Citgroup would need extra capital at $13 billion next year under a 10% capital target
Large U.S. financial institutions might be forced to sharply increase their capital cushions as part of a plan discussed by the Federal Reserve to help prevent another financial crisis.
Daniel Tarullo, governor of the U.S. Federal Reserve speaks during a Senate Banking hearing earlier this year.
In a speech on Friday, Federal Reserve governor Daniel Tarullo suggested institutions could be ordered to hold capital ranging from 8% to 14% of assets, adjusted for the amount of risk they pose.
No decision has been made, but in some extreme cases that would be twice as high as the 7% agreed to last year by global policy makers in Basel, Switzerland.
"The regulatory structure…should discourage systemically consequential growth or mergers unless the benefits to society are clearly significant," Mr. Tarullo said at the Peterson Institute for International Economics. "No one wants another TARP," he said, referring to the Troubled Asset Relief Program, the $700 billion government bailout that became necessary as financial institutions teetered on the brink of insolvency in 2008.
His comments come amid continuing international disagreement over the appropriate levels of capital for such "systemically important financial institutions," or SIFIs. International policy makers agree banks need stronger capital buffers to withstand market tremors but consensus tends to end there. U.S. policy makers, including Treasury Secretary Timothy Geithner, want an international agreement so U.S. firms aren't put at a competitive disadvantage by having to hold more of their capital in reserve.
In an interview on Friday, Michel Barnier, the European Union's financial-services commissioner, rejected the need for additional capital levels beyond those agreed to in Basel. "Let's not go too fast," he said. "We can't rush forward. We have to implement what we said we should."
The Fed, as part of the Dodd-Frank financial law passed last year, must impose stringent capital requirements on large, complex financial institutions that pose a risk to financial markets. About 35 banks with $50 billion or more in assets are automatically subject to the enhanced capital rules and regulators are discussing which other nonbanks, such as insurance companies, private-equity shops and hedge funds, also should fall into the SIFI category.
The Fed is considering a stricter capital regime than many on Wall Street expected. A leading idea among Fed staff would require the riskiest institutions—those whose collapse could cause the most collateral damage—to boost capital levels 100% above the Basel international standards, while less-risky institutions would need a 20% bump. That would translate into firms putting aside between 8.4% to 14% of capital. The Basel agreement requires institutions to slowly increase capital cushions to 7% by 2019 from roughly 2% now.
Banks would have to boost their capital reserves using common equity—a stricter form of capital than many want to use because it dilutes the outstanding shares. Mr. Tarullo said other forms of capital, such as contingent capital, which allows banks to convert debt instruments into equity in an emergency, are insufficient and potentially subject to "political pressures" in times of stress.
Mr. Tarullo said the U.S. needs to move beyond the Basel requirements because they are narrowly tailored to an individual institution's ability to withstand losses and don't take into account the "high degree of risk correlation among large numbers of actors in quick-moving markets." Tougher capital standards are necessary, he said, because systemically important institutions have "no incentive to carry enough capital to reduce the chances of such systemic losses."
Source data: WsJ online - June 4, 2011
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