Systemic Risk Council Opposes Federal Reserve and OCC Proposals to Reform Leverage Ratio and Volcker Rule

WASHINGTON--(BUSINESS WIRE)-- On August 8, 2018, the Systemic Risk Council submitted a comment letter to the Federal Reserve Board of Governors and the Office of the Comptroller of the Currency on their proposals to relax the enhanced supplementary leverage ratio for big banks, and the so-called “Volcker Rule” constraints on using insured deposits to fund speculative trading and investments.

While in principle the Systemic Risk Council (SRC) supports the desire to simplify the current regulatory regime, the SRC believes the current proposals would make the US banking system materially less resilient and so expose the American economy and people to unnecessary risks. As such, the SRC is proposing an alternative way forward.

Leverage Ratio

The Federal Reserve (Fed) and Office of the Comptroller of the Currency (OCC) acknowledge that, while leaving capital in group holding companies broadly unchanged, this proposal would enable the large banking entities themselves to reduce their equity relative to total assets. The SRC’s letter offers four sets of reasons for not taking such action:

• The reduced arsenal of the macroeconomic authorities, notably the Fed, is liable to exacerbate future recessions, so that banks need more rather than less equity if they are to maintain the standard of resilience desired after the crisis of 2008-2009;
• Resilience is already being reduced by the recently-enacted legislative amendments to Dodd-Frank, the failure to implement the Net Stable Funding Requirement, and the proposed relaxations to the Volcker Rule;
• Allowing dealers to lever up more would blunt the incentives of market participants to invest in necessary improvements to the trading infrastructure for fixed-income capital markets, as they could go back to relying on government-subsidized market making; and, crucially,
• It is the resilience of operating banking subsidiaries that matters most, because it is they, not holding companies, that supply services to households and businesses. The current proposals are inconsistent with the policy behind earlier US legislation that requires operating banks to be subject to requirements enabling prompt corrective action.

The SRC has proposed an important mitigating measure if, despite those arguments, the Fed and OCC stick to their current course. It is that any reduction, relative to total assets, in the tangible common equity of operating banks should be offset by an equivalent increase in the amount of deeply subordinated bailinable debt issued by operating banks to their holding companies. The effect would be to leave unchanged the total amount of loss-absorbing capacity, while shifting its composition from equity to debt.

Volcker Rule

The principle underlying the Volcker Rule is that banks and dealers benefiting from access to Fed liquidity insurance and FDIC deposit insurance, backed ultimately by taxpayers, should not be in the business of speculative trading and investment; or, more generally, that such commercial activities should not have access to a government safety net.

The SRC has serious reservations about one aspect of the regulators’ proposals, which amount to giving more discretion to the management of banking groups to determine what are “market making” or “hedging” services provided to clients. This echoes the big mistake made by the Basel Committee when it allowed banks’ internal models to determine their capital requirements. Given the incentives banks face, the current proposal risks eroding the core substance of the Volcker Rule.

The SRC has urged the Fed and its fellow regulators to explore alternative means of simplifying the Volcker Rule without jettisoning the policy itself.

The full text of the letter is available here: https://www.systemicriskcouncil.org/2018/08/systemic-risk-council-opposes-federal-reserve-and-occ-proposals-to-reform-leverage-ratio-and-volcker-rule/

For further information please contact David R. Evanson at [email protected] or 215.460.8149 or Bristol Voss at [email protected] or 212.705.1738

View source version on businesswire.com: https://www.businesswire.com/news/home/20180808005575/en/

for Systemic Risk Council
Bristol Voss, 212-705-1738
[email protected]
or
David R. Evanson, 215-460-8149
[email protected]

Source: Systemic Risk Council

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