Why the U.S. Is Taking a Harder Line on Banking Regulation

WASHINGTON — U.S. regulators are continuing to send a clear message about global financial services standards forged with other countries: they're not strong enough.

Last week, a top Federal Reserve official said that the internationally agreed Basel capital surcharge for the biggest banks is just "a starting point" for the U.S. version, reinforcing a pattern in which domestic regulators have gone further — in some cases significantly so — than the international rule.

But observers say a tougher approach here compared to abroad makes sense. The U.S. industry is considerably larger than that of other countries, requiring stricter rules. Some also point to the tendency of other Basel members to be more closely aligned with their banks.

The Basel Committee "standards are what is acceptable to everybody. The U.S. will accept that maybe in the global regime. But there is unique experience in this country, the Fed's own perspective and the fact that the regulators can drive toward a higher standard in the U.S.," said Alok Sinha, a principal at Deloitte & Touche. "They're wielding that power."

Since the financial crisis, U.S. regulators have often chosen to take a more rigorous approach, but just in the past year, that trend appears to have accelerated. The U.S. finalized a "liquidity coverage ratio" two weeks ago that was stricter than the Basel accord. It adopted a tougher leverage ratio as well earlier this year.

Other examples include a provision in the Dodd-Frank Act setting a capital floor — which does not exist internationally — for bank holding companies and depository institutions. The U.S. has also favored a more conservative timeline than other countries for when large banks can report risk-weighted capital ratios.

"To the extent, that we can get multilateral agreement — as opposed to take action unilaterally — I think the globe is better off," said Eugene Ludwig, the founder and chief executive of Promontory Financial Group. "But our regulators implicitly suggest that they're not achieving what they believe they want for our system internationally."

Analysts say the distinction between the U.S. and its foreign counterparts is partly reflective of how the two sides view "too big to fail."

"You've got macroeconomic and political pressures as well as significant structural differences between U.S. and [European Union] banking that account for the differences," said Karen Shaw Petrou, managing partner at Federal Financial Analytics.

Petrou said the U.S. financial services industry compared with that of the EU and Japan "is fundamentally structurally very different."

"Banks here and the regulatory framework are premised, especially in the wake of Dodd-Frank, on wanting lots of banks that compete vigorously and can fail under market conditions, not rescued," she said. "The EU banks and banks in Japan are 'national champion banks': there are very few and very big banks that are essentially arms of the government."

Ludwig agreed that "some non-U.S. jurisdictions" are "intertwined with their largest financial institutions and therefore the rules-based approach favored in the U.S. is in their view less needed."

The gulf between U.S. and international regulations is only likely to grow.

In his testimony before the Senate Banking Committee last week, Fed Gov. Daniel Tarullo reiterated plans to establish risk-based common equity capital surcharges for large, globally active U.S. banks. The proposal, he said, will be consistent with Dodd-Frank and "will build on" the surcharge methodology developed by the Basel Committee, of which the U.S. is a member.

He added that the Fed "will strengthen the … [Basel] framework in two important respects." One is an expectation that U.S. banks will face higher surcharges than those imposed by Basel, and the other is the Fed's plan to incorporate a bank's reliance on short-term wholesale funding in the surcharge calculation.

"We believe the case for including short-term wholesale funding in the surcharge calculation is compelling, given that reliance on this type of funding can leave firms vulnerable to runs that threaten the firm's solvency and impose externalities on the broader financial system," Tarullo said.

His comments came just days after the U.S. bank regulators had finalized a liquidity measure for the biggest banks that similarly took a harder line than an earlier Basel version.

Under the "liquidity coverage ratio" rule, banks must keep enough "high-quality liquid assets" to cover cash outflows over a 30-day stressed period. The U.S. rule not only puts domestic banks on an accelerated compliance schedule — requiring a 100% LCR by 2017, compared with 2019 in the Basel standard — but also omits certain assets from the "high-quality" category that are included in the international version.

The Basel rules allow banks to include private-label mortgage-backed securities, covered bonds and municipal bonds as high quality assets, but all three are excluded from the U.S. regulation. (The Fed says it will explore whether municipal securities will be added in the future.)

Meanwhile, in April the U.S. agencies raised Basel's 3% supplemental leverage ratio — a measure of Tier 1 capital to total exposures — to a more demanding 5% for the eight largest domestic companies and 6% for their insured subsidiaries.

Sinha cited other examples. He said the so-called "Collins amendment" — a provision in Dodd-Frank championed by Sen. Susan Collins, R-Maine — applies a capital minimum to U.S. institutions that "doesn't apply internationally."

"What that does is take out a little bit of the risk sensitivity and it limits how much your minimum capital ratio can draw up even if the risk in the portfolio under the advanced approaches is lower," he said.

He added that the Fed could decide to move more aggressively on setting minimum loss absorbency requirements for large financial firms — a prerequisite to their being wound down through a new resolution facility — than the international community. "This may be another example where the U.S. is leading the pack," Sinha said.

Still, the U.S. has remained a willing collaborator on the Basel Committee.

Petrou notes that every Basel issuance includes the disclaimer that members can impose tougher versions of the international standard.

"The U.S. doesn't say… it's departing from Basel because nominally it's consistent with Basel, except factually the rules are a lot tougher," Petrou said. She added that "the U.S. soldiers on" in the Basel process "because it fears that if it's not" involved in crafting international standards, "the efforts at international harmonization will be discarded and the floor that Basel sets will fall out."