Federal Reserve Tightens the Screws On Financing Requirements For Biggest Banks With Adoption Of Basel III

Michael Teague  |

In a significant though by no means complete victory for the effort to reign in the various risks associated with too-big-to-fail financial institutions, the board of governors of the Federal Reserve on Tuesday approved implementation of the international regulatory framework laid out by the Basel Committee on Banking Supervision’s Basel III document.

Basel III was put together in 2009 as a response to the previous year’s global financial meltdown. The document was focused in particular on reducing risk in the banking sector by creating a global framework for applying more strict and uniform capital requirements and leverage ratios on the world’s biggest financial institutions.

In the US, banks have already had to contend with more strenuous capital requirements as a result of the 2010 Dodd-Frank financial regulatory act and subsequent stress-testing. The provisions of Basel III would strengthen capital requirements even further by, among other stipulations, forcing banks to maintain a 7 percent equity-to-risk ratio. Under the plan, securities that are considered safe, such as US Treasury notes, are beholden to no minimums while riskier loans will need to be backed over 100 percent.

The Fed has indicated that these rules will mostly affect the largest and most complex financial institutions in the US, removing most of the burden from smaller regional and community banks whose success or failure have little chance of triggering a worldwide financial crisis in the same way as their substantially bigger peers. Additionally, insurance companies have been given at least a momentary reprieve, as savings and loan holding companies who are substantially involved in underwriting will be exempt from the new requirements, though the Fed is expected to eventually introduce a separate regulatory framework for the industry.

Instead, the new requirements will fall mostly on the shoulders of Wells Fargo (WFC), Citigroup (C), Bank of America (BAC), Goldman Sachs (GS), and Morgan Stanley (MS), and the most stringent of them will likely hit U.S. Bancopr (USB), Capital One Financial (COF), and General Electric’s (GE) GE Capital Corp.

While Tuesday’s decision was by no means unexpected, there were some surprises, particularly with the imposition of a leverage-ratio threshold above the minimum required by Basel III. Fed Chairman Ben Bernanke opened the meeting that introduced the new rules by saying that  the framework “requires banking organizations to hold more and higher-quality capital, which acts as a financial cushion to absorb losses, while reducing the incentive for firms to take excessive risks,” noting that the move would contribute to the tentatively improving health of the US economy.

The new regime introduced by the Fed on Tuesday will be submitted to the Basel Committee for review in order to measure how closely the regulations follow the guidelines laid out in Basel III.

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