The politicians who crafted and ultimately passed the Dodd-Frank financial reform bill last year made some big promises about how the law would boost safety and soundness at America's biggest banks, but the biggest blow for bank safety and soundness may have been struck in Basel, Switzerland this week. From Huw Jones at Reuters:
Global banking regulators have agreed on a proposal to slap an extra capital charge on the world's biggest banks to make them safer by 2019.
The surcharge is part of a series of regulatory reforms launched in response to the financial crisis, which forced countries worldwide into costly bailouts of their banking sectors to prevent systemic collapses.
The Group of Governors and Heads of Supervision (GHOS) said after a meeting in Basel on Saturday the proposal would be put out to public consultation next month.
"The additional loss absorbency requirements are to be met with progressive common equity tier 1 capital requirement ranging from 1 percent to 2.5 percent, depending on a bank's systemic importance," the group said in a statement.
An additional 1 percent surcharge would also be imposed if a bank becomes significantly bigger, pushing the total to 3.5 percent.
The plans, which need approval from world leaders (G20) in November, would be phased in between January 1, 2016, and end of 2018.
Known as the systematically important financial institutions, or SIFI, surcharge, this extra reserve of capital will likely help banks weather severe financial crises more effectively. What's more, banks will have to use more solid assets to satisfy these requirements than had been expected. Banks were hoping to use shakier assets such as contingent capital, a sort of insurance policy that pays out in case of a financial crisis, rather than harder assets.
International agreements on bank safety are crucial for a couple of reasons. One is most of the SIFIs stretch across many different countries, so even if the U.S. effectively regulated banking operations within its borders, those banks could still be at risk from financial crises originating in their overseas operations.
The second is that in the absence of international standards, some SIFIs would seek out countries with the loosest regulations and create a huge incentive for countries seeking to become a base of operations for SIFIs to engage in a regulatory "race to the bottom."
In addition to the safety and soundness benefits of the new requirements, Reuters blogger Felix Salmon also points out they may bring some balance to the global banking market. Right now, SIFI institutions gain a huge advantage from investors believing they'll be bailed out by world governments in a financial crisis.
These more stringent capital requirements will offset that advantage to a certain extent, because banks will necessarily earn a lower return on investment on the capital they're forced to set aside to meet them.
The takeaway for consumers is that if their bank is a SIFI, it will be more secure and less subject to a chaotic government bailout than before. If they choose to bank at a small or midsized bank, a more level marketplace could make their bank less likely to be absorbed into a larger institution.
What do you think? Is forcing banks to meet expensive capital requirements a good idea? Or should banks be left to their own devices?