NEW YORK (MainStreet) – Call it an insurance policy against the kinds of financial troubles banks are having in the eurozone these days.
The Federal Reserve has proposed a new set of rules and regulations that would directly hold big banks (those with at least $50 billion in assets) more accountable for capital (they’d be required to hold more of it), liquidity and risk management, among other issues. The result for consumers is mixed, since more fiscally sound institutions help avoid another collapse in the banking sector, but in the short term it means fewer loans and a possible impediment to economic recovery.
The new directives, released on Dec. 20, are forged from the hot iron of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was passed in June 2010. But they’re also a nod to the woes big banks are having in debt-ravaged Europe.
Congress summarizes the Dodd-Frank legislation as a bill “to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail,’ to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.”
To fulfill the promise to “protect the American taxpayer,” the Fed is mandating several new specific proposals, which could have definite implications for consumers. The proposals include:
- Risk-based capital and leverage requirements. In large part, this rule requires firms to develop annual capital plans, conduct stress tests, and maintain adequate capital, including a tier-one common risk-based capital ratio greater than 5% of assets (the previous standard was 4%), under both expected and stressed conditions.
- Liquidity requirements. Big banks would be subject to qualitative liquidity risk management standards that would require companies to conduct internal liquidity stress tests and set internal limits to manage liquidity risk.
- Stress tests. Stress tests of the companies would be conducted annually by the Board using three economic and financial market scenarios. A summary of the results, including company-specific information, would be made public. In addition, the proposal requires companies to conduct one or more company-run stress tests each year and to make a summary of their results public.
- Early remediation requirements. Big banks would be required to address “financial weaknesses” at an early stage, as determined by the Fed. According to the Fed’s Dec. 20 statement, the Board is proposing a number of triggers for remediation – such as capital levels, stress test results and risk-management weaknesses – in some cases calibrated to be forward-looking. Required actions would vary based on the severity of the situation, but could include restrictions on growth, capital distributions, and executive compensation, as well as capital raising or asset sales.
The Fed is giving large banks until March 31 to submit comments, so what do consumers need to know?
Beyond the nuts and bolts of the new Federal Reserve directive, the rules would affect Main Street consumers in three possible ways:
- Fewer loans: Keeping more capital on hand could mean less money to lend out to borrowers. This isn’t guaranteed – banks can still lend as much money as their risk models deem feasible – but having to keep more cash on hand could trigger even further caution among big banks, which have already cut way back on things like small business loans, mortgages and auto loans.
- “Collapse” protection: The new rules could protect consumers against another economic crash – a big part of what the Fed is addressing with its new rules is credit exposure. That means the Fed is getting ahead of the curve on a big problem that occurred in 2008 – one that fueled the Great Recession. There, banks entered into huge credit deals with other big banks and large corporations. When those credit deals begin to unravel, some banks were left without the all-important cash cushion needed to bulwark banks in times of crisis. Now, the Fed is keeping a close eye on credit exposure, and can act before a massive bank failure, thus adding another layer of protection against a big economic collapse.
- Possible economic slowdown. Expect large banks to argue that putting financial institutions into a tighter straightjacket could further tighten the nation’s credit market, and further slow economic growth. Their larger point is that the more the federal government intervenes, the less freedom big banks will have to provide loans to individuals and businesses.
The Fed’s directive is brand new and will need to play out more fully before the real impact can be measured. But for now, Uncle Sam wants a greater say in how banks operate, with tighter financial limits in mind.
Banks may not like the hand they’ve been dealt, but considering the recent outrage at some of their practices, they have less and less to say in the matter.
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