Consumers are encouraged to keep savings in the bank to cushion themselves against a job loss, medical bills or other financial emergencies. But how much savings should banks have to protect themselves -- and their shareholders and customers -- against a downturn in the bank's business?
That question is at the center of three Federal Reserve proposals that would help ensure banks maintain strong capital positions, enabling them to continue lending to creditworthy households and businesses even after unforeseen losses and during severe economic downturns.
"Taken together, the proposals would establish an integrated regulatory capital framework that addresses shortcomings in regulatory capital requirements that became apparent during the recent financial crisis," the Fed said in a statement.
The three proposals are all quite complicated and burdened by lengthy technical names that might cross anyone's eyes to try to read.
The first would increase the quantity and quality of capital banks are required to hold, revise the definition of capital, establish limitations on capital distributions and certain discretionary bonus payments if additional specified amounts, or "buffers," of a certain class of capital aren't met, and introduce a supplementary leverage ratio for internationally active banking organizations, according to the Fed.
The second would revise and harmonize the Fed's rules for calculating risk-weighted assets to enhance risk sensitivity and address weaknesses that have been identified over the past several years.
The third would enhance the risk sensitivity of the current rule for internationally active firms to better address counterparty credit risk and interconnectedness among financial institutions.
Fed Chairman Ben Bernanke explained that capital is important to banking organizations and the financial system because "it acts as a financial cushion to absorb a firm's losses."
"With these proposed revisions, banking organizations' capital requirements should better reflect their risk profiles, improving the resilience of the U.S. banking system in times of stress, thus contributing to the overall health of the U.S. economy," Bernanke said.
Fed Gov. Daniel Tarullo added that while rigorous capital requirements aren't a sufficient condition for a strong financial system, they are a necessary condition.
Each new requirement would apply to certain groups of banking institutions and be phased in over a period of time to reduce banks' compliance costs and minimize the effects of higher capital on lending.
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