Why Bigger ‘Capital Cushions’ Have Banks On Edge

US regulators want to require banks to add billions of dollars to their capital cushions in the aftermath of the collapse of several lenders in early 2023. The trio of US agencies proposing the new rules say they’ll make banks stronger by reducing their risk of insolvency. The biggest and most powerful Wall Street banks, for their part, say they’re resilient enough under existing requirements. They say that the changes would increase their costs and reduce their lending, stifling economic growth in the process, and that they plan to appeal to regulators to modify some provisions before they’re finalized.

1. What’s the proposal?

The plan lays out sweeping changes to the way that large and midsize banks account for, and protect against, the risks associated with their business. That includes big increases in the amount of capital banks must set aside as cushions. (A bank’s total capital is derived by subtracting the value of its liabilities from the value of its assets.) Under the plan:

• The eight biggest US banks — institutions such as JPMorgan Chase, Goldman Sachs, Bank of America and Citigroup — would have to increase their capital by about 19%. That amounts to roughly an additional $2 of capital for every $100 of assets held by a bank, on top of the $7 to $14 per $100 they already set aside. The variation in buffer amounts arises from the different “risk weights” assigned to products like government bonds or mortgages. The proposal includes a standardized approach to determine the credit, operational and trading risks of midsize and large banks, rather than relying on the lenders’ internal models. Those banking giants would also have to set aside an additional $13 billion in capital collectively as a surcharge for their designation as “systemically important” lenders whose collapse would pose a serious risk to the economy.

• Midsize banks with assets of $100 billion to $250 billion — such as Regions Financial Corp., KeyCorp and Huntington Bancshares Inc. — would also have to increase their capital levels, by about 5%. The resilience of such banks was called into question this year after bank runs caused the failure of Silicon Valley Bank and Signature Bank in March. Community banks would be exempted from the new rules.

2. Where did the idea for these capital rules come from?

The three US agencies behind the 1,089-page proposal — the Federal Reserve, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency — are making good on the US’s obligations under Basel III, an international agreement to overhaul bank rules that started more than a decade ago in response to the financial crisis of the late 2000s. Convened by the Bank for International Settlements in Basel, Switzerland, the agreement includes a raft of capital, leverage and liquidity requirements. It was finalized in 2017, but US progress toward its goals stalled during the Covid-19 pandemic.

3. How would the capital rules affect the banks?

Regulators say the stricter requirements would bolster the affected banks and ensure their solvency even in the worst foreseeable circumstances. But that protection comes at a price for the biggest banks: Bloomberg Intelligence says it could erase the $126 billion they hold in “excess capital,” or the amount that exceeds what’s required by liabilities and regulatory requirements. That could make it hard for those banks to continue rewarding investors with stock buybacks, as they did to the tune of $137 billion from 2020 to 2022, according to Bloomberg data. Already, banks reduced their buybacks by 63% in 2022, according to S&P Global Market Intelligence, after Fed “stress tests” found that banks needed to increase their cushions. The proposed rules would also subject midsize banks to the kind of stringent requirements that had been reserved for the largest lenders, forcing them to track and protect against losses associated with their investment holdings. The FDIC said that most banks currently have enough capital to meet the higher requirements.

4. What do the banks say?

The American Bankers Association called the proposal unnecessary and a threat to economic growth. The Bank Policy Institute warned that by restricting credit availability to individuals and businesses, regulators were pushing customers to “unregulated parts of the financial sector.” “This is great news for hedge funds, private equity, private credit, Apollo, Blackstone,” JPMorgan Chief Executive Officer Jamie Dimon said on July 14, after Michael Barr, the Fed vice chair in charge of bank supervision, gave an outline of the plan. After the plan was released, he called it “bad for America.” The Mortgage Bankers Association said one new rule that will make it more expensive to hold the riskiest residential mortgages will have a “devastating impact” on efforts to increase home purchases by Black and first-time buyers.

5. What’s the timeline for the new rules?

The agencies are accepting public comments on the proposal, including from the banks, through Nov. 30. The rules are scheduled to be phased in starting in 2025 and fully in place by July 1, 2028.

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