The heads of the Basel Committee on Banking Supervision, an international bank regulatory body, reached a highly anticipated agreement Saturday to impose additional capital buffers on systemically risky financial firms.
The move is an attempt to strike a balance between strengthening financial stability across the globe by ensuring financial companies are not so over-leveraged that they cannot cover their liabilities, but without requiring them to hold so much additional reserves that it puts unnecessary constraints on economic growth.
“The agreements reached today will help address the negative externalities and moral hazard posed by global systemically important banks,” said Jean-Claude Trichet, the president of the European Central Bank and chairman of Basel’s governing board, in a press release.
The agreement reached by Federal Reserve Board Chairman Ben Bernanke and his counterparts in the European Union and across Asia at the two-day meeting in Basel, Switzerland, has a long way to go before it is enacted, however.
The agreement will go through a formal proposal and rule-writing process in each country that adopts it, allowing feedback to influence its contours. Like other international bank capital standards agreed to last year, which required all institutions’ capital levels to equal 7 percent common equity, known as Basel III, this agreement has until January 2019 to become fully implemented.
Specifically the additional capital surcharges agreed to Saturday would range on a progressive scale from 1 percent to 2.5 percent common equity Tier 1 capital depending on a bank’s systemic importance. The capital calculation is based on risk-weighted assets and share-holder equity and is used to determine a bank’s ability to absorb losses. The Basel Committee said it would factor “size, interconnectedness, lack of substitutability, global (cross-jurisdictional) activity and complexity when deciding the risk levels of financial firms” to decide where institutions fall in the range.
To create disincentives for the largest global institutions become more significant, banks risky enough to be required to hold the highest level of capital would be subjected to an additional 1percent surcharge if they increased their global importance, according the agreement.
Banks are sure to push back on the agreement, citing the slew of tougher standards coming down the pike from last year’s Dodd-Frank financial reform overhaul. For example, the Federal Reserve Board is required to also set heightened prudential standards for systemically significant firms, later this year.
But the capital levels are not as high as some regulators have discussed. Outgoing Federal Deposit Insurance Corp. Chairwoman Sheila Bair told a House subcommittee Wednesday she supported a 3 percent surcharge, and Federal Reserve Board Gov. Daniel Tarullo spooked markets a couple weeks ago when he suggested capital surcharges could go as high as 7 percent, which is a level closer to what U.K. regulators had been eyeing.
Congressional Democrats could question whether the standards are tough enough.
Several Senate Democrats including Sens. Sherrod Brown of Ohio, Jack Reed of Rhode Island and Jeff Merkley of Oregon, jumped on Acting Comptroller of the Currency John Walsh last week, calling for his ouster after he expressed caution that higher capital surcharges could weaken economic recovery.