On July 9, the FDIC Board completed action on proposed new capital rules that were approved last week by the Federal Reserve Board and issued Tuesday by the Comptroller of the Currency. Therefore, all three federal banking agencies have taken the same action, but the discussion at the FDIC meeting provided more insight into the state of the debate over the adequacy of capital at U.S. banks.
The meeting was noteworthy in that Thomas Hoenig, vice chairman of the FDIC, voted against the proposed rule on the ground that after a year's deliberation, it does not go far enough. This article will summarize the remarks of the five board members and then offer some concluding comments.
In his opening remarks, Chairman Martin Gruenberg called the changes in the proposed rule "significant" for strengthening the quality and quantity of capital in order to create a stronger, more resilient industry that would be better able to withstand stress.
However, he went on to say that it retains several provisions that accommodate the practices of community banks and does not change the 3 percent leverage ratio for the largest 16 banks. A separate proposal seeks comment on raising the leverage ratio to 6 percent for the eight largest banks and to 5 percent for their holding companies.
Hoenig faulted the board for not moving simultaneously on both proposals, and he voted against the first rule as a protest against the failure to take action to raise the leverage ratio. He disagreed with the claim that the new proposal provides more and better capital, because he considers the existing Basel II standard not to be a worthy standard for comparison.
Therefore, he said, "Without a binding leverage constraint, capital remains inadequate to prevent future losses." He observed that 3 percent proved to be "woefully low" during the 2008 episode, and he also complained that the rules still rely on risk weights that "retain the shortcomings of Basel II and are just begging to be gamed."
Board Director Jeremiah Norton voted for both rules, but called the pace of rulemaking "disappointing" and warned that the time consumed by international negotiations to harmonize capital requirements is delaying changes that are needed in the United States.
Norton then listed a number of faults with the board's proposal: 1) failure to modernize the risk weights on mortgage loans, despite the role they played in the 2008 episode; 2) failure to increase the risk weights on government-sponsored enterprise debt, despite the failures of Fannie Mae and Freddie Mac; 3) maintaining a mere 20 percent risk weight on exposure to other depository institutions; 4) continuing to assign zero risk weight to the sovereign debt of Organization for Economic Co-operation and Development countries; and 5) ignoring the effect of quantitative easing on interest-rate risk, given the levels of holdings of interest-sensitive assets.
He welcomed the shift in the debate that has occurred over the past year, but concluded, "A meaningful increase in the leverage ratio is critical to making meaningful progress."
Comptroller of the Currency Thomas Curry, who serves ex officio on the FDIC Board, touted the principle of a higher leverage ratio and defended the provisions to minimize the burden on community banks. He issued an identical proposal Tuesday on behalf of the Office of the Comptroller of the Currency.
Consumer Financial Protection Bureau Director Richard Cordray, who also serves ex officio, stated that more needs to be done to strengthen capital, and he added that the work would be "incomplete" without the notice of proposed rulemaking on the leverage ratios for the largest banks.
He expressed a preference for a blend of both risk-based capital and a leverage requirement "to ensure that the largest banks would be sturdy enough." Cordray argued that supporters of retaining the existing capital charge on mortgages can take comfort that the rules issued by his agency has reduced the risk that imprudent mortgage lending will occur again.
I would observe that Tuesday's action, or inaction, as the case may be, is yet another illustration of the inability of financial regulators to take timely and effective action and of the ability of industry lobbyists to thwart even tentative efforts at reform.
Finally, it is disappointing, but not at all surprising, that the so-called regulators cave so readily before the weak arguments put forward on behalf of community bankers. These banks are going to be allowed to continue to hold so-called "trust-preferred securities" as capital, despite the fact that they are treated as debt for tax purposes, on the ground that to go ahead with previously announced plans to phase out this dodgy practice would introduce untoward volatility in their capital plans, given that these banks typically lack access to capital markets.
Someone needs to tell these bankers that any volatility in their business is due to the nature of their business and should not be fudged by accounting gimmicks and that lack of access to capital markets is no excuse for a "community" bank.
Community banks should be funded by the community. What a concept.
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