Quarles talks revised enhanced standards under S. 2155, eyes tailoring of living will requirements, more

Factors other than asset size will need to be addressed in the Federal Reserve’s application of enhanced regulatory and supervisory standards for banks with $100 billion to $250 billion in assets as a result of the recently enacted financial reform law, and the Fed is looking, at least in part, to a couple “G-SIB” surcharge indicators in figuring out what those factors will be.

These and other considerations being made as the Fed addresses rulemaking in this area – required under the recently enacted Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA, S. 2155) – were discussed in a recent speech before bankers by Federal Reserve Board Vice Chairman for Supervision Randal Quarles.

Quarles said that in applying enhanced prudential standards for firms with assets exceeding $100 billion, the Fed is required by law to consider “not only size but also capital structure, riskiness, complexity, financial activities, and any other factors the Board deems relevant.” He said similar factors are already used to “calibrate” the capital surcharges imposed on global systemically important banking organizations (G-SIBs) but generally not others.

Some of those G-SIB factors, such as cross-border activity and use of short-term wholesale funding, could be considered as the Fed determines how to measure complexity in the over-$100 billion to $250 billion group, he said. Outside of the G-SIB factors, he said nonbank activities could also be used. “For example, some nonbank entities engage in complex trading that is not permitted in depository institutions because of their risk,” he said.

EGRRCPA immediately exempted institutions between $50 billion and $100 billion from enhanced prudential standards. Meanwhile, regulators have 18 months from the law’s May 24 enactment – until Nov. 25, 2019 – to determine which enhanced standards will apply to institutions above $100 billion and not more than $250 billion.

As Quarles pointed out, the law also requires the Fed to consider how banking firms with more than $250 billion, but which do not qualify as G-SIBs, could be more efficiently regulated through more-tailored standards.

“In my view, the Board should make it a near-term priority to issue a proposed rule concerning tailoring of enhanced prudential standards for large banking firms,” Quarles said, noting such a proposal would address the Fed’s EGRRCPA obligations “by proposing to tailor enhanced prudential standards in a manner that recognizes relative complexity and interconnectedness among large banks.”

Though the Fed has 18 months to complete that work, he said “we can and will move much more rapidly than this.”

For capital requirements, he said, both risk-based and leverage capital requirements “should remain core components of regulation for large firms with more than $100 billion in total assets,” he said. He said stress testing will remain important and that the Fed’s proposed stress capital buffer, if finalized, still “would be critical” to large firms. Capital requirements could be modified for less complex, less interconnected firms, he said, as could requirements for asset risk weights, minimum liquidity standards and internal liquidity stress tests.

“Similarly, banks with more than $250 billion in assets that are not G-SIBs currently face largely the same liquidity regulation as G-SIBs,” Quarles noted. “As I’ve said previously, I believe it would make sense to calibrate the liquidity requirements differently for these firms relative to their G-SIB counterparts.”

He also envisions changes in resolution plan, or living will, requirements. “Most firms with total assets between $100 billion and $250 billion do not pose a high degree of resolvability risk, especially if they are less complex and less interconnected,” Quarles said. “Therefore, we should consider scaling back or removing entirely resolution planning requirements for most of the firms in that asset range.“

Quarles said the Fed should consider limiting the scope of application for resolution planning requirements “to only the largest, most complex, and most interconnected banking firms because their failure poses the greatest spillover risks to the broader economy.” For those still subject to the requirements, “we could reduce the frequency and burden of such requirements, perhaps by requiring more-targeted resolution plans.”

Getting It Right: Factors for Tailoring Supervision and Regulation of Large Financial Institutions (July 18, 2018)