For release on delivery
9:00 a.m. EST
January 17, 2024
The Path Forward for Bank Capital Reform
Remarks by
Michelle W. Bowman
Member
Board of Governors of the Federal Reserve System
at
Protect Main Street
Sponsored by the Center for Capital Markets at the U.S. Chamber of Commerce
Washington, D.C.
(virtual)
January 17, 2024
"More is better." This axiom often holds true in many respects, but experience also
Today, I'm
teaches us that there are limits. happy to join you here at the U.S. Chamber of
Commerce to talk about proposed changes to bank capital rules in the United States and to probe
the limits of the notion that "more is better" when regulators seek to apply it to bank capital
requirements.1
In July 2023, the federal banking agencies proposed changes to implement the Basel III
"endgame" capital reforms.2
The published capital rulemaking proposal incorporated an
expansive scope and a notable shift in approach by pushing down new Basel capital requirements
to all banks with over $100 billion in assets, regardless of their international activities. The
proposal would substantially increase regulatory capital buffer and minimum capital
We've
requirements for the covered firms. The comment period closed yesterday, January 16th.
seen a robust response from commenters, with a large number of comments submitted during the
latter part of the comment period. As a policymaker, I am pleased to see the careful attention
stakeholders have paid to this proposal and the thoughtful feedback that has been provided
during the comment period. Public input should help to improve the efficiency and effectiveness
of the proposal.
From my perspective, given the significant response from a number of industries and
perspectives, as a bank regulatory policymaker, the agencies are obligated to think carefully
about the best path forward for this proposal. This should include making substantive changes to
address known deficiencies with the proposal and giving the public an opportunity to comment
- 2 -
on any reformulated proposal, to ensure the best possible outcome for the Basel capital reforms.
That path should ensure that sufficient consideration is given to the wide-reaching consequences
of capital reform to the U.S. banking industry, the U.S. economy, and, importantly, U.S.
businesses. We should consider tradeoffs in addressing scope, calibration, and tailoring. And
we should appropriately adjust the excessive calibrations and eliminate regulatory overreach in
the proposed rule.
like
Today, I'd to briefly discuss what I see as the consequences of miscalibration of
testing the "more is better"
capital reforms-and principle-through a discussion of the impacts
of finalizing the proposed capital reforms without significant revisions. I will then outline ideas
for a path forward and highlight what I see as the two most pressing problems in the proposal,
issues that we must address before finalizing these and other pending rules. And finally, at the
risk of lulling those to sleep who do not eat, drink, and breathe bank capital rules 24/7, I will
identify a few important technical issues for resolution because they lead into the two
overarching problems that I referenced a moment ago.
Considerations in Capital Policy
Capital plays a critical role in the U.S. banking system, promoting the safe and sound
operation of banks and supporting confidence in the broader banking system. Capital helps
banks provide financial products and services, including credit, that support American
businesses. I think we can all agree that higher levels of capital enhance financial resilience-up
to a point. At the time of a bank's failure,
capital-especially common equity capital, as the first
type of funding to absorb losses-protects depositors and other creditors. Capital allows banks
to continue providing products and services, promoting a well-functioning financial system, even
during times of stress.
- 3 -
But capital is not costless. Capital does not come into existence only at the point of
failure-capital is an ongoing requirement, and an ongoing cost, for all banks. The cost of
capital- both the required minimum amount of capital and buffers and the market price of
capital-influences every aspect of the business of banking, including the business lines a bank
pursues, the products and services it offers, and the cost and availability of those products and
services. Banks are not obligated to offer the same financial products or services over time.
Banks also are not obligated to maintain the same costs of products and services. Indeed, it
would be irresponsible for a bank to ignore the cost of capital in managing its business, just as it
would be irresponsible for a bank to ignore market preferences and forces when choosing its
do not simply evaporate on a bank's balance
lines of business. Increases to the cost of capital
sheet, they are passed through to customers in various ways, including in the form of higher costs
for financial services or in reduced availability of services available in the market.
The cost of bank capital also influences where activities occur, either within the
regulatory perimeter of the banking system or in non-bank entities and the broader shadow-
banking system. When the cost of a bank engaging in an activity exceeds the cost of performing
the same activity in a non-bank, that cost differential creates pressure that over time leads to a
shift in these activities to non-bank providers.
Where does that leave us? Achieving good policy requires acknowledging and balancing
the benefits and costs of capital requirements, since it is one of the most important inputs
policymakers can use to enhance the safety and efficiency of the banking system. Relying
"more is better"
simply on the approach downplays or ignores these critically important
tradeoffs. When policymakers consider changes to the capital framework, particularly increases
of the magnitude contemplated in the proposal, we must carefully weigh the benefit of increased
- 4 -
safety from higher capital levels, with the direct costs to banks, and the downstream effects on
consumers, businesses, and the broader economy. We must also consider the broader regulatory
landscape and how changes to capital regulations may complement, overlap, or conflict with
other regulatory requirements. And importantly, we must consider the broader implications for
the structure of the U.S. financial system and for financial stability. While these considerations
may caution us against capital increases of the magnitude contemplated in the proposal, I do see
a potential path forward for capital reform.
The Path Forward
As I consider next steps, I am cautiously optimistic that policymakers can work toward a
reasonable compromise, one that addresses two of the most critical shortcomings of the proposal:
over-calibration and the lack of regulatory tailoring. Public feedback has also assisted in
identifying the aspects of the proposal that result in the most severe unintended consequences. In
my mind, it will be necessary for policymakers to modify the proposal to mitigate these issues
and concerns as we move forward.
Calibration
First, I would like to address calibration. The costs of this proposal, if implemented in its
current form, would be substantial. As the proposal describes, Federal Reserve staff estimates
these changes to result in an aggregate 20 percent increase in total risk-weighted assets across
bank holding companies subject to the rule, although some commenters have projected much
greater effects on some firms.3 While the actual impact on binding capital requirements will
- 5 -
vary by firm, it is apparent even with the incomplete information available today that this will
represent a large increase in capital requirements.
In October of 2023, the Federal Reserve launched a data collection to gather more
information from the banks affected by the Basel III capital proposal.4 The purpose of this
quantitative impact study was to help better understand the estimated effects of the proposal. My
understanding is that the Federal Reserve will release its analysis of those findings and some
aggregated information for comment. And just as for the initial proposal, stakeholder feedback
on this quantitative impact study and staff analysis will be very instructive as we seek to analyze
and understand the expected impacts of the proposed capital reforms. Based on the information
available, increasing capital requirements as initially proposed could result in significant harm to
the U.S. economy through the impact on U.S. businesses, while failing to achieve the intended
goals of improving safety and soundness and promoting financial stability.
Much of the public feedback and concern focused on the calibration of the proposal and
the corresponding impact across a number of industries. Farmers, ranchers, and agricultural
producers that use derivatives to hedge price risks in agricultural supply chains have noted that
the increased costs of providing these services from the proposal could lead banks to limit their
availability in the marketplace.5 Small-business owners (including builders, manufacturers,
4
See Board of Governors of the Federal Reserve System, "Federal Reserve Board Launches Data Collection to
Gather More Information from the Banks Affected by the Large Bank Capital Proposal It Announced Earlier This
Year," press release, October 20, 2023,
https://www.federalreserve.gov/newsevents/pressreleases/bcreg20231020b.htm.
5
See National Council of Farmer Cooperatives, Commodity Markets Council, National Cattlemen's Beef
Association, National Grain and Feed Association, American Farm Bureau Federation, National Milk Producers
Federation, National Pork Producers Council, American Cotton Shippers Association, Farm Credit Council,
"Comments on Regulatory Capital
Rule: Large Banking Organizations and Banking Organizations with Significant
Trading Activity and Regulatory Capital Rule: Risk-Based Capital Surcharges for Global Systemically Important
Bank Holding Companies" (December 11, 2023),
https://www.federalreserve.gov/SECRS/2023/December/20231229/R-1813/R1813_121123_156411_319900252084_1.pdf.
- 6 -
"make borrowing costs
restaurant owners, and others) have indicated that the proposal could
unaffordable and capital inaccessible."6
These real-world examples only scratch the surface of
the harmful effects of this proposal as described by a broad range of stakeholders noting the
impact on a wide array of businesses. My initial observation is that, in the aggregate, the
comments reflect a spectrum of concerns that are largely driven by calibration.
These well-founded concerns and the risks they highlight are not surprising in light of the
scale of the proposed capital increase. In addition, this direct independent feedback provides a
new lens through which to view the proposal, enabling us to specifically identify and confront
the predictable effects: higher costs of capital for banks and services for customers, less
availability and narrower selection of services, and increased concentration in the providers of
financial products and services. These consequences could disproportionately harm underserved
markets, businesses, and communities, as bank customers will bear the cost of these increased
capital requirements.
In addition to the direct impacts of excessive calibration, policymakers must also
consider international comparability and competitive disadvantages. A key element of the Basel
capital rules is to promote greater international comparability, a goal that is frustrated when U.S.
regulators over-calibrate requirements, at a level in excess of international peers and not
supported by proportionate levels of risk. Significant banking activities occur in the international
and cross-border context, and we know that financial stability risks can spread throughout global
financial markets. One approach to mitigate the spread of financial stability risks is to promote
- 7 -
minimum standards across jurisdictions that not only improve competitive equity in banking
markets but that also make the financial system safer.
The capital proposal reflects elements of the agreed upon Basel standards, but it far
exceeds those agreed standards. Adjusting the calibration of the Basel capital reform proposal
would have the important secondary benefit of enhancing this international consistency.
To address this issue of calibration, policymakers must develop and work toward a target,
a top-line aggregate capital level that would best promote safety and soundness and one that has
a broad consensus among policymakers. Earlier efforts on the Basel proposal would have
resulted in something closer to "capital neutrality"-with essentially minimal top-line change in
aggregate capital requirements across the U.S. banking system.7 I would note that the U.K.
approach contemplates an average increase in the low single digits.8 I look forward to learning
more about stakeholder views on calibration from the comments we have received.
Tailoring
Next, I will turn to the role of tailoring in bank capital reform efforts.
The U.S. banking system is now much better capitalized than after the 2008 financial
crisis, with substantially more liquidity. The current capital framework represents a risk-based,
tailored approach, with the goal of aligning regulation with risk. The largest firms are divided
into four categories based on size and complexity, with the largest and most complex firms
7
See Randal K. Quarles, "Between the Hither and the Farther Shore: Thoughts on Unfinished Business" (speech at
("A major issue that we are grappling with
the American Enterprise Institute, Washington, D.C., December 2, 2021),
is how to implement these [Basel III endgame capital] reforms, which reduce the role of bank internal models on
(emphasis
bank capital requirements, while maintaining the overall level of aggregate capital requirements.")
added), https://www.federalreserve.gov/newsevents/speech/quarles20211202a.htm.
8
See Bank of England, "The PRA
Publishes the First of Two Policy Statements for the Implementation of the Basel
3.1 Standards," press release, December 12, 2023, ("Based on its latest data, the PRA estimates that the impact of
Basel 3.1 requirements will be low and result in an average increase in Tier 1 capital requirements for UK firms of
around 3% once fully phased in...."),
https://www.bankofengland.co.uk/news/2023/december/pra-publishes-first-oftwo-policy-statements-for-basel-3-1-standards-implementation.
- 8 -
subject to the most stringent requirements. Regional banks, with $10 billion to $100 billion in
assets, are subject to a somewhat more streamlined capital framework. And finally, the simplest
rules are reserved for community banks that rely on a less complex, relationship-based business
model.
Despite the past success in this approach, tailoring has recently come under attack in
regulatory reform efforts and applications.9 Some have argued that the bank stress last spring
was the result of changes Congress made several years ago to promote risk-based and tailored
supervision.10 The theory is that following the implementation of tailoring rules, regulators
adopted a less assertive supervisory approach, and that regulators should instead move toward a
regime that imposes uniform standards to firms with significant variability in size, risk,
complexity, and business model-shifting back to a one-size-fits-all regulatory approach.
I have still not seen compelling evidence that removing tailoring is a productive
regulatory approach. To the contrary, the existing capital framework demonstrates how the
tailored approach can help support appropriate requirements based on firm characteristics.
In my mind, the failure to apply tailoring is a fundamental flaw of the Basel capital
capital
reforms as proposed, and one that must be addressed. The application of today's
requirements can be illustrated as an incline, with different or enhanced requirements kicking in
at specific levels of size and complexity.11 By contrast, if you were to superimpose the current
9
See Michelle W. Bowman, "Statement by Governor Bowman on
Advance Notice of Proposed Rulemaking on
Resolution Requirements for Large Banks and Application by U.S. Bancorp," press release, October 14, 2022,
https://www.federalreserve.gov/newsevents/pressreleases/bowman-statement-20221014.htm.
10
Economic Growth, Regulatory Relief, and Consumer Protection Act, Pub. L. No. 115-174, 132 Stat. 1296 (2018).
11
"Federal Reserve Board
See Board of Governors of the Federal Reserve System, Finalizes Rules That Tailor Its
Regulations for Domestic and Foreign Banks to More Closely Match Their Risk Profiles," press release, October 10,
2019, https://www.federalreserve.gov/newsevents/pressreleases/bcreg20191010a.htm; Tailoring Rule Visual
(October 10, 2019),
https://www.federalreserve.gov/aboutthefed/boardmeetings/files/tailoring-rule-visual20191010.pdf.
- 9 -
Basel proposal on the tailoring framework, you would see something in the capital space that
looks more like a single step, with a broad set of capital requirements kicking in at the $100
billion threshold. It is easy to see the difference between a slope and a cliff, and it is reasonable
to expect that this cliff effect could become even more pronounced if we abandon tailoring in
other areas, like liquidity regulation and long-term debt requirements.
As I have noted in the past, incorporating graduated requirements not only helps to
effectively allocate limited supervisory resources, but it also avoids creating regulatory
incentives that could unintentionally alter the banking landscape. Capital requirements are a
prime example of a regulatory requirement that could have a transformative effect on the
structure of the banking system. Banks near the $100 billion asset size are already carefully
considering the ongoing viability of remaining at an asset size near that threshold. Firms just
above the threshold will face strong pressure to shrink or to merge with other firms to achieve
economies of scale to comply with the breadth and complexity of the existing and proposed
requirements. Firms just below the threshold will need to be very intentional about approaching
the $100 billion threshold, and it would be reasonable to expect that they may consider revising
business strategies and activities to remain well below. While these distortive effects on the
banking system may be unintended, they are a predictable consequence of pushing down
requirements designed and calibrated for larger and more complex banks to those that are smaller
and less complex.
The critical role of tailoring must be incorporated as a foundational element of these
regulatory reforms. In practice, I think this requires us to take a hard look in a more granular
way at the banks that should be subject to different elements of the capital requirements-such
as market-risk and credit valuation adjustment (CVA) requirements, credit and operational risk
requirements, and the revised treatment of accumulated other comprehensive income (AOCI).
Splitting out elements of the rule-thinking about the appropriate application of each-can result
in more targeted revisions that improve the effectiveness of the capital framework, while
minimizing unnecessary burden and costs.
Technical Areas of Change
I would also like to highlight a few important technical issues that should be addressed in
ongoing reform efforts. To be sure, this is not an exhaustive list, but as policymakers consider
the path that lies ahead, these are areas in the proposal where I see room for significant
improvement.
•
Recognizing the Benefits of Diversification, Particularly in Operational Risk.
Diversification in revenue streams can enhance the stability and resilience of a financial
institution, and excessive capital charges for these revenue-generating activities could
create incentives for banks to roll back the progress they have made to diversify
revenues. Basel capital reforms should not penalize noninterest and fee-based income
through the proposed operational risk requirements. There are a number of different
approaches that could effectively address this concern.
•
Calibration of the Market Risk Capital Rule. Based on the information presented in the
proposal, the revisions to the market risk rule alone will increase risk-weighted assets
from $430 billion to $760 billion for Category I and II firms and from $130 billion to
$220 billion for Category III and IV firms. These increases are significant, with broad-
based impacts, affecting business and municipal bond issuance and other forms of debt
financing, risk management, hedging of foreign exchange and interest rate risk, or
managing the risks of fluctuating commodity prices through hedging activities. The
calibration of these changes could have a disproportionate impact on important derivative
end-users: the farmers, manufacturers, small businesses, and others who rely on financial
products to hedge some of their production cost and other business risks. While this
calibration point may be a mere subset of the broader calibration concerns about Basel
III, the significance of the capital charges in this area warrants attention.
Address Redundancy or "Over-Calibration."
o I have heard some interesting
philosophical debate about how to characterize the interaction of the Basel III
there elements of "overlapping"
capital proposal and stress testing. Are
requirements, which implies redundancy in capital charges? Or are these rules
seeking to identify and mitigate different risks, with stress testing focusing a
narrower subset of tail risks? This debate, while interesting, seems to miss the
broader calibration point. When looking at both the global market shock as
applied in stress testing and the calibration of elements of the market risk rule that
capture similar risks, the aggregate calibration is simply too high to accomplish
the goals of capturing baseline risks and tail risks.
• Better Alignment of Risk Weights and Credit Risk. Credit risk weights should correspond
to underlying credit risk-this matching of credit risk and capital requirements helps to
promote safety and soundness. I think there are a number of areas where the proposal
missed the mark in meeting this objective, including credit risk weighting for privately
held companies and small businesses, residential real estate, and retail credit exposures.
• Looking Beyond Basel III: Leverage Ratio Capital requirements are
Requirements.
intended to be complementary-risk-based capital rules require banks to hold capital
against more granular and specific risks, while leverage requirements operate as a
backstop in the ordinary course of business. This arrangement works by design, but we
have seen some cracks emerge, particularly around the impact of the 5 percent leverage
ratio that applies to U.S. global systemically important banks at the holding company,
commonly referred to as the enhanced supplementary leverage ratio (or eSLR). While
risk-based and leverage capital requirements are intended to be complementary and
disrupt banks'
promote the safe and sound operation of the banking system, the eSLR can
ability to engage in Treasury market intermediation, which we saw occur in the early
days of market stress during the pandemic. I consider reform of the eSLR to fall in the
category of "fixing what is broken." This is an issue that would be prudent to address
before future stresses emerge that could disrupt market functioning.
Closing
In closing, I would like to thank the Center for Capital Markets at the U.S. Chamber of
Commerce for the invitation to speak with you today about bank capital reform. Bank capital
policy involves tradeoffs and policy decisions, and as you all know, policymakers have different
views about how to strike the right balance. But as I view the landscape today, I do not view
these differences as insurmountable obstacles to achieving a more effective and efficient set of
Basel capital reforms. Unlike many other areas of reform, the impact of changes to bank capital
can be analyzed and understood, which provides a much better ability to compare and reconcile
the tradeoffs of specific reforms. In many ways, this is one of the empowering aspects of capital
reform. In considering a reform, we have a greater capacity to understand and assess the true
costs, including both the direct costs to banks and their customers, but also the potential harm to
U.S. bank competitiveness in the global economy. The impact data collected from financial
institutions subject to this rule describing effects directly linked to the proposed capital reforms
will allow us to consider the combined and aggregate impact, to help us avoid a capital "end
state" that is overlapping, inefficient, contradictory, and potentially harmful to banks, their
customers, and the broader economy.
As I have noted, my understanding is that the Federal Reserve will release its analysis of
its findings and some aggregated information for comment. The data collected and released
should help public commenters and policymakers assess the impact of the proposal. It should
also serve as a guide to assist in shaping the next iteration of this proposal, whether that be in the
form of a re-proposal or significantly revised final rule.