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Systemic Risk Council Opposes Federal Reserve and OCC Proposals to Reform Leverage Ratio and Volcker Rule

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On August 8, 2018, the Systemic Risk Council submitted a comment letter
to the Federal Reserve Board of Governors and the Office of the
Comptroller of the Currency on their proposals to relax the enhanced
supplementary leverage ratio for big banks, and the so-called "Volcker
Rule" constraints on using insured deposits to fund speculative trading
and investments.

While in principle the Systemic Risk Council (SRC) supports the desire
to simplify the current regulatory regime, the SRC believes the current
proposals would make the US banking system materially less resilient and
so expose the American economy and people to unnecessary risks. As such,
the SRC is proposing an alternative way forward.

Leverage Ratio

The Federal Reserve (Fed) and Office of the Comptroller of the Currency
(OCC) acknowledge that, while leaving capital in group holding companies
broadly unchanged, this proposal would enable the large banking entities
themselves to reduce their equity relative to total assets. The SRC's
letter offers four sets of reasons for not taking such action:

  • The reduced arsenal of the macroeconomic authorities, notably the Fed,
    is liable to exacerbate future recessions, so that banks need more
    rather than less equity if they are to maintain the standard of
    resilience desired after the crisis of 2008-2009;
  • Resilience is already being reduced by the recently-enacted
    legislative amendments to Dodd-Frank, the failure to implement the Net
    Stable Funding Requirement, and the proposed relaxations to the
    Volcker Rule;
  • Allowing dealers to lever up more would blunt the incentives of market
    participants to invest in necessary improvements to the trading
    infrastructure for fixed-income capital markets, as they could go back
    to relying on government-subsidized market making; and, crucially,
  • It is the resilience of operating banking subsidiaries that matters
    most, because it is they, not holding companies, that supply services
    to households and businesses. The current proposals are inconsistent
    with the policy behind earlier US legislation that requires operating
    banks to be subject to requirements enabling prompt corrective action.

The SRC has proposed an important mitigating measure if, despite those
arguments, the Fed and OCC stick to their current course. It is that any
reduction, relative to total assets, in the tangible common equity of
operating banks should be offset by an equivalent increase in the amount
of deeply subordinated bailinable debt issued by operating banks to
their holding companies. The effect would be to leave unchanged the
total amount of loss-absorbing capacity, while shifting its composition
from equity to debt.

Volcker Rule

The principle underlying the Volcker Rule is that banks and dealers
benefiting from access to Fed liquidity insurance and FDIC deposit
insurance, backed ultimately by taxpayers, should not be in the business
of speculative trading and investment; or, more generally, that such
commercial activities should not have access to a government safety net.

The SRC has serious reservations about one aspect of the regulators'
proposals, which amount to giving more discretion to the management of
banking groups to determine what are "market making" or "hedging"
services provided to clients. This echoes the big mistake made by the
Basel Committee when it allowed banks' internal models to determine
their capital requirements. Given the incentives banks face, the current
proposal risks eroding the core substance of the Volcker Rule.

The SRC has urged the Fed and its fellow regulators to explore
alternative means of simplifying the Volcker Rule without jettisoning
the policy itself.

The full text of the letter is available here: https://www.systemicriskcouncil.org/2018/08/systemic-risk-council-opposes-federal-reserve-and-occ-proposals-to-reform-leverage-ratio-and-volcker-rule/

For further information please contact David R. Evanson at devanson@comcast.net
or 215.460.8149 or Bristol Voss at bristol.voss@cfainstitute.org
or 212.705.1738

     

Notes for Editors:

 
(1)

The independent, non-partisan Systemic Risk Council (www.systemicriskcouncil.org)
was formed to monitor and encourage regulatory reform of U.S. and
global capital markets, with a focus on systemic risk.

 
(2) The Council is funded by the CFA Institute, a global association of
more than 125,000 investment professionals who put investors'
interests first and set the standard for professional excellence in
finance. The statements, documents and recommendations of the
private sector, volunteer Council do not necessarily represent the
views of the CFA Institute. The Council works collaboratively to
seek agreement on each of its recommendations.
 
(3) The enhanced supplementary leverage ratio (eSLR) is an additional
leverage requirement that applies to (and only to) banking groups
that have been designated as global systemically important banking
organizations (GSIBs). It is currently 6% for insured depository
institutions (i.e., operating banks) (IDIs) that are subsidiaries of
such GSIBs; and 5% for the consolidated group holding company. Under
the proposed changes to the eSLR, both GSIB operating banks and
holding companies would be subject to an additional leverage buffer
equal to 50% of its GSIB risk-weighted capital ratio surcharge. The
Fed and OCC estimate that as a result of this proposed change the
amount of tier 1 capital required to held by the lead GSIB IDIs (ie
the operating banks) would fall by approximately $121 billion from
the amount required under the current eSLR standard.
 
(4)

The note about amendments to Dodd-Frank is referencing S. 2155,
the Economic Growth, Regulatory Relief and Consumer Protection
Act, commonly referred to as the Crapo Bill. The SRC wrote a
comment letter on this legislation back in February (https://www.systemicriskcouncil.org/2018/02/systemic-risk-council-comments-on-the-s-2155-the-economic-growth-regulatory-relief-and-consumer-protection-act/).

 
 

Systemic Risk Council Membership

 

Chair:

    Sir Paul Tucker, Fellow, Harvard Kennedy School and Former Deputy
Governor of the Bank of England

Chair Emerita:

Sheila Bair, Former Chair of the FDIC

Senior Advisor:

Jean-Claude Trichet, Former President of the European Central Bank

Senior Advisor:

Paul Volcker, Former Chair of the Federal Reserve Board

Members:

 
Brooksley Born, Former Chair of the Commodity Futures Trading
Commission
 
Baroness Sharon Bowles, Former Member of European Parliament and
Former Chair of the Parliament's Economic and Monetary Affairs
Committee
 
Bill Bradley, Former U.S. Senator
 
William Donaldson, Former Chair of the Securities and Exchange
Commission
 
Peter R. Fisher, Tuck School of Business at Dartmouth, Former Under
Secretary of the Treasury for Domestic Finance
 
Jeremy Grantham, Co-Founder and Chief Investment Strategist,
Grantham May Van Otterloo
 
Richard Herring, The Wharton School, University of Pennsylvania
 
Simon Johnson, Massachusetts Institute of Technology, Sloan School
of Management
 
Jan Pieter Krahnen, Chair of Corporate Finance at Goethe-Universität
in Frankfurt and Director of the Centre for Financial Studies
 
Sallie Krawcheck, Chair, Ellevate, Former Senior Executive, Citi and
Bank of America Wealth Management
 
Lord John McFall, Former Chair, UK House of Commons Treasury
Committee
 
Ira Millstein, Senior Partner, Weil Gotshal & Manges LLP
 
Paul O'Neill, Former Chief Executive Officer, Alcoa, Former U.S.
Secretary of the Treasury
 
John Reed, Former Chairman and CEO, Citicorp and Citibank
 
Alice Rivlin, Brookings Institution, Former Vice-Chair of the
Federal Reserve Board
 
Kurt Schacht, Managing Director, Standards and Advocacy Division,
CFA Institute
 
Chester Spatt, Tepper School of Business, Carnegie Mellon
University, Former Chief Economist, Securities and Exchange
Commission
 
Lord Adair Turner, Former Chair of the UK Financial Services
Authority and Former Chair of the Financial Stability Board's
Standing Committee on Supervisory and Regulatory Cooperation
 
Nout Wellink, Former President of the Netherlands Central Bank and
Former Chair of the Basel Committee on Banking Supervision
 
 
* Affiliations are for identification purposes only. Council members
participate as individuals and this letter reflects their own views
and not those of the organizations with which they are affiliated.
 

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