Fed to Resist Adding Capital Demand for Biggest Banks

The Federal Reserve is facing calls within its ranks to consider activating an obscure capital buffer meant to bolster big banks against coming storms when economic conditions are sunny.

But for now, those pushing to weigh the demand for billions of dollars in new capital haven’t persuaded the key agency staffers who are reviewing the decision, according to people familiar with talks among U.S. banking agencies.

Even as regulators appointed by President Donald Trump move to ease rules for Wall Street, prominent Fed leaders — including one of the three current governors — are arguing that the so-called countercyclical capital buffer could provide a vital safeguard against a sudden downturn. But officials in the trenches at the Fed and other agencies see current risks as too remote to justify using it, though they’ve discussed emerging economic factors that could shift their future thinking, said the people, who requested anonymity because the talks are private.

The buffer, which has never been used in the U.S., is meant to be activated when asset prices and credit are at risk of becoming overheated. But a new requirement for a heftier capital cushion on Wall Street — even a momentary one — would go against the recent trend of regulators dialing back such demands.

‘Cyclical Pressures’#lazy-img-327840218:before{padding-top:66.75%;}

Lael Brainard on April 3.

Photographer: Kholood Eid/Bloomberg

“If cyclical pressures continue to build and financial vulnerabilities broaden, it may become appropriate to ask the largest banking organizations to build a countercyclical buffer of capital to fortify their resilience and protect against stress,” Fed Governor Lael Brainard said in an April 3 speech, noting that the buffer was meant to be turned on about a third of the time.

Three presidents of regional Fed banks have made comments similar to Brainard’s in recent weeks, making this an unusually public debate on agency policy. But regional presidents don’t have a say in the decision to activate the buffer, which would be made by the Fed’s board.

Brainard is the lone Democrat among the three sitting members, and it’s unclear whether Chairman Jerome Powell and Vice Chairman for Supervision Randal Quarles share her view. They were installed in their roles by Trump, who has argued for looser reins on banks. Powell said in March that the U.S. has “high capital” in the system, and Quarles has said he’s not looking to lower bank capital.

The countercyclical buffer, set up in 2013 by the Fed, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp., is similar to tools being used in other countries. It’s supposed to be triggered by a general credit boom that isn’t backed by economic fundamentals.

Joint Decision

The Fed has indicated that any decision will be made “jointly with the OCC and FDIC,” and that the buffer will only be activated “when systemic vulnerabilities are meaningfully above normal.” It would take effect 12 months after the decision and return to zero 12 months later, unless regulators decide to keep it active.

“Some market participants have taken note of Governor Brainard’s remarks,” said Bill Nelson, chief economist of the Clearing House Association, a banking industry group that lobbies on behalf of its Wall Street members. Nelson, a former Fed official, wrote on the association’s website that the central bank would give real consideration to activating the buffer. “It seems possible, but I don’t think it’s likely now,” he said in an interview.

Comptroller of the Currency Joseph Otting said he hasn’t yet considered whether to activate the buffer, and an OCC spokesman said staff-level discussions among the agencies are ongoing. Spokesmen for the Fed and FDIC declined to comment on the talks.

‘Sustained Expansion’

Because the U.S. economy is “in a sustained expansion and at risk of growing financial imbalances,” now is the time for building capital, Kansas City Fed President Esther George said last week. Boston Fed President Eric Rosengren said in March that there may be good reason to mobilize the buffer, noting that post-crisis laws limiting regulators’ ability to intervene in a future crisis leave it as a potentially attractive safeguard.

The countercyclical buffer is “worth reviewing and considering,” Dallas Fed President Robert Kaplan said in an interview.

“We’re having intensive discussions” about it and other possible methods for reining in excessive risk-taking in the financial system, he said. “I’m not advocating for any one at this particular point.”

Other Countries

U.S. regulators routinely consider whether to use the buffer, most recently deciding on Dec. 1 that overall economic risks were moderate so there was no reason to impose it. But similar capital buffers are currently active in other countries, including 2 percent rates in both Sweden and Norway. The U.K. is set to ramp up its own to 1 percent in November. The U.S. buffer can go as high as 2.5 percent of a bank’s assets.

The biggest U.S. lenders already have complex targets for how much capital they must maintain relative to their risk-weighted assets, and the countercyclical buffer would add to that. The capital formulas are already in flux as a recent Fed proposal seeks to tie them directly to how well each bank weathers annual stress tests.

The banking industry has climbed out of its post-crisis trench and routinely reported record quarterly profits. Loan and lease balances have also been rising, up another $416 billion in 2017, a 4.1 percent gain from a year earlier.

Though Brainard said the overall risks of a dangerous economic decline are still moderate, she noted that employment may reach “levels not seen in several decades,” asset valuations “seem stretched” and cyclical pressures are building.

Stress Testing

Still, the Clearing House’s Nelson cautions that the capital buffer would only apply to 15 banks that represent about an eighth of the financial system, and those lenders are already subject to Fed stress-testing that has massive influence on their capital.

Applying an extra capital boost would “lead to an increase in the cost of borrowing and reduction in economic activity” and could force risks to move outside of those institutions, he said.

“It’s hard to see a situation in which the buffer would be the right tool to use,” Nelson said.

— With assistance by Rich Miller