OCC's Walsh Signals Discord Among U.S. Regulators on Capital Surcharge

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WASHINGTON — While international regulators continue to spar over the right size of a proposed capital surcharge for the largest banks, the U.S. banking agencies are disagreeing among themselves on the issue.

In an interview with American Banker, Acting Comptroller of the Currency John Walsh said his agency favors a relatively "modest" charge, but acknowledged that other banking agencies are pushing for a higher one.

"Different agencies in the U.S. have different ideas about having an add-on," said Walsh. "We argue for something moderate. [Federal Deposit Insurance Corp. Chairman Sheila] Bair is clearly in the [camp], 'We think a very solid buffer is needed.' She would always err on the side of more capital where we would be more cautious there. So there are those differences of view."

Federal Reserve Board Gov. Daniel Tarullo alarmed bankers earlier this month when he suggested the surcharge could go as high as 7%. Most analysts had expected the surcharge to be around 3%.

Tarullo has subsequently downplayed that figure, telling lawmakers last week, "That's not to say that that's the one that gets eventually adopted."

Walsh said U.S. regulators are currently debating a charge between 1% and 3%, with the OCC favoring a lower amount. But he acknowledged that some within the agencies are pushing to go even higher.

"Our tendency is toward the low end," Walsh said. "There's a range of opinion about what's the right amount, including folks who would favor higher numbers than that range."

At issue is a proposed capital surcharge for systemically important financial institutions. Under proposed Basel III requirements, all banks would have to hold 4.5% of common equity by 2015, plus a 2.5% conservation buffer that would take effect in full in 2019.

International regulators are in the midst of finalizing a proposal for an extra surcharge for the largest institutions. That plan, which will be open for public comment, is expected to be released in July by the Basel Committee on Banking Supervision.

Walsh said that Tarullo's suggestion of a 7% capital surcharge was "wildly excessive," but acknowledged there are some who strongly think otherwise. (A 3% surcharge would effectively set capital requirements for SIFIs at 10% total, while a 7% surcharge would set them at 14%. Some European countries want to go even higher.)

"There clearly is a school of thought that believes that well north of 10%, up in the range of 20%, is where you should go to really fortify the system, and we just think that goes too far in terms of constraining the system," said Walsh.

U.S. regulators' views are not as divergent, Walsh said, but there are critical differences.

"It's not world's apart, but it makes a difference and we want to make sure that we don't overdo it," said Walsh. "We just think at some point it does bind and begins to constrain [lending], and I think others are genuinely less concerned about that."

Supporters of a higher charge claim that forcing banks to accumulate additional capital will come at little cost to the economy, while making the system much safer.

Walsh disagrees. He said a bigger buffer could potentially hurt lending as well as hurt the ability of banks to earn a viable rate of return.

"No one is arguing against some kind of buffer," said Walsh. "Let's have an additional buffer, but let's proceed with caution in how much you add-on."

Walsh said that regulators are cognizant of concerns of spurring a credit crunch.

"I honestly think all of the agencies, if you will, will want to err on the side of caution," said Walsh. "I think that's a common theme… If we have an add-on, and it gets too big, do we start to constrain lending? Do we put too much burden on the system?"

Currently, global regulators are working on what the appropriate number would be, as well as the composition of the surcharge, and who the rule would apply to.

Across the board, U.S. agencies have been consistent in calling for the surcharge to comprise of Tier 1 common equity, while foreign counterparts have pushed for hybrids instruments to be included.

As for which institutions should be subject to the charge, Walsh suggested starting with institutions that hold more than $50 billion of assets — a threshold that was part of the Dodd-Frank law to designate which banking companies were systemically important. Then regulators can begin to talk about differential treatment among banks, while later weaving in Basel III requirements.

"The way Basel has always worked is the central focus and the commitment with respect to the internationally active banks, but the way it has evolved I think people increasingly think the requirements there have more general application because the Basel committee moved in that direction," said Walsh.

Such an approach, he said, would fare better than regulators setting up a second test to determine how internationally active the bank would be, according to Walsh. Smaller institutions, meanwhile, could receive a capital break, he said.

"Why not use the Basel 7% for internationally active banks?" Walsh asked. "Then a second decision is what do you want to do about smaller institutions? You could set the capital level for them at 5% or 6%."

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