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Senators Try to Gum Up Dodd-Frank (Update 1)

"Each dollar would be leveraged down significantly as a result of the capital requirement, requiring significant further study" of the effect on the economy, he says.

Headaches for Banks and Regulators

Senators Brown and Vitter said their new rules would "focus on common equity and other truly loss-absorbing forms of capital." While it certainly was an impressive thing for the senators to say, this has already happened under the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was signed into law by President Obama in July 2010.

Under Dodd-Frank, most forms of trust-preferred equity are excluded from banks' regulatory Tier 1 capital. Cumulative preferred shares are also excluded, which is why the nation's large banks over the past year have been redeeming trust preferred shares and issuing noncumulative perpetual preferred shares. The latter are allowed to make up a relatively small portion of Tier 1 capital. The noncumulative preferred shares are considered a "higher quality" of capital than cumulative preferred shares, since banks are free to suspend dividend payments without having to make them up later.

Basel III takes a similar approach on the quality of regulatory capital. According to Rodriguez Valladares, "European and Japanese regulators have long advocated for different assets to be used as capital. Americans have said that retained earnings and common stock were the best forms of capital, because they have real ability to absorb losses. U.S. Regulators finally won this battle with Basel III."

Dodd-Frank has also led to a much stronger supervisory role for the Federal Reserve, including annual stress tests and reviews of banks' capital plans. This year's stress tests gauged the banks' ability to weather a "severely adverse scenario," including an increase in the U.S. unemployment rate to over 12% in the second half of 2013, with a 50% drop in equity prices and a 20% decline in real estate prices. Following the stress tests, the Fed applied the same harsh scenario to large banks' plans to deploy excess capital through dividend increases and share buybacks.

"Banks have already spent billions of dollars to upgrade their management information systems to comply with Dodd-Frank and Basel III," according to Rodriguez Valladares.

The Federal Reserve is working to finalize various regulations based on requirements of Dodd-Frank, including enhanced capital requirements and the Volcker Rule, which bans proprietary trading by banks that gather deposits insured by the Federal Deposit Insurance Corp.

"It is not the job of politicians to set capital standards. It is the job of bank regulators by law, reinforced by Dodd-Frank, to come up with the standards," Rodriguez Valladares says.

"If the Federal Reserve wanted to, the big U.S. banks could already be holding 16% capital, half risk-weighted and half not. It is already within the power of the Fed," she says, asking "why are we having this populist tirade, when nothing new is being proposed?"

Hobbling U.S. Competitiveness

One of the best things about the enhanced capital requirements under Basel III is that all of the major economies within the G-20 are represented. This means a level playing field for trading partners and economic competitors of the U.S., including the European Union, the United Kingdom, China, Japan, Russia, South Korea, India and Brazil.
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