WASHINGTON — The No. 2 leader of the Federal Deposit Insurance Corp. board warned policymakers Wednesday not to ease capital standards on large banks as they move to enact regulatory relief measures.

In his last policy speech as the FDIC's vice chairman, Thomas Hoenig said it would be “a serious policy mistake” to ease capital standards such as the "supplementary leverage ratio" for megabanks.

Lawmakers and financial regulators in the Trump administration have voiced support for revamping certain post-crisis capital requirements over concerns that they overly burden banks and restrict lending. For example, the Senate-passed regulatory relief bill would allow custodial banks to exclude deposits at central banks in the calculation of the SLR. Others have supported removing initial margin and Treasury securities from the calculation as well.

FDIC Vice Chairman Thomas Hoenig
“I caution strongly against eroding the post-crisis capital standards that have contributed to the strength of U.S. banks and the long-awaited recovery of the U.S. economy,” said FDIC Vice Chairman Thomas Hoenig. Bloomberg News

“I caution strongly against eroding the post-crisis capital standards that have contributed to the strength of U.S. banks and the long-awaited recovery of the U.S. economy,” said Hoenig during a speech at the Peterson Institute for International Economics in Washington. “For example, reducing the capital requirements of the most systemically important banks by excluding central bank reserves from the supplemental leverage ratio ... is a serious policy mistake.”

Banks have long argued that the leverage ratio, which requires banks to hold a certain amount of capital against all assets — without applying risk weights — has unintended consequences and penalizes them for complying with other requirements of the Dodd-Frank Act.

The Treasury Department and the new Federal Reserve Board Chair Jerome Powell have suggested some form of relief to the leverage ratio.

“We need a leverage ratio as a high and hard backstop to risk-based capital,” Powell said during a House Financial Services Committee hearing Feb 27. But “I think we got the calibration a little bit wrong so our plan is to roll it back.”

Hoenig, on the other hand, was adamant that easing capital standards would eventually amplify liquidity risk and force the government to offer bailouts during the next financial crisis. He also criticized a decision by U.S. regulators to join a recent Basel Committee agreement that, Hoenig said, could result in an estimated $145 billion reduction in capital for the eight largest banking firms.

"This is counterproductive," he said. “Should the U.S. banking agencies embrace the Basel standard," he added, "the reduction in private capital would necessarily be underwritten by the FDIC, the Federal Reserve, and then the taxpayer. ... The United States should not engage in this race to the bottom.”

Hoenig, who has repeatedly taken a more cautious approach against easing regulation, said there were some areas he would be open to curtailing. One area was the Volcker Rule, which was meant to restrict banks from proprietary trading but many regulators have said has become too complex and burdensome.

“The application of the Volcker Rule can be greatly simplified,” Hoenig said. “Commercial banks should be free to enter into swaps and other derivatives to accommodate loan customers or hedge their own risks.”

Hoenig suggested that “such activities be entitled to a presumption of compliance with zero additional reporting requirements, unless compelling evidence to the contrary is identified during the normal supervisory process.”

He also suggested streamlining the "living will" process for large banks, a process that Hoenig said is becoming repetitive and costly every year that banks submit reports on their resolution planning.

“The living will process is cumbersome, political and misleading,” he said. “Most of what is learned is available through the examination process and the annual stress test. Eliminating or extending the reporting cycle would reduce bank and regulatory costs with access to information no less available.”

Hoenig said he supports significant regulatory relief for community and regional banks, which Congress and other policymakers have advocated of late. Hoenig said he was open to “elimination or simplification” of rules for smaller banks including certain capital and liquidity requirements, exam cycles and appraisal requirements.

“The failure to better understand the nature and disparate effect of regulations on the industry will be to increase the costs of banking and encourage ever-greater consolidation of the industry,” he said. “Prudential standards strengthen performance, while administrative procedural rules raise new barriers, increase costs and discriminate against banks that are less able to absorb those costs.”

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