Federal regulators are poised to increase risk-capital requirements on large banks, but not before addressing some key criticisms of their proposal.
Leaders of the Federal Reserve, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency seem to be in strong alignment on new risk-based capital rules for banks with at least $100 billion of assets and they have — at least tentatively — enough support within their agencies to enact the plan.
But ensuring the rules — which would increase aggregate capital obligations within the affected banks by an average of 16% — are not scuttled by a legal challenge or congressional intervention could require regulators to address concerns raised by outside groups and members of their governing boards.
Fed Gov. Philip Jefferson, who voted yes on issuing the proposal,
"I will evaluate any future proposed final rules on their merits," Jefferson said during an open meeting last Thursday. "My views on any proposed final Basel III endgame requirements for U.S. banking organizations will be informed by the potential impact on banking-sector resiliency, financial stability and the broader economy stemming from the implementation."
When introducing their proposal, regulators noted that the new regulatory burdens would weigh heaviest on global systemically important banks, which will see their average aggregate capital increase by 19% compared with just 10% by other banks with at least $250 billion of assets. Fed Vice Chair for Supervision Michael Barr, the architect of the reforms, also said most banks already have sufficient capital to meet the requirements of the proposed rules and those who do not could raise the additional equity needed within two years.
But, when pressed for details, Fed staffers simply stated that their analysis determined that the additional costs associated with the new regulatory regime would be outweighed by loss-prevention benefits of higher capital.
Jefferson was not the only interested party left wanting for more specifics. Lawyers, analysts and trade groups say the analytics included in the proposal were scant considering its potentially sweeping implications.
"One of the surprises about the proposal is the relative lack of quantitative analysis about its potential impacts — either of its benefits or of its costs," said Andrew Olmem, a partner at the law firm Mayer Brown. "The analysis is only 17 pages in a 1,100 page proposal. This issue was even raised by several members of the FDIC and the Fed. As a result, commentators are likely to argue that more analysis is needed before the proposal should proceed."
Banks and their advocates were particularly critical of the proposal, noting that the document provided little evidence of the monthslong
"While we will comment extensively on the proposal and recommend changes to avoid economic harm, we remain disappointed that the agencies are moving forward without data, analysis, or findings from the Federal Reserve's holistic review on capital to justify such changes," said Kevin Fromer, head of the Financial Services Forum, a trade group representing the eight-largest financial institutions in the country. "The capital framework is a complicated and interconnected set of individual regulations. The public should have the ability to understand and respond to the findings of the holistic review, and to comment on specific rules in the context of other potential changes."
Last week's Basel III endgame proposal drew swift rebukes not only from banking groups, but also from housing advocates and mortgage industry associations, which worry that a new capital charge on mortgages with higher loan-to-value ratios will crimp credit availability for low- and moderate-income homebuyers. Even more generalist trade groups, such as the U.S. Chamber of Commerce, were critical of the rules and their lack of data disclosures.
"To date, the Federal Reserve Board has failed to meet its obligation to make public its policy assessment of why these rules are necessary," Tom Quaadman, executive vice president of the Chamber's Center for Capital Markets Competitiveness, said in a statement. "The Federal Reserve Board should make public the findings of its holistic capital review before attempting to advance these new rules."
For regulators, the issues around data disclosures could prove to be more than gripes from unhappy bankers. They could be grounds for litigation, Chen Xu, a lawyer with Debevoise & Plimpton, said, noting that the Administrative Procedures Act, or APA, requires regulators to consider the impacts of their proposed rules.
Fed Chair Jerome Powell also flagged several topics on which he would like to see public comments, including the impact on new capital obligations for market risks, the potential for regulatory arbitrage with other global regulatory regimes and whether the rules are sufficiently tailored to the size and riskiness of individual banks. Govs. Michelle Bowman and Christopher Waller, who voted against the proposal, expressed concern about those same topics.
Because of these publicly disclosed concerns by Fed leaders, Xu said, regulators will face additional pressure to address these issues in their final proposal. At the same time, he said, they will have to be careful not to change the framework so much that it necessitates issuing another proposal.
"The agencies have timelines to work toward, and the proposals will have been sitting out there for quite a while, so the agencies have a very strong incentive to not re-propose, even if that is the right thing to do," Xu said. "At the same time, the Fed board members were unusually candid in acknowledging questions that need to be answered. It was striking to me that they even acknowledged the possibility for meaningful changes in the final rule."
The APA also sets standards for when a new proposal must be issued, Xu noted, creating another possible pathway for a legal challenge. But, under the law's "logical outgrowth" doctrine, agencies have quite a bit of leeway to argue that a final rule aligns closely enough with a proposal to avoid needing a fresh notice-and-comment process.
Open disagreements among board members are common at the FDIC, where members have explicit partisan affiliations. They are less common at the Fed, for which members are — at least in theory — appointed to serve terms that cross presidential administrations. The Fed also aims to build consensus on issues wherever possible and often holds votes in private.
The decision to discuss the topic openly drew praise from some in Washington.
"All of that was healthy. I'm glad they did it," former FDIC Chair Bill Isaac said. "You've got a debate here on whether to do these changes, and there's a lot of issues that need to be debated. I'm glad they put it out and debated it [in public]."
The public will have 120 days to weigh in on the proposed rule. After that, regulators would be able to revise the rules and then put them to a vote. Both the FDIC and the Fed only need a simple majority to enact the rule.
By the time that vote is held, the Fed will likely have added a seventh member, as Biden nominee
Still, losing Jefferson's vote would not bode well for the package's longevity, Derek Tang, co-founder of the Washington-based research firm Monetary Policy Analytics, wrote in a note last week.
Jefferson is the Biden administration's pick to fill the vice chair position on the board left open by Lael Brainard's
"The leadership needs his yes in the final vote — not just for numbers but because a vice chair dissenting against the decision would undermine its viability," Tang wrote. "So, the changes he wants will be reflected."
Still, even if Barr secures the support of his fellow board members, that might not be enough to ensure the long-term viability of his capital framework. Once passed, the rule could be blocked through the Congressional Review Act, which gives legislators the ability to strike down rules passed by agencies. If President Joe Biden is reelected next fall, he could veto such an action if it made it to his desk. But a potential Republican occupant of the White House could support such an act.
This dynamic raises questions about how much support the proposed rules enjoy in Congress. Republicans in the House and Senate have expressed strong opposition to capital increases in recent months. Some moderate Democrats in the Senate have also indicated their skepticism about regulatory changes. The proposal does not yet have a strong vocal proponent on Capitol Hill.
Todd Phillips, an independent consultant and former FDIC lawyer, said he expects the plan to enjoy strong support from Democrats in Congress. He said the initial response was muted because of other issues going on in Washington —
"As members take a look at it, I do imagine that there will be quite a bit of support for it," Phillips said. "Whether it will be enough to withstand a Congressional Review Act resolution in 2025, I don't know. It depends a lot on how the election goes. But I think there will be decent House support."
Xu said several elements of the Basel III endgame proposal broke from the Fed's normal approach to regulation in ways that could open the effort to additional scrutiny. The most noteworthy, he said, was the decision to abandon the previous commitment to keep the implementation of the international regulations without changing the overall amount of capital in the banking system.
"There was a general understanding between the agencies and Congress that the Basel III endgame should be capital neutral, but somewhere along the way, maybe after the bank failures earlier this year and with Barr at the helm, the agencies decided to take a different path," Xu said. "They seem to have made that decision unilaterally, which is a significant departure from how the agencies have historically operated."
