WASHINGTON — Federal Reserve Board Gov. Daniel Tarullo acknowledged Wednesday that capital requirements for smaller banks are too complicated, and he suggested they could be retooled to be closer to earlier Basel Committee standards.
"Capital requirements for smaller institutions in the United States need to be simpler than they are," Tarullo said during an event sponsored by The Wall Street Journal. "When it comes to smaller institutions and certainly community banks, any institution under $10 billion, I think we can and should have a substantially simpler capital system — one that looks more like the original Basel I" with a limited number of risk categories.
However, Tarullo rebuffed the plan proposed by House Financial Services Committee Chairman Jeb Hensarling, R-Texas, to allow banks to replace current risk-weighted capital requirements with a simple 10% leverage ratio.
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Hensarling's bill would give banks the option to choose compliance with a strict leverage ratio in lieu of other post-crisis standards. Not only is the leverage ratio seen by many as a tougher hurdle than current risk-weighted capital measures used by the Basel Committee, but supporters of the plan also say a simpler capital requirement would enable institutions to focus on their core businesses rather than complying with complicated formulas.
But Tarullo said the 10% threshold would have significant drawbacks.
"My own judgment is that 10% number would have to be substantially higher to have regulators comfortable that in fact there were not safety and soundness considerations, and with a substantially higher number one really wonders whether that is the most efficient," use of capital, he said.
Some argue the leverage ratio is a purer reflection of a bank's capital standing than risk-weighted capital requirements. But Tarullo said both a risk-weighted and non-risk-weighted measure have merits. He warned that moving to an exclusively non-risk-weighted calculation could lead banks to bulk up on riskier assets.
"A leverage ratio is very important … but the risk-weighting actually focuses on the actual riskiness of the portfolio, so my view is you really need both," Tarullo said.
