With financial stability risks moderate, regulator sees no reason to invoke ‘counter cyclical capital buffer’

The Federal Reserve views risks to financial stability as “moderate” now and sees no reason to call for increased bank capital levels under the “counter cyclical capital buffer,” the central bank’s top regulator said Thursday.

In questions and answers following a speech on the economy at the Economic Club of New York, Federal Reserve Vice Chairman for Supervision Randal H. Quarles said raising the “counter cyclical capital buffer” is not yet necessary. (The buffer is a tool given to the Fed by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) to force an increase in banks’ capital requirements when financial stability risks are elevated.)

“At the Fed, we have a very comprehensive and unanimously agreed framework for evaluating financial stability risks,” he said. “We review that at the board regularly. Currently we view financial stability risks as moderate,” which argues, he said, that there is no reason to turn on the capital buffer.

(In the video, Quarles discusses the impact invoking the capital buffer might have on the existing capital framework for the financial system.)

But he did acknowledge that there are some calls for invoking the buffer, which he said seems to be a reflection of “where we are now in the business cycle” as opposed to stability risks.

In calling for “turning on” the buffer, he said, “the phrase is ‘if not now when,’” as the economy gains steam, as a method of ensuring the economy doesn’t overheat (similar to monetary policy, he agreed).

“That’s not how our current framework works,” Quarles said. “That’s not part of the international approach” (although he noted that regulators in the United Kingdom have taken a similar approach).

He pointed out that most U.S. banks are better capitalized now than most of their international counterparts, even with the international banks’ capital buffers turned on.

He said the Fed intends to adhere to the international agreements in its use of the capital buffer as a financial stability tool, rather than a device to respond to the business cycle, but he also said he doesn’t speak for everyone at the Federal Reserve.

Quarles equivocated on whether the use of the capital buffer should be revisited, as a way to employ it in the face of a burgeoning economy. “That would require a significant rethinking of our overall capital framework,” Quarles said, citing high levels of capital in U.S. banks now, and the cost that raising capital requirements would have on the financial system’s ability to provide credit.

“I think we’d have to think very carefully about that – but I’m always willing to listen to intelligent cases that are being made,” he said.