Bank regulators are on the cusp of weakening a rule put in place to prevent the nation’s biggest banks from causing another financial crisis, marking the first significant attempt by policymakers to fulfill President Trump’s promised regulatory rollback.
The effort is causing friction among regulators, who broadly agree that some post-crisis rules need to be revised but disagree about how far Washington should go in changing them. The debate is expected to be the first of many as financial regulators begin changing post-crisis rules through actions that do not require congressional approval.
In recent weeks, federal banking regulators have proposed softening a requirement that puts a hard limit on how much the largest banks can borrow. The rule, known as the supplementary leverage ratio, requires that banks prepare for a disaster by maintaining a certain level of capital on their balance sheets based on their total size.
Banks have long complained that the rule is too restrictive and makes it harder for them to do business, including lending, in important markets. They have asserted that the ratio is too blunt of an instrument and often the strictest of the various capital requirements that were put in place after the crisis.
James P. Gorman, chief executive of Morgan Stanley, summed up this view on a conference call last week, saying, “Our constraint has been the leverage ratio.”
Regulators appear ready to agree. The Federal Reserve, along with the Office of the Comptroller of the Currency, has proposed changing the capital requirement to make it “more closely tailored to each firm.” That could wind up lowering the amount of capital that big banks must maintain.
The change was not supported by another bank regulator, the Federal Deposit Insurance Corporation, which is currently headed by Martin J. Gruenberg, an Obama administration appointee. It also prompted a “no” vote from one of the Fed’s three sitting governors, Lael Brainard, also an Obama administration appointee, who recently said it was too soon to lower capital requirements for the biggest banks.
“Some observers contend that current capital requirements are too onerous and are choking off credit,” Ms. Brainard said last Thursday in a broad speech about bank regulation. “But the evidence suggests otherwise: U.S. bank lending has been healthy over recent years and profits are strong.”
Under the Fed’s proposed new method, Bank of America and Goldman Sachs’s leverage ratio would most likely drop from 5 percent to 4.25 percent of their assets and certain off-balance sheet holdings, while Wells Fargo’s might fall to 4 percent. Capital required for eight large banks under the proposed leverage ratios is around $86 billion less than the amount demanded at the 5 percent level, according to calculations by The New York Times.
The Fed, in explaining the impact of the changes, said capital held by the banks would not fall by much. That’s because a second set of capital requirements, based on assets’ riskiness, would be set higher than the leverage ratio after the changes. The Fed estimated a theoretical reduction of $9 billion across the eight banks. That amount would be even smaller once the Fed’s annual tests of banks’ strength are taken into account.
But as regulators adjust capital rules in the coming months, the big banks are expected to enjoy significant relief. Several proposed changes could free up more than $50 billion of capital at large banks, according to recent research by Goldman Sachs, money that could in theory be distributed to shareholders.
The changes are part of a push, spearheaded by Randal K. Quarles, who oversees bank supervision at the Fed, to ease some of the regulations that came into effect after the financial crisis of 2008. The leverage ratio proposal builds on ideas that were under discussion at the Fed before Mr. Quarles’s confirmation as a Fed governor last year but go beyond that approach. It is prompting concern from those who view the leverage ratio as an important tool to help protect the financial system by preventing banks from becoming overextended.
“The leverage ratio was a much better predictor of financial health of banks going into the crisis,” said Sheila C. Bair, who was head of the F.D.I.C. during the tumult of 2008, and who does not support the proposed changes.
The change most likely won’t lead to an immediate weakening of the financial system. But, over time, if the financial industry keeps pressing for looser regulations, and Washington obliges, there is concern that the absence of a strong leverage ratio could reduce confidence in the financial system, particularly in periods of stress.
The leverage ratio’s importance is revealed in how large banks finance themselves. They get most of the money they need for lending and trading from two main sources — they borrow it in markets or they raise it from depositors. But an overreliance on those two sources can leave a bank vulnerable to runs, because many of the creditors and depositors can demand the bank return their money at short notice. That is why banks must get some of their funding from equity capital, which consists of retained profits and funds from shareholders, who cannot demand immediate repayment of their money.
Some capital rules allow banks to hold less capital against an asset that is perceived by regulators to be less risky. The weakness of this approach was revealed in 2008 and during the European debt crisis when supposedly safe assets turned out to be dangerously risky. The leverage ratio, by contrast, requires banks to have a set amount of capital, regardless of the type of assets it holds.
Acknowledging the importance of the leverage ratio, regulators increased it for the largest banks four years ago. At the higher ratio, the big banks had to have capital equivalent to 5 percent of their assets and certain off-balance sheet holdings. Under the new rule, it would decline significantly. The Fed and the Comptroller want to set the ratio at 3 percent, and then add half of a capital surcharge that is applied to eight large United States banks because their operations pose a heightened risk to the global financial system. (Daniel K. Tarullo, the Fed governor who previously oversaw bank supervision, floated this sort of change a year ago, but his suggestion would not have led to lower leverage ratios for three banks and it would have resulted in smaller reductions for the five others.)
Bank representatives say the leverage ratio has been a crude tool that has not made the financial system safer. “The best analogy is that it’s like having the same speed limit for every road in the country,” said Greg Baer, president of the Clearing House Association, which represents banks.
Supporters of the leverage ratio, however, say that it should be at least as important as the malleable capital requirements, to provide reliable protection in a storm. “It’s important to have strong, vigilant regulators but we shouldn’t put all of our faith in them,” Gregg Gelzinis of the left-leaning Center for American Progress said. “We should have this capital requirement that is simple, transparent and doesn’t rely on expert determinations.”
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