USA TODAY International Edition
Fed bank downsizing rule honors Dodd- Frank reform
The Federal Reserve marked the fifth anniversary of the Dodd- Frank financial reform act with its toughest action yet to make banks downsize.
But the impact of the Fed’s new requirements for equity capital at the nation’s eight biggest banks is due more to the determination of Daniel Tarullo, the longest- serving governor on the Fed board, than to anything in the law itself.
It was Tarullo who pushed through the capital surcharge for megabanks as the way to partially fulfill the Dodd- Frank mandate for enhanced prudential requirements for banks and other financial institutions whose failure would endanger the entire financial system.
And it was Tarullo who toughened the international accords on the surcharges so the extra capital buffer required of these banks is twice as high as it would have been under the minimum requirements of those agreements.
The former Georgetown law professor, an adviser to Barack Obama during his 2008 presidential campaign and the new president’s first appointee to the Fed board, shows how Dodd- Frank works best when regulators charged with translating the law into rules enthusiastically follow not only the letter of the reform but the spirit.
Tarullo’s enthusiasm contrasts with the foot- dragging at other regulatory agencies — notably the Securities and Exchange Commission under chairs Mary Schapiro and Mary Jo White — which have been far slower in implementing Dodd- Frank rules.
Equity capital is expensive, and requiring a surcharge of 1% to 4.5% of capital on top of the 7% capital ratio for all banks penalizes these big banks for their size while providing an extra capital buffer to cover losses should they run into trouble.
“In practice, this final rule will confront these firms with a choice,” Fed chair Janet Yellen said in the open meeting Monday as the Fed board unanimously approved the capital surcharges. “They must either hold substantially more capital, reducing the likelihood that they will fail, or else they must shrink their systemic footprint, reducing the harm that their failure would do to our financial system. Either outcome would enhance financial stability.”
Tarullo kept his comments to some cut- and- dried observations about the rule that included the threat of making the capital surcharge part of its annual stress tests, which would effectively require banks to create a further buffer for this capital buffer.
He also emphasized that the Fed had gone beyond the requirements of the Basel Committee on Banking Supervision, the Swissbased body that coordinates international banking regulation, by making a bank’s reliance on short- term securities for funding a key component in determining the amount of the surcharge.
If a bank relies on this wholesale funding instead of retail customer deposits, it is much more vulnerable to a “run” by creditors when markets seize up, as they did in the financial crisis of 2008.
Tarullo reminded the banks, in case they had forgotten, that the Fed is implementing other tools to penalize this reliance — such as a “Liquidity Coverage Ratio” already approved by the board and a “Net Stable Funding Ratio” it will take up later this year.
The big banks — including JPMorgan Chase, Citigroup, Bank of America and Goldman Sachs — don’t like the new rule, but they have already responded to the pending changes by raising capital and jettisoning less profitable operations to reduce capital requirements.
JPMorgan, the nation’s biggest bank, for instance, faces the biggest surcharge requirement — 4.5% — and will need to raise an additional $ 12.5 billion in capital or reduce its balance sheet as the rule is phased in over the next three years. But that amount is already much lower than the $ 20 billion addition it faced in December, when the rule was first proposed, due to actions by the bank to close down or spin off activities such as trading in physical commodities.
The anniversary of the financial reform signed into law July 21, 2010, has brought interviews and comments from the Democratic lawmakers whose names are on the act — former Connecticut senator Chris Dodd and former Massachusetts Rep. Barney Frank — as well as Republican critics such as Texas Rep. Jeb Hensarling, current chair of the House Financial Services Committee.
But now the act now belongs to history and to the regulators charged with enforcing it, and it is the action by Tarullo and the Fed to push banks to downsize that is the most fitting way to honor Dodd- Frank.