Three Observations on Claims of the “Deregulation of Wall Street”

17 Sep 2020
Read Time 4 mins
Categories :
Bank Capital
, GSIB Surcharge
, Liquidity
, Volcker Rule

This week, Better Markets published a report with a number of recommendations for regulators on how they can reverse the “deregulation of Wall Street” that the organization says has occurred in recent years. In this post, we briefly respond to three key points made in the report with regard to Federal Reserve policy. More specifically, we comment on the points made regarding the Federal Reserve’s capital requirements, liquidity requirements, and the Volcker rule, with a particular emphasis on how these rules are applied to Financial Services Forum members versus other banks.

Capital Requirements

First, it should be noted that Financial Services Forum members—who are all designated as Global Systemically Important Banks, or GSIBs—are subject to the most stringent capital standard of all U.S. banks. Specifically, only Forum members are subject to the Federal Reserve’s GSIB capital surcharge, which is an additional capital buffer requirement that raises the quantity of capital maintained by Forum members. Moreover, the calibration of the GSIB surcharge has not been changed since it was adopted in 2015. Accordingly, capital requirements are uniformly higher for Forum members than for other banks.

Second, the report takes issue with the recently adopted stress capital buffer (SCB) that incorporates the Federal Reserve’s stress tests into bank regulatory capital requirements. In this regard, it is worth noting that not all banks are treated equally by the Federal Reserve’s stress capital buffer requirement. As we previously noted, the Federal Reserve’s own analysis shows that while the final SCB rule results in a decline in required capital for banks other than Forum members, the SCB rule actually raises capital requirements for Forum members. More specifically, the Federal Reserve’s analysis shows that Forum members are expected to see a $46 billion increase in required capital as a result of the SCB rule. Accordingly, while some banks may face lower capital requirements, Forum members are subject to the most stringent capital standards and have seen their capital requirements increase as a result of recent changes to the Federal Reserve’s bank capital regime.

Liquidity Requirements

Banks are generally subject to liquidity requirements that require them to hold sufficient amounts of highly liquid assets such as cash and government securities to ensure that they can make payments to depositors and other counterparties during times of stress. The main liquidity requirement for banks is the Federal Reserve’s liquidity coverage ratio (LCR). 

The report has a lot to say about lowering liquidity requirements. And the factual statements in the report are correct. However, it is important to note that none of the reductions to the LCR cited in the report apply to Forum members. Under the Federal Reserve’s recent tailoring final rule, all Forum members are required to fully comply with the LCR. Smaller banks are allowed to comply with a less stringent LCR requirement that applies a discount of between 15 and 30 percent or provides for a full exemption relative to the LCR that applies to Forum members. Moreover, not only are Forum members subject to the most stringent liquidity requirements, they routinely exceed the rule’s requirements. In particular, as of the second quarter of 2020, in the aggregate, Forum members maintain 122% of the liquid assets required by the Federal Reserve’s LCR. Accordingly, while some banks are held to less stringent liquidity standards, Forum members are held to the most stringent liquidity requirements—which have not changed—and regularly exceed them.

The Volcker Rule

The report makes much out of recent changes to the Volcker rule. It is well-known that representatives of both Democratic and Republican administrations long argued that the Volcker rule was in need of serious reform. Governor Daniel Tarullo himself, a key architect of post-crisis large bank regulation, publicly endorsed several changes to the Volcker rule that would streamline and simplify its implementation without sacrificing the statutory ban on proprietary trading. The changes made by the Federal Reserve and other regulators implemented a number of commonsense reforms. What’s more, all of these changes were made in the context of an open and transparent rulemaking process that considered a range of feedback from the public, including feedback from Better Markets.

Finally, and perhaps most importantly, it should be noted that the only structural change to the Volcker rule that was enacted by recent legislation exempted smaller banks with total assets less than $10 billion from the Volcker rule and its ban on proprietary trading. Accordingly, while all Forum members are subject to all of the requirements of the Volcker rule—a regulation that spans several hundred pages—some banks are completely exempt from these requirements. As a result, it seems difficult to understand how one can find fault with large banks that must comply with the many strictures of the Volcker rule while some other banks are completely exempted from its requirements.

The report issued by Better Markets covers quite a lot of ground. And, indeed, the report makes some points worth considering, such as the recognition that the stringent regulation of the banking sector has provided material incentives for unregulated financial institutions to grow (see pp 8-10 of the report). Our aim in this post is to draw an important distinction between the capital, liquidity and trading requirements to which Financial Services Forum members are subject and those to which other large banks are subject. Forum members are subject to the most stringent regulatory standards and typically exceed them. This hasn’t changed. Any desire to review the bank regulatory regime and identify shortcomings can most usefully be executed by reviewing the standards that apply to large banks other than Forum members.

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