May 22, 2024 7:54 pm

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Major US banks considering legal action against federal regulators

WASHINGTON, D.C.—First reported by Semafor on January 11, Bank Policy Institute (BPI), a nonpartisan public policy and advocacy group representing the nation’s leading banking institutions, is gearing up to sue U.S. regulators over proposed rules that would increase capital reserve requirements on banks with total consolidated assets of at least $100 billion.

The changes would implement the final components of the Basel III agreement, also known as the Basel III endgame, according to a press release by the Federal Reserve, and would increase capital (cash) reserve requirements for large banks on average 16 percent. The Feds also want these changes in response to the recent banking turmoil in the first six months of 2023.

Cash reserves are the amount of liquid assets a bank must hold to protect the institution from a run on deposits (a buffer against economic downturn). A bank cannot lend this cash reserve to the public nor other financial institutions; hence reducing the money supply in circulation and increasing the interest rate to lend (cost of credit) on monies over the reserve threshold.

Ever since the 2020 Pandemic, the Feds have been in a period of quantitative tightening—reducing the number of dollars circulating in the economy—to rein in inflation as a result of both the Trump and Biden administrations printing of trillions of dollars for COVID economic recovery such as the CARES Act and the Inflation Reduction Act.

At the Federal Reserve Board Meeting on July 27, 2023, the agency, along with the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC) collectively issued a notice of proposed rulemaking to substantially revise the regulatory capital framework for U.S. banking organizations with total assets of $100 billion or more and their depository institutions (DI) subsidiaries (large banking organizations) and banking organizations with significant trading activity. The proposed requirements would be phased in over three years starting July 1, 2025, and fully implemented by July 1, 2028.

“The goal of our actions today is simple: to increase the strength and resilience of the banking system by better aligning capital requirements with risk,” wrote Michael S. Barr, Vice Chair for Supervision, Federal Reserve, in a statement regarding the July 27 Board Meeting.

The feds propose revising the capital framework for banks with total assets of $100 billion or more in four main areas:

  • Credit risk, which arises from the risk that an obligor fails to perform on an obligation;
  • Market risk, which results from changes in the value of trading positions;
  • Operational risk, which is the risk of losses resulting from inadequate or failed internal processes, people, and systems, or from external events; and
  • Credit valuation adjustment risk, which results from the risk of losses on certain derivative contracts.

Additionally, the proposal would require banks with total assets of $100 billion or more to:

  • Include unrealized gains and losses from certain securities in their capital ratios;
  • Comply with the supplementary leverage ratio requirement; and
  • Comply with the countercyclical capital buffer, if activated.

“Banks with inadequate levels of capital are vulnerable, and that vulnerability can cause contagion, which threatens the stability of the banking system and hurts families and businesses,” Barr added.

Eugene Scalia, son of former Supreme Court Justice Antonin Scalia, on behalf of the BPI and the nation’s largest financial institutions—JPMorgan Chase, Citibank, and Goldman Sachs—is said to be drafting a lawsuit to block the proposed rule changes.

BPI argues that the proposed rules would have a greater impact on capital reserves than the Feds’ calculation of a 16 percent average increase requirement.

“The largest banks in the country, which represent 80 percent of total bank assets, would be forced to increase their capital materially… The industry’s estimates show a far greater impact, with many banks estimating an increase of over 20 percent and with the G-SIBs [Global Systemically Important Banks] needing to increase capital by 25 percent,” the BPI and ABA Comment on Basel Endgame Proposal reads.

The report further states that the proposed rule would be harmful to the economy: “The U.S. economy would suffer a significant, permanent reduction in GDP and employment; U.S. capital markets would become less liquid, and therefore more dependent on non-bank intermediation [insurance firms, pension funds, and venture capitalists] in normal times and on governmental support when those non-banks step away from financial markets during times of stress.”

Lastly, the BPI report alleges that the rule changes would violate the Administrative Procedure Act: “The proposed rule appears to be based on the agencies’ erroneous belief that they have unlimited and unreviewable discretion to set capital requirements at whatever level they wish, and thus do not have to ensure that those requirements comply with any statutory standard or provide any data and analysis to show that proposed requirements meet that standard.”

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