WASHINGTON The Federal Reserve Board released a proposal Tuesday laying out how it would institute capital surcharges on the country's biggest banks, saying it plans to be tougher than an international agreement on the issue.
The plan effectively lays out two tracks for U.S. banks deemed "globally significant financial institutions" to assess their capital surcharges, with banks bound by the more stringent of the two. The proposal would currently apply to eight banks, including Citigroup, JPMorgan Chase, Bank of America and Wells Fargo, but could eventually include more institutions if they increase their risk and complexity.
The first method is identical to that detailed by the Basel Committee on Banking Supervision in 2011, which requires all G-SIBs to hold extra capital of between 1% and 2.5% of total assets, depending on the riskiness of those assets and interconnectedness of the bank's dealings.
The second method would use many of the same inputs as the Basel rule, but would require banks to hold additional capital based on their reliance on short-term wholesale funding. Because banks' wholesale funding profiles are not public information, Fed officials said the surcharge assessed against individual banks would not be publicly available.
However, the central bank said in the proposal that the second method would "result in significantly higher surcharges than the [Basel] framework." Fed staff said banks, on average, would have to keep 1.8% more capital on hand as a result of the rule.
Fed Chair Janet Yellen said the proposal would "provide incentives to these banking organizations to hold substantially increased levels of high-quality capital" which in turn would "encourage such firms to reduce their systemic footprint and lessen the threat that their failure could pose to overall financial stability."
Fed Gov. Daniel Tarullo likewise said the plan is meant to target and reduce reliance on short-term wholesale funding because it is one of the most consistent determinants of global systemic risk. The Basel proposal, Tarullo said, did not appropriately weight those risks.
"Inclusion of a short-term wholesale funding factor reflects the fact that reliance on short-term wholesale funding can leave a firm vulnerable to creditor runs that force the firm to rapidly liquidate its own positions or call in short-term loans to clients," Tarullo said. "Thus, reliance on short-term wholesale funding is among the more important determinants of the potential impact of the distress or failure of a systemically important financial firm on the broader financial system."
The proposal is subject to a three year phase-in beginning in January 2016. But Fed officials said that despite the higher capital requirements in the proposal, almost all of the eight banks subject to the plan are already in compliance with the fully phased-in rule. It estimated the total capital shortfall at roughly $21 billion.
Under the proposal, all systemically important financial institutions that is, banks with more than $50 billion in assets would have to undergo an annual systemic indicator test to determine whether it is a G-SIB and subject to the surcharge. The test is based on five broad categories: size, interconnectedness, cross-jurisdictional activity, substitutability and complexity. Within those categories there are 12 additional systemic indicators that identify and weight a bank's risk profile. Banks who score more than 130 basis points in the annual test are considered G-SIBs under the proposal.
The board is expected to vote on the proposal at the end of its meeting on Tuesday afternoon. If approved, it would be open for comment until Feb. 28.
The rule comes as the Financial Stability Board last month released its 2014 list of globally significant banks. The Fed had been hinting for months that its surcharge would go even farther than the FSB, and that it would heavily weight a firm's reliance on short-term wholesale funding.