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Changes are coming to the so-called Basel III endgame — which would raise cumulative capital requirements for large banks by 16% — but whether regulators modify the current proposal or unveil an
Depending on the tack taken by the Federal Reserve, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency, adopting new capital rules could take anywhere from a few months to well over a year. And their specific changes could result in a wide range of outcomes.
For banks keen on adjusting their business models and balance sheets to meet regulatory standards as quickly as possible, this uncertainty means having to prepare for all possibilities.
"Our institutions don't know what the path forward is, so they're going to operate on the basis of being prepared for whatever outcomes may occur," said Kevin Fromer, president and CEO of the Financial Services Forum, a trade group for the eight largest banks in the country. "Investors expect our members to meet regulatory proposals long before they are implemented, and they therefore have to be able to manage their capital according to the best information that they have."
Francisco Covas, executive vice president and head of research at the banking trade group Bank Policy Institute, said the organization began advising its members to retain earnings and take other preemptive steps when the proposal was issued last summer.
The consensus view is that the final version of the rule — however it is reached — will include lower capital requirements than in the initial plan. But, Covas said the uncertainty means banks will have to be conservative until they know how and when those changes are likely to take effect.
"Until this gets resolved in terms of the timing, firms will be cautious on how they're going to deploy capital and take advantage of opportunities that arise," he said. "We are eager to know more details and exactly where things will eventually land."
Fed Chair Jerome Powell promised "
Last week, Powell said the central bank remains committed to implementing the international standards agreed upon by the Basel Committee on Banking Supervision in 2017. He added that the proposal is the agency's top regulatory priority, but said the Fed's board of governors has not settled on a course of action.
"We haven't made any decisions on policy or on process at all, nothing — no decisions have been made," Powell said during his
The FDIC and OCC declined to comment on the rulemaking process this week.
Agency rulemakings are governed by the Administrative Procedure Act, which requires policy changes to be put through a so-called notice and comment process for the public to weigh in on the proposal and voice concerns. Agencies must then absorb this commentary, respond to it and, where appropriate, use it to amend the final version of a rule.
Changes made to final rules must be a "logical outgrowth" of what was in the original proposed rule. Many in and around the banking sector argue that the changes needed for the Basel III endgame proposal exceed this standard, and therefore an entirely new rule should be put through its own notice and comment period.
"The rule should change significantly given the concerns raised by a broad spectrum of industries and organizations, the expected impact on the economy, the complexity of the rule, as well as the impacts it has on other parts of the capital framework and regulation," Fromer said. "With such significant changes expected, the industry and other interested parties should be able to understand those changes and comment on them to make sure there aren't unintended consequences. That would be a reasonable way forward for a rule that has raised very substantive issues and many process issues as well."
Others say the regulators have a wide berth for making changes under the logical outgrowth doctrine.
Jeremy Kress, a law professor at the University of Michigan and a former Fed lawyer, said agencies are given broad deference on what is a logical outgrowth. He added that the way regulators approached the Basel III endgame — by including 174 specific questions and alternatives for some provisions — gave them ample latitude to make changes without having to repropose.
"As long as they're in the realm of risk-based capital dealing with credit risk, operational risk and market risk, the agencies have opened those frameworks for such broad comment and have received such broad comment and on all aspects of those issues, that they have a pretty significant amount of leeway in going straight to a final rule," Kress said.
The Fed, FDIC and OCC received more than 400 letters about the Basel III endgame during an extended comment period of nearly six months. Even during typical rulemakings, the review process takes several months. But not only has the Basel III endgame proposal received more comments than usual, the commentary is also decidedly one-sided, with 97% of comments being negative, according to analysis by the law firm Latham & Watkins.
Shayna Olesiuk, director of banking policy for the consumer advocacy group Better Markets, said the extensive opposition has contributed to a narrative in and around the banking industry that reproposal is necessary. In reality, she said, many of the concerns can be addressed by making minor adjustments to the proposal.
"In many ways, the amount of opposition to the proposal does feel like new territory," Olesiuk said. "But despite this, we should not and cannot lose focus on the many important benefits of the rulemaking for the American people, like financial stability and increased lending through the ups and downs of the economic cycle."
Advancement of the Basel III endgame — be it finalization or reproposal — seems to hinge on the Fed governors arriving at what Powell has described as a
At the time of the proposal, Powell noted various areas that he would like to see comments on, including the proposal's impact on capital markets and operational risk management. He also flagged the fact that the proposal exceeds the standard set by the Basel Committee and comparable reforms being considered by regulatory agencies around the world — a point he reiterated last week, noting that the rule should be "faithful to Basel and also comparable to what the other large comparable jurisdictions are doing."
Jefferson has shared few comments on the proposal since it was released last summer. But, at the time, he expressed concern about the framework's impact on the banking sector and the broader economy.
Olesiuk, a former deputy director for deposit insurance and risk analysis at the FDIC, said there are numerous ways for regulators to tweak the proposal without touching its most critical components.
"Making adjustments on the credit side would be a reasonable trade-off to keep things like operational and market risk, which are much more meaningful in magnitude and materially bolster the capital framework," she said.
Some say the operational changes — specifically the shift away from banks being able to use internal models to standardized ones for calculating capital requirements — are the most onerous in the proposal and must be adjusted.
Other analysts have noted that changes could be made to reduce the overall capital burden of the reform. These might include amending the surcharge proposal for global systemically important banks, or GSIBs, that was put out alongside the Basel III reform or dropping the stress capital buffer requirement from the newly expanded risk-based approach.
Regardless of what trade-offs are made internally within the agencies, the final version of the rule — whether it arrives later this year or further down the line — will be heavily scrutinized by the banking industry, which has expressed a greater
"I hope and expect that the banking agencies want to get this done and want to get it done in a way that's going to shield it from industry challenges," Kress said.
