Fed plan to ease capital rules courting disaster: Bair, Hoenig

WASHINGTON — The outgoing No. 2 of the Federal Deposit Insurance Corp. and the agency's former chair are arguing against recent proposals to modify bank capital rules, saying the proposed changes would increase the likelihood of another financial crisis and make future crises more severe.

Thomas Hoenig, who also announced Friday his resignation from the FDIC, and former Chair Sheila Bair said in an op-ed published in The Wall Street Journal that recent proposals by the Federal Reserve and Office of the Comptroller of the Currency to change banks’ capital regimes would repeat many of the same mistakes that led to the 2008 financial crisis.

“These proposals have the laudable goals of simplifying bank capital rules and boosting lending to the real economy,” the authors wrote. “But we fear their unintended impact would be to make the financial system less resilient and to make another financial crisis likelier and more severe.”

Hoenig and Bair called the idea that lowering capital standards results in greater lending an “urban legend,” and said it actually could reduce lending overall by increasing the likelihood of a recession. Banks reduced lending by 18% in 2008 and 2009 because of capital and liquidity concerns, the authors said, and in any event, there is no reason to believe that credit is constrained.

“Changes in capital rules should, if anything, boost capital buffers during growth periods,” they said. “The proposals the Fed is currently considering would not only weaken them but rely less on the leverage ratio—a simple and understandable metric capping the ratio of debt to equity in bank funding that has proven a strong predictor of banks’ financial health.”

The Fed and OCC issued a proposal that would revise the enhanced Supplementary Leverage Ratio — which had applied an additional 2% leverage capital requirement for global systemically important banks, or G-SIBs — to 50% of those banks’ risk-based capital surcharge. The Fed also issued a proposal that would modify how the Fed determines banks’ minimum capital requirements for the agency’s annual stress tests, including the application of the leverage ratio as a minimum capital requirement.

The FDIC notably did not propose the eSLR rule along with the Fed and the OCC, and Fed Gov. Lael Brainard took the novel step of voting against the proposal. FDIC Chairman Martin Gruenberg said in a statement that enhancing the leverage requirements of the biggest banks was “among the most important post-crisis reforms.”

And Brainard said in a speech last week that while improving regulations and removing undue burdens are important goals, the time to make those adjustments might be at a point where regulators have had a chance to observe how the existing capital structure performs under stress conditions.

“Prudence would argue for waiting until we have tested how the new framework performs through a full cycle before we make judgments about its performance,” Brainard said. “At this point in the cycle, it is premature to revisit the calibration of core capital and liquidity requirements for the large banking institutions.”

Bair, who served as FDIC chair from 2006-2011, was a strong proponent of boosting capital at the largest U.S. banks in the wake of the crisis. Hoenig has long been an advocate for stronger leverage capital requirements for banks and has warned against loosening those standards.