Yesterday, the Federal Reserve released its long-anticipated stress capital buffer, or “SCB,” final rule that integrates the stress testing regime into the Board’s point-in-time capital requirements. The integration of the stress testing and point-in-time capital rules simplifies the large bank capital regime and moves us towards a capital regime with a single capital standard for all of the nation’s large banks.
The release of the final rule also makes clear that the aggregate capital adequacy of large banks – those banks subject to stress tests – will increase as well. According to the Federal Reserve Board’s analysis, common equity tier 1 capital (CET1) requirements – the highest quality and most loss-absorbing form of capital – will increase by $11 billion as a result of the final rule. Importantly, all of the increase in CET1 will come from increased capital requirements for U.S-based Global Systemically Important Banks – Financial Services Forum members. As shown in Figure 1 below, the Federal Reserve Board’s analysis finds that CET1 is expected to increase by $46 billion for Forum members while CET1 is expected to decline by $35 billion for all other banks that will be subject to the SCB final rule. Accordingly, all of the increase in capital adequacy resulting from the SCB is being provided by Forum members.
Source: Federal Reserve Board
In a number of previous posts, we have demonstrated how Forum members are among the best capitalized banks that are subject to the most stringent standards in both the U.S. and abroad. The SCB final rule further underscores this point.
Everyone should take comfort in the strong resilience of Forum members. In the past decade, Forum members have substantially improved their resiliency through higher capital. At the same time, we should also reflect upon the fact that capital is not a free resource in the economy. As we have pointed out in previous posts, increased capital requirements come at a cost because equity financing is expensive. In particular, there is mounting evidence that increased capital requirements have put pressure on small business lending, which has had broader negative effects throughout the U.S. economy. Getting capital policy right depends on appropriately balancing the safety and soundness benefits of capital against the costs that higher capital requirements pose on the rest of the economy. Whether the SCB final rule strikes the right balance will only be known with time and experience as the economy works through the net impact of these more stringent capital requirements for large banks.
Finally, one additional aspect of the SCB final rule is worth highlighting. As the Board’s analysis shows, the increase in CET1 for Forum members (+$46BN) and the decline in CET1 for other banks (-$35BN) is driven by the impact of the GSIB capital surcharge. Specifically, Forum members are subject to an additional capital buffer, the GSIB surcharge, that is not applied to other banks, which raises the CET1 of Forum members relative to other banks. As we have discussed in various other posts, there are a number of important reasons, such as significant improvements in large bank resolvability and significant increases in total loss absorbing capacity for U.S. GSIBs, to reconsider the calibration of the GSIB surcharge. Moreover, the Federal Reserve itself indicated that it would reevaluate the GSIB surcharge over time as appropriate. The SCB final rule and the resulting increase in capital stringency for U.S. GSIBs that is driven by the GSIB surcharge further demonstrates the need for regulators to evaluate the calibration of the surcharge.