FED squeezes big banks with higher capital requirements

US Federal Reserve

The Federal Reserve has put further pressure on Wall Street with moves to impose tougher capital requirements on the biggest US banks.

America’s eight largest banks will be forced to raise capital levels significantly above international standards after the Fed unveiled requirements designed to reduce the “systemic footprint” of the largest institutions.

It will affect Bank of America, BNY Mellon, Citigroup, Goldman Sachs, JPMorgan Chase & Co., Morgan Stanley, State Street Corporation, and Wells Fargo.

These global systemically important banking organisations, or GSIBs, will incur a ‘capital surcharge’ of between one and 4.5 per cent of their total risk-weighted assets. The US rules are a step further than Basel requirements by penalising banks overly-reliant on short-term funding.

"This framework would provide incentives to these banking organisations to hold substantially increased levels of high-quality capital as a percentage of their risk-weighted assets," Fed chair Janet Yellen said. "This, in turn, would encourage such firms to reduce their systemic footprint and lessen the threat that their failure could pose to overall financial stability."

Failure to comply with the rules will result in restrictions on capital distributions and discretionary bonus payments, the Fed said. The rules are to be phased in beginning on January 1st, 2016, becoming fully effective on January 1st, 2019.

Does the Fed really want smaller banks? Perhaps, as Fed governor Daniel Tarullo explained how the surcharge “would be increased as a bank's systemic importance grows, and reduced as a bank reduces its size”.

But it seems the key focus is on short-term credit and the risks inherent in this. For example, Tarullo noted how reliance on short-term wholesale funding can leave a firm vulnerable to creditor runs that force it to rapidly liquidate its own positions or call in short-term loans to clients.

He added: “Both of these responses can lead to fire sales that create a vicious cycle of mark-to-market losses, margin calls, forced deleveraging, and further losses. Thus, reliance on short-term wholesale funding is among the more important determinants of the potential impact of the distress or failure of a systemically important financial firm on the broader financial system.”