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From Banking and Finance Law Daily, December 9, 2014

Fed issues capital surcharge proposal

By John M. Pachkowski, J.D.

At its Dec. 9, 2014 meeting, the Federal Reserve Board approved a proposed rulemaking that would establish a risk-based capital surcharge for the most systemically important U.S. bank holding companies pursuant to Section 165 of the Dodd-Frank Act.

The proposal is based upon the international standard adopted by the Basel Committee on Banking Supervision and is augmented to address risks to U.S. financial stability. The proposed surcharge methodology generally would result in significantly higher surcharges than those determined using the international standard and would reflect a bank holding company's use of short-term wholesale funding.

The proposed rule would require a U.S. top-tier bank holding company with $50 billion or more in total consolidated assets to calculate a measure of its systemic importance and would identify a subset of those companies as global systemically important bank holding companies (GSIBs) based on that measure. Each GSIB would calculate a GSIB surcharge that reflects its systemic risk profile. The proposal would increase a GSIB's capital conservation buffer by the amount of its GSIB surcharge, such that the firm would be required to hold additional common equity tier 1 capital in order to avoid limitations on capital distributions and certain discretionary bonus payments. The proposed surcharge framework would be phased in beginning on Jan. 1, 2016, becoming fully effective on Jan. 1, 2019.

Identification of a GSIB. The proposal would use five broad categories correlated with systemic importance—size, interconnectedness, cross-jurisdictional activity, substitutability, and complexity—to calculate a numerical score that would be used to determine whether a U.S. bank holding company would be identified as a GSIB. Using year-end 2013 data, eight bank holding companies would be identified as GSIBs under the proposal.

The proposal provided that “The eight U.S. top-tier bank holding companies that are ‘covered BHCs’ under the enhanced supplementary leverage ratio rule’s definition are the same eight U.S. top-tier bank holding companies that would be identified as GSIBs under this proposal.” Those eight BHCs are: JPMorgan Chase & Co., Citigroup Inc., Bank of America Corp., Wells Fargo & Co., Goldman Sachs Group Inc., Morgan Stanley, Bank of New York Mellon Corp., and State Street Corp.

GSIB surcharge amount. A GSIB would calculate its surcharge under two methods. Method 1 would consider the GSIB’s size, interconnectedness, cross-jurisdictional activity, substitutability, and complexity, consistent with the methodology developed by the Basel Committee. Method 2 would use similar inputs, but generally would result in significantly higher surcharges than the Basel Committee framework and would replace substitutability with use of short-term wholesale funding. A GSIB’s resultant surcharge would be the higher of the surcharges determined under the two methods.

staff memorandum noted that the GSIBs’ surcharge amounts under the proposal using 2013 data would range from 1.0 to 4.5 percent, measured as a percentage of the GSIB’s risk-weighted assets.

Comments. Throughout the proposed rulemaking notice, the Fed has also posed a number of questions for comment on various aspects of the proposal. These questions relate to:

  • GSIB identification;

  • computing the applicable GSIB surcharge;

  • implementation and timing;

  • periodic review and refinement of GSIB identification and surcharge calculation; and

  • indicators of global systemic risk.

Important milestone. In her opening statement, Fed Chair Janet L. Yellen called the proposal “an important milestone in the Board's effort to mitigate the potential risks that systemically important financial companies could pose to financial stability and our economy.” She added the framework would provide incentives for GSIBs “to hold substantially increased levels of high-quality capital as a percentage of their risk-weighted assets,” which in turn, “would encourage such firms to reduce their systemic footprint and lessen the threat that their failure could pose to overall financial stability.”

Short-term wholesale funding. Fed Governor Daniel K. Tarullo stated that the proposal “lies at the intersection of two important principles of post-crisis regulatory reform: one is that strong capital requirements are central to ensuring a safe and sound financial system. The second is the relatively new principle that the stringency of prudential standards should be proportional to the systemic importance of regulated firms.” He added that, although the proposed surcharge levels are higher than required by the Basel Committee, they “should provide substantial net economic benefits by reducing the risks of destabilizing failures of very large banking organizations.” Finally, Tarullo noted that inclusion of reliance on short-term wholesale funding as one of five factors in the systemic significance formula is intended principally as a means for assuring the resilience of large firms that are in fact dependent on such funding. The Basel framework does not have reliance on short-term wholesale funding as a factor.

Industry reaction. The Independent Community Bankers of America® (ICBA) supports the Fed’s proposal to require a capital surcharge on systemically important financial institutions (SIFIs). “Imposing a capital surcharge on the nation’s largest, riskiest and most complex financial institutions is a positive step toward containing the too-big-to-fail threat and leveling the playing field between megabanks and the rest of the banking industry,” ICBA President and CEO Camden R. Fine said. “Reducing the risks that too-big-to-fail institutions pose to our economy is essential to mitigating their substantial funding advantage over community banks and supporting economic stability in local communities.”

The Financial Services Roundtable said, “Today’s proposal could affect the American financial industry’s ability to remain competitive in international markets,” said Richard Foster, FSR’s Vice President & Senior Counsel for Regulatory and Legal Affairs. “FSR supports regulations that improve financial stability and encourage consumer access to financial services, but holding U.S. banks to a more stringent capital framework than our global competitors could be a misguided economic decision.”

Companies: Bank of America Corp.; Bank of New York Mellon Corp.; Citigroup Inc.; Financial Services Roundtable; Goldman Sachs Group Inc.; Independent Community Bankers of America; JPMorgan Chase & Co.; Morgan Stanley; State Street Corp.; Wells Fargo & Co.

MainStory: TopStory BankHolding BankingOperations CapitalBaselAccords DoddFrankAct FederalReserveSystem FinancialStability

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