Just months after the shocking unravelling of Silicon Valley Bank and First Republic Bank last year, Michael Barr unveiled a new set of guardrails for the US’s biggest lenders and an uncompromising defence of why they were needed.
“Some industry representatives claim that inadequate capital had nothing to do with those bank failures,” the Federal Reserve’s vice-chair for supervision said in July 2023, one year into his tenure as Wall Street’s top regulator. “I disagree.”
Fourteen months later, Barr has walked back the landmark proposal that sought to apply more stringent rules on major US lenders such as JPMorgan Chase and Goldman Sachs, after one of the fiercest opposition campaigns from the banking lobby and a bipartisan group of US lawmakers.
“Life gives you ample opportunity to learn and relearn the lesson of humility,” he said on Tuesday.
US regulators are not the only ones having to embrace humility when it comes to implementing “Basel III Endgame” — the final rules tied to an international effort that emerged in the wake of the 2008 financial crisis to shore up the banking sector.
Globally, there is a retreat among the financial system’s top cops, who have pared back proposals in response to fervent pushback from the very institutions they oversee. The UK this week is set to join the US and EU in making concessions and delaying the eventual implementation of their own rules.
The scope and scale of the reversal from regulators speaks to the intensity of the industry opposition, which at its peak included lawsuits threatened and billboards by bank lobbyists warning “everyday Americans” would suffer if the rules were adopted. That the criticism also stemmed in part from Democratic lawmakers also did not help their cause, forcing them to rethink what at the time represented the most extensive effort in more than a decade to safguard the financial system.
The argument from banks has been that higher capital requirements would not take into account the progress made since the 2008 financial crisis to fortify lenders and would have diminishing returns for safety. But for some, the Fed’s surrender will leave critical areas unaddressed.
Anat Admati, a professor at the Stanford Graduate School of Business, said: “Memories of the global financial crisis have faded and even though we had another flare-up with the collapse of Silicon Valley Bank and First Republic last year that showed the many flaws of the rules, the main flaws persist.”
The so-called re-proposal from Barr featured sweeping changes that taken together are estimated to halve the increase in capital requirements to 9 per cent for the largest US banks, compared to the 19 per cent rise initially floated.
For the nation’s six largest banks the change translates into a savings of roughly $100bn. Under the new proposal those banks would be required to add roughly $80bn in capital, compared with $180bn previously. Banks can now take more risk with that money than they would have been able to.
Banks with less than $250bn in assets would no longer be subject to the bulk of the rules. Moreover, capital requirements related to operational risks, mortgages and other business lines were also reduced.
“This is not a middle-ground re-proposal,” said Jeremy Kress, a former Fed lawyer who now teaches at the University of Michigan. “On nearly every point of contention, this is a capitulation to the banks.”
The Bank of England is widely expected to announce on Thursday that it is delaying the start date for the tougher capital rules from the middle of next year until at least the start of 2026, while City lobbyists say they expect it to also make some concessions on lending to small businesses and mortgages.
The UK move follows the EU’s decision earlier this year to press ahead with introducing some of the Basel rules in January 2025, while postponing the part of its package that covers investment banks’ trading books by a further year. This followed pressure from the French government in response to lobbying by the country’s banks, which warned they would fall further behind big US rivals.
Sam Woods, head of the BoE’s Prudential Regulation Authority, has said the new rules will not lead to a “significant increase” in overall capital requirements for British banks. The PRA estimated the total impact at about 3 per cent in a consultation last year. The EU’s version of the rules is expected to lead to an increase of almost 10 per cent in capital requirements for its banks.
UK finance executives are confident they have convinced the BoE to take longer to scrap measures that lower capital requirements on loans to small businesses, while also easing the rules on mortgages when property prices rise.
The response from the US banking industry in particular was splashy, loud and aggressive. Bank leaders including JPMorgan’s Jamie Dimon and Citigroup’s Jane Fraser made pilgrimages to Washington to meet rulemakers.
The biggest weapon, though, was the banking industry’s threat of a lawsuit under the premise that regulators had not followed their own standards when it comes to rulemaking. The industry hired legal heavy hitter Eugene Scalia to take up the case.
Congressional leaders also piled on, with Patrick McHenry, the Republican chair of the House financial services committee, telling the Financial Times this week that without a full overhaul, the Fed would face a congressional challenge for the first time in its history. McHenry warned about invoking the Congressional Review Act, which empowers Congress to overturn final rules issued by federal agencies.
“If they take the deeply political approach that Michael Barr has taken to regulatory policy, you will see the Congress and the courts severely curtail the Fed’s regulatory policy capacity,” he said on Monday. “I don’t think the Fed is dumb enough to do that.”
The result has been what Gene Ludwig, a former Comptroller of the Currency, said was “certainly one of the more significant changes of regulations after a comment period that I’ve seen”.
The question now is whether banks will decide they can live with Barr’s latest proposal, which Ludwig suggested could go either way. Speaking at an industry conference on Tuesday, Bank of America chief executive Brian Moynihan said regulators over-reached and the industry’s pushback resulted in compromise.
“There’s an old saying, show them death, and they will take despair, and I think that’s what we got,” he said. “They showed us 20, and they said ‘we’ll take 10’, and we are saying, ‘wait a second, let’s think through the logic of that’.”
Barr made clear the Fed would again solicit feedback on the new plan, and that banks will probably be given a year after finalisation before implementation. Certain changes will be phased in over time, suggesting a long wait before lenders are subject to more onerous rules.
“It is unfortunate that we are more than a year into this process and we are looking at a preview of a re-proposal that’s not yet out,” added Kathryn Judge, a professor at Columbia University with expertise in financial regulation. “When we think about the overall timeframe, this is not an optimal position to be in for the Federal Reserve and for the other bank regulators.”
https://www.ft.com/content/3c6e14c3-9a9a-46c8-8b4f-a10da949fb9e
