Fed’s Barr: 2008 financial crisis highlighted need for new capital standards

Federal Reserve Vice Chairman for Supervision Michael Barr today laid out his case for higher capital requirements for banks with more than $100 billion in assets during the American Bankers Association Annual Convention in Nashville, arguing that the private costs of capital must be weighed against the social benefits of creating a more resilient financial system. “Historical experience—particularly our experience during the [2008] Global Financial Crisis—demonstrates the severe impact that distress or failure at individual banking organizations can have on the stability of the U.S. banking system,” he said.

The FDIC, Federal Reserve and Office of the Comptroller of the Currency in July issued a proposal to implement the so-called “Basel III endgame” standards. Barr argued that the vast majority of U.S. banks would not be affected by the proposed standards. And while the result may be higher funding costs, “this is only half the story,” he said. “Capital also enables banks to absorb more losses without risking their ability to repay their creditors.”

First, the proposal would remove the use of banks’ internal models to set credit risk capital requirements, Barr said. “In the agencies’ experience, the subjective choices made for internal models have produced unwarranted variability across banking organizations in requirements for exposures with similar risks,” he said. Second, large banks have experienced significant losses due to operational weaknesses over the past two decades, and under the proposal, operational risk capital requirements would be standardized rather than modeled and would be a function of a banking organization’s business volume and historical operational losses, he said.

Finally, the 2008 financial crisis taught banks and regulators “many difficult lessons” about the importance of robust capital requirements, Barr said. “[Bank] models under the new framework would need to better account for the possibility of large outlier events—tail risk—and for the illiquid nature of some trading exposures.” At the same time, the proposal would “backstop” internal modeling with a new standardized approach to market risk, which would be applied to trading portfolios where banks are unable to demonstrate that their models adequately capture risk, he added.

ABA’s Nichols probes Barr on capital requirements, Bank Term Funding Program

During a Q&A, ABA President and CEO Rob Nichols challenged Barr on the need for the proposed capital standards as well as how open federal agencies have been in making available the data they used in drafting the regulations. “ABA and many other groups have highlighted the importance of having adequate opportunity for public review and comment on the data underlying the proposal,” Nichols said.

Asked why the proposed U.S. standards would be more stringent than those proposed by the Basel Committee and implemented in Europe, Barr said U.S. rules for capital in the last 15 years have been stricter than those in the European Union, but that agencies are open to public feedback on that aspect. He also disputed the assertion that the agencies were withholding information, arguing that the agencies released a 500-page preamble with the data that served as the basis for the proposal. They are also allowing 120 days for public comment instead of the 30-day minimum required under federal law, he added. “We’re really open to public input and we’re following the normal procedures of doing so.”

Outside of capital standards, Nichols asked Barr about reducing stigma surrounding the bank use of the discount window, as well as about possible changes to the Bank Term Funding Program that was established after the bank failures earlier this year, given that the program is set to expire in March 2024. Barr said banks are encouraged to use the discount window. He also said that while the BTFP contributed to calming markets in the wake of the failures, there are currently no plans for changes. Barr added that the deadline doesn’t mean loans need to be repaid by March 2024; just that no new loans can be made after that time.