Nice design, but are they strong enough?
Photo: Hulton Archive/Getty Images
Having spent nearly a decade crafting new capital requirements to bolster the resilience of the country’s largest banks, the U.S. Federal Reserve is getting ready to do some fine-tuning. The rules can certainly be improved — but what’s needed is more than tinkering around the edges.
The Fed has two main tools to ensure banks have enough equity capital, the bedrock financing that lets them absorb losses and continue lending in difficult times. It sets minimum levels, and it conducts annual stress tests to see whether the thresholds would be breached in a crisis. Its new idea is to link the two together — using the tests to help adjust the levels.
Currently, if a bank flunks a stress test, the Fed restricts how much equity can be given back to shareholders — in the form of dividends and share buybacks — until the bank is better capitalized. Under the Fed’s new proposal, banks that suffered bigger losses in the tests would automatically face higher capital requirements, hence stricter limits on their payouts.