FRB Vice Chair Barr Seeks to Better "Align Capital Requirements with Risk Taking" Post Banking Failures

Federal Reserve Board ("FRB") Vice Chair for Supervision Michael S. Barr shared the results of his "holistic review of capital for large banks" and recommended bank resolution reforms in response to recent bank failures.

Mr. Barr emphasized the importance of implementing changes to risk-based capital requirements (also known as the "Basel III endgame") to ensure that financial institutions better "align capital requirements with risk-taking." He said that any proposed rules that follow from the review would introduce a standardized credit risk approach rather than allowing each financial institution to estimate its own risk. Proposed rules would also adjust the process for measuring market risk relating to interest rate, equity price, foreign exchange and commodities risk by (i) increasing quality standards for internal market risk models, (ii) requiring financial institutions to model risk based on the level of "individual trading desks for particular asset classes, instead of at the firm level" and (iii) introducing a standardized approach for measuring market risk. To account for operational losses, Mr. Barr said that proposed rules would replace the requirement for an internal modeled operational risk requirement with a standardized measure based on a financial institution’s activities.

Mr. Barr recommended lowering the assets threshold from $700 billion to $100 billion for applying the proposed risk-based capital rules. He argued that the expanded scope is workable for smaller banks because the proposed rules are "less burdensome" by not requiring a suite of internal credit risk and operational risk models. He added that the failure of Silicon Valley Bank ("SVB") also showed the importance of requiring banks to account for unrealized losses and gains in their available-for-sale securities when determining their regulatory capital.

Mr. Barr also recommended reforms that would address:

• Stress Testing. While calling the framework for stress testing "generally sound," he recommended that the FRB review its approach toward addressing global market shock and estimating operational risk.
• G-SIB Surcharge. Mr. Barr recommended technical adjustments to the surcharge framework.
• Long-Term Debt. To improve the resolution process, Mr. Barr stated that a proposal for long-term debt requirements for all large banks would be introduced. He stated that long-term debt, upon the failure of a bank, can be converted to equity and used to absorb losses, and also provide the FDIC with additional options for structuring or winding down the failed bank. In the case of SVB, Mr. Barr stated that had the bank had enough outstanding long-term debt, it could have reduced the risk of a run by uninsured depositors.