WASHINGTON — Federal Reserve Board Governor Daniel Tarullo cast some doubt Friday on the effectiveness of a new set of global capital rules signed off by world leaders, but said the agreement remains a "major step forward."
In a speech to a symposium on regulatory reform at George Washington University, Tarullo said that "Basel III is not a perfect agreement."
"There are things we could have done differently if we were writing a capital regulation on our own," he said. "There will surely be some technical challenges in implementing it. It does not really address some pre-crisis problems in capital regulation such as pro-cyclicality."
Still, Tarullo said Basel III would address some deficiencies in previous capital rules, particularly by creating a new minimum common equity ratio.
That effort came underway after leaders of the Group of 20 nations agreed in Pittsburgh last year to draft new rules to improve both the quantity and quality of bank capital and discourage excessive leverage as seen during the lead up to the financial crisis. It also wanted to provide banks with an appropriate length of time to implement the new regulations.
On Friday, the G-20 meeting in Seoul for their annual summit signed off on the proposed framework, which will now require banks to now hold common equity of 4.5% by 2015.
"The United States played an instrumental role in developing the new Basel III capital framework," the White House said in a statement. "The new standards will markedly reduce banks' incentive to take excessive risks, lower the likelihood and severity of future crises, and enable banks to withstand — without extraordinary government support — stresses of magnitude associated with the recent financial crisis. This will result in a banking system that can better support stable economic growth."
The agreement also calls for a 2.5% conservation buffer to be tacked on, which will go into effect gradually by 2019; additionally, banks will be required to lift their core Tier 1 level to 6% from 4% by 2015.
But as Tarullo acknowledged, regulators left some pieces unfinished.
For example, international negotiators failed to resolve how much additional capital should be charged for systemically important financial institutions. That surcharge, which could be a combination of a capital surcharge, contingent capital and bail-in debt, would come on top of all the other requirements.
"We think it serves U.S. interests to develop our plans for implementing our domestic stability obligation in tandem with our participation in this international process, so as to maximize the chances of convergence of international standards and our own practice," he said.
Tarullo said the Basel Committee and the Financial Stability Board will continue to work on this issue well into next year.
An additional concern for Tarullo was implementation of the new Basel standards.
"The benefits of Basel III for financial stability will be realized only if they are implemented rigorously," he stressed.
That means a distinction will need to be made between enacting national regulations that incorporate Basel standards and ensuring that firms are in fact holding the amounts of capital called for by the rules, he said.
Tarullo said the Basel Committee should monitor the effective implementation and compliance of the new capital standards.
"A number of market analysts have noted that, even under current market risk capital rules, there is considerable apparent variation in the risk-weightings apparently applied by different banks," he said. "We are urging the Committee to explore mechanisms for ensuring that these strengthened capital standards lead to a consistency in application, as well as in the provisions of relevant domestic regulations."
Separately, Tarullo addressed recent criticisms that the Fed may soon allow large banks to begin issuing dividends again. The Fed governor said the central bank has always been "concerned with the safety and soundness implications of resuming or increasing capital contributions in the absence of a strong, forward-looking demonstration that the capital position of a firm would be protected even under stressed conditions."
While the Fed is still finalizing details of its guidelines on this issue after receiving request from several of the largest holding companies, Tarullo said the central bank will take a conservative approach.
"We will expect firms to submit convincing capital plans that demonstrate their ability to absorb losses over the next two years under an adverse economic scenario that we will specify, and still remain amply capitalized," said Tarullo.
He added that firms will also be asked to show how their capital distribution plans will be able to "readily and comfortably" meet the Basel III requirements, as well as maintain compliance with Dodd-Frank.
