternative means of simplifying the Volcker Rule without jettisoning the policy itself.

The full text of the letter is available here: https://www.systemicriskcouncil.org/2018/08/systemic-risk-council-opposes-federal-reserve-and-occ-proposals-to-reform-leverage-ratio-and-volcker-rule/

For further information please contact David R. Evanson at devanson@comcast.net or 215.460.8149 or Bristol Voss at bristol.voss@cfainstitute.org or 212.705.1738

     

Notes for Editors:

 
(1)

The independent, non-partisan Systemic Risk Council (www.systemicriskcouncil.org) was formed to monitor and encourage regulatory reform of U.S. and global capital markets, with a focus on systemic risk.

 
(2) The Council is funded by the CFA Institute, a global association of more than 125,000 investment professionals who put investors’ interests first and set the standard for professional excellence in finance. The statements, documents and recommendations of the private sector, volunteer Council do not necessarily represent the views of the CFA Institute. The Council works collaboratively to seek agreement on each of its recommendations.
 
(3) The enhanced supplementary leverage ratio (eSLR) is an additional leverage requirement that applies to (and only to) banking groups that have been designated as global systemically important banking organizations (GSIBs). It is currently 6% for insured depository institutions (i.e., operating banks) (IDIs) that are subsidiaries of such GSIBs; and 5% for the consolidated group holding company. Under the proposed changes to the eSLR, both GSIB operating banks and holding companies would be subject to an additional leverage buffer equal to 50% of its GSIB risk-weighted capital ratio surcharge. The Fed and OCC estimate that as a result of this proposed change the amount of tier 1 capital required to held by the lead GSIB IDIs (ie the operating banks) would fall by approximately $121 billion from the amount required under the current eSLR standard.
 
(4)

The note about amendments to Dodd-Frank is referencing S. 2155, the Economic Growth, Regulatory Relief and Consumer Protection Act, commonly referred to as the Crapo Bill. The SRC wrote a comment letter on this legislation back in February (https://www.systemicriskcouncil.org/2018/02/systemic-risk-council-comments-on-the-s-2155-the-economic-growth-regulatory-relief-and-consumer-protection-act/).

 
 

Systemic Risk Council Membership

 

Chair:

    Sir Paul Tucker, Fellow, Harvard Kennedy School and Former Deputy Governor of the Bank of England

Chair Emerita:

Sheila Bair, Former Chair of the FDIC

Senior Advisor:

Jean-Claude Trichet, Former President of the European Central Bank

Senior Advisor:

Paul Volcker, Former Chair of the Federal Reserve Board

Members:

 
Brooksley Born, Former Chair of the Commodity Futures Trading Commission
 
Baroness Sharon Bowles, Former Member of European Parliament and Former Chair of the Parliament’s Economic and Monetary Affairs Committee
 
Bill Bradley, Former U.S. Senator
 
William Donaldson, Former Chair of the Securities and Exchange Commission
 
Peter R. Fisher, Tuck School of Business at Dartmouth, Former Under Secretary of the Treasury for Domestic Finance
 
Jeremy Grantham, Co-Founder and Chief Investment Strategist, Grantham May Van Otterloo
 
Richard Herring, The Wharton School, University of Pennsylvania
 
Simon Johnson, Massachusetts Institute of Technology, Sloan School of Management
 
Jan Pieter Krahnen, Chair of Corporate Finance at Goethe-Universität in Frankfurt and Director of the Centre for Financial Studies
 
Sallie Krawcheck, Chair, Ellevate, Former Senior Executive, Citi and Bank of America Wealth Management
 
Lord John McFall, Former Chair, UK House of Commons Treasury Committee
 
Ira Millstein, Senior Partner, Weil Gotshal & Manges LLP
 
Paul O’Neill, Former Chief Executive Officer, Alcoa, Former U.S. Secretary of the Treasury
 
John Reed, Former Chairman and CEO, Citicorp and Citibank
 
Alice Rivlin, Brookings Institution, Former Vice-Chair of the Federal Reserve Board
 
Kurt Schacht, Managing Director, Standards and Advocacy Division, CFA Institute
 
Chester Spatt, Tepper School of Business, Carnegie Mellon University, Former Chief Economist, Securities and Exchange Commission
 
Lord Adair Turner, Former Chair of the UK Financial Services Authority and Former Chair of the Financial Stability Board’s Standing Committee on Supervisory and Regulatory Cooperation
 
Nout Wellink, Former President of the Netherlands Central Bank and Former Chair of the Basel Committee on Banking Supervision
 
 
* Affiliations are for identification purposes only. Council members participate as individuals and this letter reflects their own views and not those of the organizations with which they are affiliated.
 

for Systemic Risk Council
Bristol Voss, 212-705-1738
bristol.voss@cfainstitute.org
or
David R. Evanson, 215-460-8149
devanson@comcast.net

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