Quarles Calls for ‘Further Calibration’ of Leverage Capital Standards

In a lengthy farewell speech today as his tenure on the Federal Reserve Board of Governors comes to a close, former Vice Chairman for Supervision Randal Quarles outlined several “further refinements to the bank supervisor and regulatory framework” that still need to be made in the near term, including further calibration of leverage capital standards.

Quarles warned that a binding leverage ratio “or even one that threatens to become binding—may discourage banks from engaging in safe activities, such as those involving U.S. Treasury securities.” He called for the recalibration of the fixed 2% enhanced supplemental leverage ratio buffer requirement to equal 50% of the applicable G-SIB surcharge, with corresponding recalibration at the bank level—an approach endorsed by the Basel Committee.

“Whatever the form of the adjustment, this issue needs to be addressed to ensure that our capital framework does not lead to increased risk taking and reduced safe-asset intermediation,” Quarles emphasized. “As it stands, we are driving deposits out of the highly regulated banking system and requiring that cash be held in other, less stable parts of the financial sector, such as money market funds. If we enter another crisis with this issue unaddressed, the leverage ratio fundamentalists will have much to answer for.”

Among other things, Quarles also addressed additional changes that may be required as regulators work to implement the Basel III reforms; the need to address volatility in the Fed’s stress testing framework; issues related to supervision; and lessons learned from the COVID-19 event.

Quarles also touched on the future of the Financial Stability Board, as his term as chairman expired yesterday. (Quarles’ successor, Klaas Knot, president of De Nederlandsche Bank, began his term today.) Among the top priorities for FSB in the near term will be addressing vulnerabilities related to non-bank financial intermediation, or shadow banking, he noted.

While he noted that FSB has made progress in this area—highlighting recent work to address structural vulnerabilities in money market mutual funds—he warned that “we cannot lose momentum” and noted that additional work must be done on “specific risk areas, such as open-ended funds and margining practices, that appear to have contributed to stress during the COVID event.”

He added that “we also need to develop a shared understanding of how vulnerabilities in the NBFI sector may cause spillover effects or impact broader market functioning in the future.”

In previous comments to the FSB, the American Bankers Association emphasized that any changes to money market funds should not include changes for regulated banks, and that FSB should carefully balance the need for increased stability with the viability of these funds for investors.