Fed Said to Draft Rules for Biggest U.S. Banks Following Basel Standards

Federal Reserve officials are drawing up rules for the largest U.S. banks that won’t be more stringent than global capital standards agreed to in Basel, Switzerland, according to a person familiar with the discussions.

Federal Reserve Governor Daniel Tarullo cited a “goal of congruence” between the Basel standards and the Fed’s work on rules under the Dodd-Frank Act, which overhauls banking regulation, in a June 3 speech. The central bank hasn’t veered from that, according to the person, who declined to be identified because the rules are still being drafted.

The Basel Committee on Banking Supervision, which includes regulators from the U.S. and Europe, set an additional capital buffer standard for the largest international banks in June that will range from 1 percentage point to 2.5 percentage points of risk-weighted assets. That comes on top of a requirement of 7 percent of common equity for all banks.

“I have always thought it was very important to try to preserve the level playing field for internationally active banks, and those are the key terms in Basel,” said Ernest Patrikis, partner at law firm White & Case LLC and a former general counsel at the Federal Reserve Bank of New York. “There will be a sigh of relief” among bank executives that the Fed is staying within the Basel framework, he said.

Largest Banks

Regulators worldwide are trying to curb the risk the largest banks pose to taxpayers and the financial system. The rule-making comes as bank stocks worldwide have plunged on forecasts for lower economic growth. Higher capital levels could have crimped bank returns even more, posing greater risk to a flagging U.S. recovery.

“Higher and higher levels of capital mean less lending, risking a policy error given the fragility of the economic recovery,” said John Dearie, executive vice president for policy at the Financial Services Forum, a Washington-based organization whose members include Goldman Sachs Group Inc. and JPMorgan Chase & Co. Capital requirements “determine how much banks can lend.”

A draft of the Fed’s rule-making on a section of the Dodd- Frank Act that calls for “enhanced prudential standards” for banks with $50 billion or more in assets should be finished by the end of September, according to the central bank. The rules will also apply to nonbank financial firms that regulators determine pose systemic risk. The rule proposal will also cover liquidity requirements, credit exposure limits and risk management standards for the biggest U.S. banks.

‘High Enough’

Richard Spillenkothen, a former director of banking and supervision for the Fed, said the capital standards are “high enough to be credible.” He said the central bank still has latitude to go even further later.

“U.S. regulators retain the authority to require any individual U.S. global bank to operate with capital above the Basel surcharge levels based on the bank’s unique circumstances and risks -- which is to say that the proposed Basel surcharges remain minimum systemic risk add-ons,” he said in an e-mail yesterday. “This is an important tool that regulators should not be afraid to use.”

Bank Stocks Drop

The KBW Bank Index (BKX), which tracks shares of 24 banks including Citigroup Inc., Bank of America Corp., and Wells Fargo & Co., is down 30 percent this year, compared with an 11 percent decline in the Standard and Poor’s 500 Index. The Bloomberg Europe 500 Banks and Financial Services Index is down 29 percent.

The rout in banks stocks is risky because financial institutions could pull back on lending as they try to curb risks and protect returns. Fed officials attempted to support the economy this week by pledging to keep the benchmark lending rate in a range of zero to 0.25 percent, where it has been since December 2008, for at least the next two years.

Simon Johnson, the former chief economist at the International Monetary Fund who is now a professor at Massachusetts Institute of Technology, said Fed officials may be missing an opportunity to force banks to hold even more capital against losses.

“They certainly should have higher capital requirements for systemically important financial institutions,” he said. “This week is going badly in the markets partly because one or more global megabanks is under pressure -- precisely because their buffers against losses are so low.”

To contact the reporters on this story: Craig Torres in Washington at ctorres3@bloomberg.net; Cheyenne Hopkins at chopkins@bloomberg.net;

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net

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