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Governor Tarullo Outlines Federal Reserve’s Prudential Regulatory Priorities for 2014

In his written testimony before the Senate Banking Committee on Dodd-Frank implementation, Federal Reserve Board Governor Daniel K. Tarullo outlined the Federal Reserve’s prudential regulatory and supervisory priorities for 2014.  As discussed further in this blog post, these priorities include, among other things: (1) finalizing, in the “near term,” Dodd-Frank enhanced prudential standards for large domestic and foreign banking firms; (2) proposing, “fairly soon,” to implement the Basel Committee’s risk-based capital surcharge for global systemically important banks (G-SIBs); (3) finalizing, in the “coming months,” higher Basel III supplementary leverage ratio standards for the 8 U.S. G-SIBs, which Governor Tarullo referred to as the G-SIB leverage surcharge; (4) implementing in the United States the Basel Committee’s recent revisions to the denominator of the Basel III leverage ratio; (5) proposing to require the largest, most complex U.S. banking firms to maintain a minimum amount of long-term unsecured debt at the holding company level to facilitate orderly liquidation; and (6) considering a number of policy measures (including capital requirements, liquidity standards and minimum collateral haircuts for securities financing transactions) to address certain risks relating to short-term wholesale funding.

 

1.  Finalizing Dodd-Frank enhanced prudential standards for large domestic and foreign banking firms in the “near term”

Governor Tarullo stated that the Federal Reserve anticipates that the Dodd-Frank enhanced prudential standards for large domestic and foreign banking firms will be finalized in the “near term.”

  • Background:  Section 165 of the Dodd-Frank Act requires the Federal Reserve to issue enhanced prudential standards (including heightened capital standards, liquidity standards, single counterparty credit limits, enhanced risk management requirements, stress testing requirements (final rules already issued) and an early remediation framework) for:
    • U.S. bank holding companies with $50 billion or more in total consolidated assets (Large U.S. BHCs);
    • Foreign banking organizations with $50 billion or more in global total consolidated assets (Large FBOs); and
    • U.S. and foreign nonbank financial companies that have been designated as systemically important by the Financial Stability Oversight Council (Nonbank SIFIs).
  • Related resources:
    • Domestic Proposal.  In December 2011, the Federal Reserve proposed Dodd-Frank enhanced prudential standards for Large BHCs and U.S. Nonbank SIFIs.  Our memo on the Domestic Proposal is available here.
    • FBO Proposal.  In December 2012, the Federal Reserve proposed Dodd-Frank enhanced prudential standards for Large FBOs and non-U.S. Nonbank SIFIs.  Our memo and visuals on the FBO Proposal is available here.

 

2.  Proposing to implement the Basel Committee’s G-SIB risk-based capital surcharge “fairly soon”

According to Governor Tarullo, the Federal Reserve is currently working on a proposal to implement the Basel Committee’s G-SIB risk-based capital surcharge and expects to issue the proposal “fairly soon.”

  • Background:  Under the Basel Committee’s G-SIB surcharge framework, each G-SIB will be required to maintain a Common Equity Tier 1 capital surcharge of 1.0% to 2.5% of risk-weighted assets, depending on the size of its systemic footprint.  Under the Basel Committee’s framework, the G-SIB risk-based capital surcharge would function as an extension of the Basel III capital conservation buffer and would be phased in parallel with the capital conservation and countercyclical buffers, i.e., from January 1, 2016 until January 1, 2019.
  • Related resources:  Our blog post on the Basel Committee’s G-SIB surcharge framework and methodology for identifying G-SIBs is available here.  Our blog post on the November 2013 list of G-SIBs is available here.

 

3.  Finalizing the U.S. banking regulators’ G-SIB leverage surcharge in the “coming months”

Governor Tarullo stated that the U.S. banking regulators plan to finalize, in the “coming months,” their July 2013 proposal to impose higher Basel III supplementary leverage ratio standards on the 8 U.S. G-SIBs, which he referred to as the G-SIB leverage surcharge.

  • Background:  In July 2013, the U.S. banking regulators proposed higher leverage capital standards for the 8 U.S. BHCs that have been identified as G-SIBs (Covered BHCs) and their insured depository institution (IDI) subsidiaries.  The proposal would require a Covered BHC’s IDI subsidiaries to maintain a Basel III supplementary leverage ratio of at least 6% to be considered “well-capitalized” for U.S. bank regulatory purposes.  The proposal would also require Covered BHCs to maintain a leverage buffer that would function in a similar way to the Basel III capital conservation buffer.  A Covered BHC that does not maintain a Basel III supplementary leverage ratio of greater than 5%, i.e., a buffer of more than 2% on top of the 3% minimum, would be subject to increasingly stringent restrictions on its ability to make capital distributions and discretionary bonus payments.
  • Related resources:  Our memo on the G-SIB leverage surcharge proposal is available here.

 

4.  Implementing the Basel Committee’s recent revisions to the denominator of the Basel III leverage ratio

Governor Tarullo stated that the U.S. banking regulators intend to incorporate in the United States the Basel Committee’s recent revisions to the Basel III leverage ratio.

  • Background:  The current calibration of the Basel III supplementary leverage ratio contained in the U.S. Basel III final rule is based on the original December 2010 version of the Basel III leverage ratio.  In January 2014, the Basel Committee finalized revisions to the Basel III leverage ratio, making a number of important changes to the way the denominator is calculated.
  • Related resources:  Our visual memo on the Basel Committee’s revised Basel III leverage ratio is available here. 

 

5.  Proposing a minimum long-term debt requirement

Governor Tarullo stated that the Federal Reserve is consulting with the FDIC on a proposal that would require the largest, most complex U.S. banking firms to maintain a minimum amount of long-term unsecured debt outstanding at the holding company level.  Governor Tarullo also stated that, at the international level, the Federal Reserve is working through the Basel Committee and the Financial Stability Board (FSB) to develop an international proposal for gone concern loss absorbency requirements for G-SIBs.

 

6.  Considering policy measures to address certain risks related to short-term wholesale funding

Echoing his earlier speeches (see e.g., our blog post on Governor Tarullo’s November 2013 speech, available here), Governor Tarullo discussed possible regulatory measures to address certain risks related to short-term wholesale funding.  These possible regulatory measures include:

(1)   Requiring banking firms that rely on greater amounts of short-term wholesale funding to hold higher levels of capital.

(2)   Pursuing modifications to bank liquidity standards that would require firms that have matched books of securities financing transactions (SFTs) to hold larger liquid asset buffers or maintain more stable funding structures.  Governor Tarullo noted that the Basel Committee’s recently proposed changes to the Net Stable Funding Ratio (NSFR) “would move in this direction.”  Our blog post on the Basel Committee’s proposed revisions to the NSFR is available here.

(3)   Establishing minimum numerical floors for collateral haircuts on SFTs.  Governor Tarullo noted that if the scope of the FSB’s proposed regulatory framework for minimum haircuts on SFTs “was expanded to cover a much broader range of firms and securities and the calibration of the proposal was strengthened, the FSB proposal could represent a significant step toward addressing financial stability risks in short-term wholesale funding markets.”  Our blog post on the FSB’s August 2013 proposal is available here.

 

Materials:  Federal Reserve Board Governor Daniel K. Tarullo, Dodd-Frank Implementation, before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate (Feb. 6, 2014) available here: http://www.federalreserve.gov/newsevents/testimony/tarullo20140206a.pdf.

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