Regulators are aligned on capital reforms. Congress is a different story.

Bloomberg News

Federal regulators have lined up behind stronger capital requirements for large banks, but questions remain about how much political support they can generate in Washington — and how much they will need for their efforts to last.

Unlike the last time bank capital standards were increased after the subprime mortgage crisis, this latest push lacks clear champions in Congress. Instead, Republicans and some moderate Democrats have expressed skepticism about Federal Reserve Vice Chair for Supervision Michael Barr's "holistic" review of capital, which served as the basis for the policy changes he outlined Monday. 

The changes being considered — specifically updating risk-capital rules and resolution requirements on banks between $100 billion and $250 billion of assets — do not require an act of Congress to implement. Regulators need only put the policies through a rulemaking process, which is expected to kick off sometime in the coming weeks. But, some policy experts say moving forward without some kind of legislative backing could be a fraught exercise.

"The economic significance of these rules raises the bar for ensuring that they are correctly calibrated and that they have broad support," said Andrew Olmem, a partner and regulatory specialist at the law firm Mayer Brown. "Anytime an agency moves forward with a rule that could have a significant adverse impact without getting congressional support, it runs the risk of Congress or future administrations changing it. It's always in the public's best interest to take the time to get it right the first time."

So far, the loudest voices in Congress speaking about capital reform are those urging caution.

Late Friday, Reps. Andy Barr, R-Ky., and Bill Foster, D-Ill. — the chair and ranking member, respectively, on the House Financial Services Committee's subcommittee on financial institutions and monetary policy — sent a letter to the Fed's chief regulator reminding him that increased capital requirements can have negative impacts on the availability of credit for consumers.

"Your holistic review and any new requirements should consider those concerns to minimize negative impacts as we enter a phase of potential credit tightening," they wrote. "We must strike the right balance between safeguarding our financial system and ensuring banks of all sizes can support communities' access to credit."

After Monday's speech, Rep. Barr accused Vice Chair Barr of failing to take that dynamic into consideration, adding that the reforms called for were "just the opposite of what the U.S. financial system needs as we face the growing likelihood of a recession and credit crunch."

In his much-anticipated speech, Vice Chair Barr called for enhancing risk-capital rules as part of the final implementation of the Basel III international regulatory framework. He also called for modest changes to stress testing and expanding long-term debt requirements to a broader swath of banks. Critically, he called for lowering the threshold for these types of regulatory requirements from $700 billion to $100 billion.

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The changes were broadly expected and supported by other federal regulatory chiefs. Acting Comptroller of the Currency Michael Hsu said there was "strong alignment" between the agencies on Monday. Federal Deposit Insurance Corp. Chair Martin Gruenberg called for similar changes last month.

But the proposals are not universally supported by officials in Washington. Fed Governor Michelle Bowman has repeatedly argued against changing capital standards, noting that banks had enough capital to overcome recent stresses. She also warned that overregulation could drive more activity out of the banking system and into less regulated nonbanks. 

During his speech Monday, Barr pushed back against the notion that easing regulation on banks is the solution to rising risk among so-called shadow banks. In response to a moderator question about the divergent viewpoints on the board, Barr signaled that securing unanimous support for his reform package was not a top priority. The rules only need a simple majority vote from the six-member board to be approved.

"My goal has been to try and educate board members on the proposals, make sure they're informed and they can make a good judgment about the proposals," Barr said. "At the end of the day, each governor makes his or her own choice about whether to vote for or against a proposal and I respect that."

Banks and their allies have largely maligned Barr's vision for capital reform. Several bank and financial trade organizations this week called the changes unnecessary and a potential threat to the economy. Only the Independent Community Bankers Association offered an endorsement of Barr's remarks on the grounds that enhanced standards would not apply to smaller banks. 

Consumer advocates, by contrast, largely supported Barr's call for capital reform. Dennis Kelleher, head of the advocacy group Better Markets, dismissed the argument that higher capital requirements would reduce lending activity as a baseless "talking point."

"The real threat and danger to this country is not banks that have too much capital, it's banks that have too little capital. The 2008 crash and the recent crash of Silicon Valley and the other banks demonstrate that," Kelleher said. "The failure of three banks is going to cost $31.5 billion and those costs are all going to be passed onto the American people who are going to have to pay more for banking services."

However, Kelleher does not agree with Barr's call for long-term debt requirements for large regional banks, a provision intended to give banks an additional — albeit costly — mechanism for absorbing losses at times of distress. Kelleher argues that such mechanisms cannot, and likely would not, be relied upon during times of actual stress.

"Our view is it's not going to work — and it's doubly bad because not only won't it work, but it gives a false illusion that it will," he said.

Karen Petrou, managing partner of Federal Financial Analytics, said the full impact of the changes will have to be spelled out in the regulators' notice of proposed rulemaking. 

In particular, Petrou said the focus will be on differences between the current advanced approaches model used for determining risk-based capital requirements and the new standard approach that will be implemented to align with the so-called Basel III endgame. While capital levels overall will go up as a result of this change, she said, the treatment of specific exposures under the new rules will determine which firms bear the brunt of increase. 

For banks that have been subjected to the advanced regulations, a switch to a new standard could actually bring a modicum of relief. Because of this, Petrou said she puts little stock in Barr's assertion that the changes will result in an average increase in capital of 2% across the impacted banks, or that banks could raise the additional equity needed in just two years.

"That's just an average. It'll have a big impact on the individual business models. The variation around that mean or average is enormous," she said. "Look at what happened on the stress test where, on average, banks all looked pretty good, but several banks were four or five percentage points into the red."

Others in and around the banking sector argue that the sweeping nature of the changes could impact the banking sector beyond crimping profitability and curtailing lending activity. Ed Mills, an analyst at Raymond James, believes it could fundamentally alter the industry's landscape.

"There had been a reason to stay between $100 and $250 billion in assets, and the unintended consequences is that once we have these updated regulations, there's going to be an incentive in that $100 to $250 billion base to get bigger faster," Mills said. "What we'll see from these regulations is, in some ways, maybe the exact opposite of what people think, which is more consolidation and larger regional banks as a result."

While the text of the proposal will determine who supports and opposes the rule changes — and how fervently — Petrou said she is already counting on regulators making "tactical changes" between the initial proposal and the final rules to make them palatable enough to avoid a congressional showdown.

"That will allow them to give on certain key questions without, in their opinion, doing grievous damage to the package," she said. "You'll see significant compromises in the final rule that I don't think will suffice to make the industry like it any better, but it will take some of the critics off the table, particularly as they get into the 2024 election cycle and their minds go elsewhere."

— Claire Williams contributed to this report.