Delamaide: Fed isn't letting up on bank rules

WASHINGTON — Even as the dwindling number of top officials threatens to impair its functioning, the Federal Reserve shows no signs of letting up on new requirements for big banks to build up capital against potential losses if another crisis hits.

In March, the Fed barred Citigroup from proceeding with a planned dividend hike and share buyback because the bank failed its "stress test" of having enough capital cushion in a crisis scenario.

Last month, the Fed rescinded its March approval for Bank of America's dividend boost and buyback after the bank discovered it had been under-reporting its capital by $4 billion.

All this while departures from the Fed's Board of Governors may reduce it from its full complement of seven to an unprecedented three members before the end of this month and the Senate, crippled by politics and its own arcane rules, delays approving pending nominations for two new members.

But that's not stopping the remaining members — notably Chairman Janet Yellen and Governor Daniel Tarullo — from talking tough about beefing up bank requirements even further.

Last month, Yellen warned that the Fed was not satisfied that current or planned regulations include sufficient protection against runs on short-term funding for banks — one of the triggers in the financial crisis. The Fed staff is working on new measures to address this issue, she told a conference in Atlanta.

And last week, Tarullo suggested that it was time to abandon international guidelines that allow banks to set their own capital requirements according to how they assess the risk of their assets.

Federal Reserve Board Governor Daniel Tarullo testifies on Feb. 6 before the Senate Banking, Housing and Urban ! Affairs Committee in Washington, DC.(Photo: Chip Somodevilla Getty Images)

The Fed governor, who is the point man on banking regulation, said the "internal risk-based" requirements adopted by the international Basel Committee on Banking Supervision in 2004 apparently aimed to reduce capital requirements, an objective that seems "misguided" in the wake of the financial crisis. The time has come to "consider discarding" this approach, he said.

"The combined complexity and opacity of risk weights generated by each banking organization for purposes of its regulatory capital requirement," he said at a conference in Chicago, "create manifold risks of gaming, mistake, and monitoring difficulty."

For Tarullo, a combination of a higher capital ratio for all assets, including added requirements for the biggest banks, and the annual stress tests conducted under the Fed's supervision will do a better job of protecting against risk not only for the institution but for the financial system as a whole.

This latest suggestion, which could result in banks needing even more capital, follows a number of other measures the Fed is implementing under the Dodd-Frank financial reform act.

All banks of a certain size – currently set at $50 billion or more in assets – will be subject to "enhanced" supervision, including the supervisory stress tests, plans for maintaining capital (requiring approval for dividends and buybacks), a plan for winding down the bank in the face of bankruptcy, credit limits vis-à-vis individual counterparties, and a new "Liquidity Coverage Ratio" to ensure funding during a crisis.

In addition, those banks with at least $250 billion are subject to even more robust requirements in each category and the eight U.S. firms designated as "global systemically important banks" will be subject to additional capital surcharges, higher leverage ratio, and a long-term debt requirement that will support an orderly resolution process.

In rattling off all these new regulat! ions, Tar! ullo acknowledged that more needs to be done to streamline the regulatory process, and especially to simplify compliance for small community banks.

In that regard, he suggested carving out exemptions for banks with less than $10 billion in assets, and reducing supervision to those smaller than $1 billion. Moreover, he suggested it might make sense to raise the threshold for enhanced supervision from $50 billion to $100 billion.

As for the largest banks, getting rid of the risk-based capital measures as he proposed would be a good way to simplify their regulatory regime in the wake of all the added requirements.

Both Yellen and Tarullo observed in passing in these recent speeches that clamping down on banks' risk-taking might encourage other types of financial institutions, the so-called "shadow banking system," to take on these risks.

Without going into details, they warned that the Fed was ready to extend regulations to these institutions as well if necessary to preserve stability in the financial system as a whole.

It is this concern for systemic stability, Tarullo emphasized in his speech, that is re-defining just how different categories of institutions will be supervised, "sometimes by paring back or foregoing regulation for certain kinds of firms, and sometimes by adding a regulatory measure," he said.

Even if they are the last two standing, it seems, Yellen and Tarullo are not going to let go of tougher limits for banks.

Darrell Delamaide has reported on business and economics from New York, Paris, Berlin and Washington for Dow Jones news service, Barron's, Institutional Investor and Bloomberg News service, among others. He is the author of four books, including the financial thriller Gold.