June 5th, 2011
Econintersect: Federal Reserve Governor Daniel Tarullo, speaking to the Peter G. Peterson Institute for International Economics, Washington, D.C., has suggested that banks could be required to hold capital reserves ranging from 8% to 14% of assets, the amount depending on the systemic risk each poses. The requirements suggested by Tarullo exceed the 7% capital requirements in the Basel III agreement last year. And Basel III requirements will not be completely in place for nearly 10 years.
Tarullo rationalized the difference. He referred to the Basel III requirements as suitable for banks that were not systemically important and the more stringent capital requirements for could pose systemic risks, those referred to as "too big to fail."
From the released text of the speech:
The pre-crisis regulatory regime had focused mostly on firm-specific or, in contemporary jargon, "microprudential" risks. Even on its own terms, that regime was not up to the task of assuring safe and sound financial firms. But it did not even attempt to address the broader systemic risks associated with the integration of capital markets and traditional bank lending, including the emergence of very large, complex financial firms that straddled these two domains, while operating against the backdrop of a rapidly growing shadow banking system.
A post-crisis regulatory regime must include a significant "macroprudential" component, one that addresses two distinct, but associated, tendencies in modern financial markets: First, the high degree of risk correlation among large numbers of actors in quick-moving markets, particularly where substantial amounts of leverage or maturity transformation are involved. Second, the emergence of financial institutions of sufficient combined size, interconnectedness, and leverage that their failures could threaten the entire system.
The Wall Street Journal indicated that there was disagreement about the type of requirement that Tarullo proposed. From the WSJ:
His (Tarullo) comments come amid continuing international disagreement over the appropriate levels of capital for such "systemically important financial institutions," or SIFIs. International policy makers agree banks need stronger capital buffers to withstand market tremors but consensus tends to end there. U.S. policy makers, including Treasury Secretary Timothy Geithner, want an international agreement so U.S. firms aren't put at a competitive disadvantage by having to hold more of their capital in reserve.
In an interview on Friday, Michel Barnier, the European Union's financial-services commissioner, rejected the need for additional capital levels beyond those agreed to in Basel. "Let's not go too fast," he said. "We can't rush forward. We have to implement what we said we should."
Hat tip to Naked Capitalism