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Fed proposes tougher capital requirements

by Ira Teinowitz | Published December 20, 2011 at 5:40 PM

The Federal Reserve Board on Tuesday, Dec. 20, unveiled its proposed rule for implementing "enhanced prudential standards" for big financial companies, suggesting that the companies' importance to the financial system together with the need to prevent "too-big-to-fail" problems warranted heightened capital safeguards.

The proposal would, among other things, implement the capital standards set by the international Basel III accords requiring larger institutions to hold ever-greater amounts of capital in reserve to insulate them from declines in the value of their assets.

"By setting forth comprehensive enhanced prudential standards and an early remediation framework, the proposal would create an integrated set of requirements that seeks to meaningfully reduce the probability of failure of systemically important companies and minimize damage to the financial system and the broader economy in the event such a company fails," the proposal said.

Banking experts said the Fed offered few surprises in the capital or stress test requirements in the proposal, reflecting statements by Fed governors and requirements of Basel III.

They pointed to the Fed's effort to establish forward-looking regulatory triggers to identify emerging issues along with a regulatory regime for early remediation as potentially new.

The Fed asked several questions about how to implement the standards, which it said will be phased in. Still, the experts said the Fed's move to impose even more stringent standards on the biggest systemically important financial institutions, or SIFIs, could have major effects.

"It's a well-thought-out attempt to prescribe prudential standards, but the covered institutions are going to see increased expenses and decreased profits," said Robert E. Bostrom, who leads the global financial institutions and funds sector at SNR Denton.

He said that managements at big financial companies will have to look at whether the additional capital standards are really going to be worth being big, and smaller institutions will have to closely look at the impact of growth.

Kevin L. Petrasic, a partner in Paul Hastings LLP's global banking practice, said the proposal "underlines the context of what large banks will have to deal with in the next few years."

"What the Fed is saying is the larger you are, the more you have to do. It's highlighted [accusations] that too-big-to-fail institutions have a competitive advantage. It's to neutralize the competitive advantage. That is their justification ... their support for ratcheting [standards] up."

Petrasic said if there was any surprise in the Fed proposal, it was that the board wasn't even more stringent.

While the Dodd-Frank Act authorized the Fed to implement additional regulations for contingent capital and short-term debt, it didn't propose them.

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