Stronger Capital Standards a Start, but More Work Needed, Says Fed Gov. Tarullo

Stronger Capital Standards a Start, but More Work Needed, Says Fed Gov. Tarullo

Fed Gov. Daniel TarulloWork is under way on proposed capital and liquidity rules aimed at preventing another financial crisis, Federal Reserve Governor Daniel Tarullo told banking lawyers during speech on November 4, 2011. Beyond these new standards, however, remain pressing issues that U.S. and international regulators must address, he said. Tarullo discussed global financial regulation at the fall meeting of the American Bar Association's Banking Committee in Washington, D.C.

Announced in 2010, the Basel III capital and liquidity standards require banks to raise tier 1 capital to 7 percent of risk-weighted assets, up from the current 2 percent. Tarullo said he expects a proposed regulation implementing the new requirements in the first quarter of 2012.

Managing the transition
Tarullo also addressed recent questions about the Federal Reserve's expectations regarding capital levels during the six-year transition period for the new framework. "While the Federal Reserve intends to ensure that firms are on a steady path to full Basel III compliance, we do not intend to require firms to raise external capital or reduce their risk-weighted assets in order to meet any target earlier than at the time specified in the Basel III transition schedule," he said.

However, large bank holding companies (those with $50 billion or more in total assets) will be required to "take affirmative steps to improve capital rations, such as external capital raises, when those steps would be needed to meet each Basel III transition on time," Tarullo added. The Federal Reserve will monitor these firms' progress via its annual review of banks' capital plans. That new rule, finalized earlier this year, requires large bank holding companies to submit capital plans to the central bank for review each year.

Rules for the largest institutions
Also under the Basel III framework, roughly 30 banks designated as systemically important financial institutions (SIFIs) will be required to set aside an additional capital buffer, or capital surcharge, ranging from 1 to 2.5 percent of assets. The list, released recently by the Financial Stability Board, will be updated annually based on financial institutions' size, complexity, interconnectedness, and cross-border activity.

Stronger capital and liquidity requirements are an important step toward a sound financial system, but international regulators must address several priority measures in the coming year, Tarullo said. These include a strong resolution framework for global SIFIs and action on other sources of risk such as wholesale funding channels and the market for over-the-counter derivatives. While a global treaty is unlikely, he said, "there should be room for more limited cooperation agreements, coordinated supervisory work on resolution plans, and other devices."

November 29, 2011