Too little capital led to bank failures last spring, Fed top supervisor says; proposals for large banks will address that insufficiency

The failure of three, large regional banks in March and May were the products of those banks having insufficient capital, according to the Federal Reserve’s top supervisor, who outlined bank capital reform proposals in a speech Monday, which he said will include higher standards.

“The failures of SVB (Silicon Valley Bank) and other banks this spring were a warning that banks need to be more resilient, and need more of what is the foundation of that resilience, which is capital,” said Michael Barr, Federal Reserve Board Vice Chair for Supervision. “Some industry representatives claim that inadequate capital had nothing to do with those bank failures. I disagree. It was an unsuccessful attempt by SVB to raise capital that caused uninsured depositors to look more closely at how the bank was capitalized.”

SVB, of Santa Clara, Calif., failed in March, along with Signature Bank of New York, N.Y. First Republic Bank of San Francisco, Calif., failed in May. Barr made the remarks during a speech at the Bipartisan Policy Center in Washington, D.C.

Barr asserted that “it is not logical to argue” that failings in supervision must have meant that SVB was adequately capitalized or that supervision alone could have somehow assured safety and soundness throughout the banking system. “It is not a choice between supervision and capital regulation—capital is and has always been the foundation of a bank’s safety and soundness,” he said.

Barr disparaged claims by some in the banking industry that raising capital requirements would push banking activity outside of the regulated financial sector, specifically to non-bank banks.

“As I discussed in my speech on capital last December, we need to worry, a lot, about nonbank risks to financial stability,” he said. “The answer, however, is not lower capital requirements for banks, but more attention to those nonbank risks. Further, as stress in nonbank financial markets is often transmitted to the banking system, both directly and indirectly, it is critical that banks have enough capital to remain resilient to those stresses.”

Barr said the process of strengthening capital standards for large banks would be “deliberative and open to public participation.” Implementation, he said, would take a least several years, a reason, he said, for beginning now.

Among the key points about capital standard changes Barr made were:

  • The new rules would apply to banks and bank holding companies with $100 billion or more in assets. Now, the rules apply to firms that are internationally active or have $700 billion or more in assets. Barr asserted that the $100 billion threshold would subject more banks to the Fed’s most risk-sensitive capital rules compared to the current framework.
  • Stress testing is sound, but it should continue to evolve to better capture risk. Any additional changes, he indicated, should be complementary to the changes to the risk-based capital framework.
  • No changes will be pursued to such capital buffers as the global systemically important bank (G-SIB) surcharge and the countercyclical capital buffer (CCyB). However, he said he recommends that the measurement of systemic indicators under the G-SIB surcharge framework be improved, “cliff effects” be reduced and the sensitivity of the surcharge to changes in a bank’s risk profile be increased.
  • No changes, at least for now, are recommended to the calibration of the enhanced supplementary leverage ratio (eSLR). He said with other changes being proposed, the eSLR generally would not act as the binding constraint at the holding company level, where Treasury market intermediation occurs.
  • Changes to both regulation and supervision will be proposed, including how the Federal Reserve regulates and supervises liquidity, interest rate risk, and incentive compensation. He also said the agency is looking at how to improve its the speed, agility, and force of supervision.
  • Multiple ways for measuring and mitigating risk will be continued, as that makes it helpful for the resiliency of banks and robustness of the banking system. “Further, a capital framework with multiple ways of measuring risk is harder for banks to game,” he asserted.

Barr said, overall, updated standards should better reflect credit, trading, and operational risk. “To help promote international comparability, the updates to the standards should be consistent with international standards adopted by the Basel Committee,” he said. “The international standards were developed through a rigorous, lengthy process, have been under discussion for nearly a decade and will improve on the extent to which capital requirements fully reflect the risks posed by different banks engaged in a variety of activities.”

Federal Reserve Vice Chair for Supervision Michael S. Barr: Holistic Capital Review