WASHINGTON — Banking regulators will soon release for public comment a proposed rule implementing aspects of
"The FDIC, together with the Federal Reserve and the Office of the Comptroller of the Currency, will issue a notice of proposed rulemaking to seek public comment on changes to the U.S capital framework to consider how best to incorporate the finalization of Basel III," Gruenberg said in a speech at the Peterson Institute for International Economics.
In light of
Gruenberg also said that unrealized losses on banks' securities portfolios — a major contributor to the failure of Silicon Valley Bank in March — should be factored into capital requirements.
The Basel III framework would have required Silicon Valley Bank, he said, to recognize in its capital the unrealized losses on its available-for-sale securities that led to a run on its deposits.
Gruenberg said that "because there would have been more capital held against these assets," the liquidity run at SVB might have been avoided under a scenario where the Basel III standards were in place.
The proposed rule, which will be issued pursuant to an update to the 2010 Basel III standards — colloquially known as the "Basel IV" standards, finalized in 2017 — is expected to increase the amount of risk-based capital that banks must hold.
Community banks, Gruenberg said, will not be subject to the proposed rule, given their smaller scale. The estimated capital impact on other banking organizations will be described in the notice of proposed rulemaking, he said.
Some in the banking industry have argued that higher capital requirements could cause banks to lend more selectively. But Gruenberg said that reeling in especially excessive lending is a positive for the long-term availability of credit. Credit is valuable to the extent that it is well underwritten, fostering the long-term strength of the banking system, he said.
"You want to reduce badly underwritten credit," he said. "And you want to be sure to capitalize against that."
A key component of the capital framework is its risk-based requirement. Capital reserves are meant to increase commensurate with any increase in risk that a bank assumes through its lending or capital markets activities, Gruenberg said.
But he acknowledged the possibility that risk-based requirements will prove ineffective, and said that they need to be paired with strong leverage capital requirements.
"Risk-based capital requirements can be managed by banks to minimize capital impacts, meaning we cannot be confident that increases in the risk-based regime will hold through time," Gruenberg said. "Banks' own models and the regulators may get the risk weights wrong."
In addition to risk-based capital increases, the banking agencies are focusing on implementing a number of reforms that attempt to incorporate lessons from the 2008 financial crisis. The goal is to apply more robust, standardized frameworks across applicable U.S. banks.
One such reform involves establishing a standardized credit risk calculation model. Gruenberg indicated that such a model would make it easier to compare the credit risks of various institutions side-by-side.
"The FDIC has long had concerns about the use of internal models in establishing minimum capital requirements for credit risk," he said. "Basel III offers an opportunity to introduce a standardized approach."
Gruenberg said the forthcoming reforms will also be a step in the right direction with respect to operational risk, especially as the size and complexity of the nation's largest banks and firms continue to increase.
He noted that cybersecurity risks like ransomware attacks are on the rise. And he said that the current U.S. framework for operational risk relies on banks' internal models — a situation that he described as less than ideal.
"Internal model estimates can present substantial uncertainty and experience volatility resulting from new data, introducing meaningful challenges to capital planning. Reliance on internal models has resulted in a lack of transparency and comparability as well," Gruenberg said.
While Gruenberg said that banks' strength throughout most of the pandemic reflects on the resilience of the 2010 Basel reforms, he noted that COVID-19 was a moment of exceptional government intervention, which contributed to the survival of banks. He argued that the experience of the pandemic should not hinder ongoing efforts to strengthen Basel III standards.
"It would be a mistake to consider the pandemic a true stress test of the capital adequacy of the banking system," he said.
Higher capital requirements could impact banks' profitability, and the American Bankers Association balked Thursday at Gruenberg's comments.
"While asking banks of any size to hold even more capital will come at a cost to the economy, broadening the scope of these complex standards designed for internationally active banks to smaller institutions will make it particularly difficult for midsize and regional banks to provide credit to consumers and businesses during times of economic stress," ABA President and CEO Rob Nichols said in a written statement. "Policymakers will need to demonstrate that the benefits outweigh the significant costs to the economy."
The Basel III framework originated in response to the global financial crisis of 2008. As Gruenberg noted, the crisis revealed a lack of understanding among both banks and their regulators regarding the extent of financial stability risks and the vulnerability of major financial institutions, which were found to be undercapitalized and highly leveraged.
The initial implementation of Basel III involved raising the overall quality and quantity of risk-based capital. Additional measures, such as enhanced leverage ratio requirements for large banks, regulatory capital buffers and quantitative liquidity requirements, were also introduced to incentivize capital buildup and improve risk management.
In 2017, the Basel Committee issued a
The final rule is not likely to be implemented before the middle of next year, following the comment period, Gruenberg said. Once the rule takes effect, he added, it will be implemented gradually over several more years.
