A senior Federal Reserve supervisor has outlined his vision for the future of capital in US bank regulation.
The Fed proposes to:
- Include a firm’s loss history in the calculation of operational risk capital
- Bring smaller banks into its supervisory regime
- Focus on the resilience of firms to withstand current and emerging risks
Speaking on 10 July 2023, Michael Barr, Vice Chair for Supervision of the Board of Governors of the Federal Reserve System (the FED), made it clear that the views in his speech were his own, and not those of the FED. In addition, there will be a long consultation process before the new rules are implemented. But despite these caveats, it’s clear that the FED is looking to increase regulatory capital levels for US banks. And that view is likely shaped in part by recent shocks to the US banking system, in particular the collapse of Silicon Valley Bank (SVB).
Loss data included
The speech is the first concrete statement from the FED that loss history will likely be included in the calculation of capital when the US implements Basel III.
Barr says that this will ‘…add risk sensitivity and provide firms with an incentive to mitigate their operational risk.’ It’s not clear what policy levers the FED has in mind for risk mitigation – for example, we don’t know whether the use of insurance will be taken into account when calculating operational risk capital.
It should be noted that this requirement is in line with Canada, but different to regulators in Europe (the European Banking Authority in the Eurozone and Bank of England) who have not included loss data in the capital calculation. The inclusion of loss data will likely mean significantly higher capital levels for US banks than for forms in jurisdictions that are not taking loss history into account. It will almost certainly also lead to higher capital levels for the largest and most complex firms.
ORX will continue to support members with an unparalleled loss database and community to inform modelling and benchmarking across jurisdictions.
Evolution of stress tests
Stress testing will see some changes. Whilst the FED thinks the stress test framework is a sound evaluation of banks’ resilience, it thinks that the operational risk element needs reviewing. The most significant regime, DFAST and CCAR, could be impacted by this. The ORX CCAR community will continue to support members with stress tests.
In addition, stress tests will evolve to better capture the range of risks that banks face. And the FED may use a range of exploratory scenarios to assess the resilience of firms to an evolving set of risks. In the speech, Michael Barr emphasises the limitations of regulators and risk managers in identifying emerging risks, and in predicting how risks can propagate through the financial system. A focus by the Fed on resilience is therefore the best way to ensure banks can withstand future challenges. The ORX Operational Resilience Community and working group is actively engaged in researching how firms are managing resilience, with recent research covering topics like impact tolerance. And our Top Risk Reviews and Operational Risk Horizon research keep members up to date about the risks that are top of the agenda for other risk managers and firms.
Smaller firms subject to the rules
More firms will be subject to the FED’s risk-based capital rules. Banks and bank-holding companies with assets of over $100 billion will now become subject to the regime. The FED thinks that this will be less of a burden for these firms under Basel III than current rules, due to the simplified and standardised nature of the new rules. And bringing smaller firms into the regime should reduce contagion risks in the system as a whole, such as the events that triggered the run on SVB.
Broadly, the FED sees the principal outcome of these changes as increasing capital requirements for the largest and most complex banks. Across the firm, this could increase capital by two percentage points, or an additional $2 of capital for every $100 of risk weighted assets.
The speech also covered small adjustments to the Global Systemically Important Bank (G-SIB) surcharge framework, no proposed changes to the Counter-Cyclical Buffer, calibration of the Enhanced Supplementary Leverage Ratio and the introduction of a long-term debt requirement.
