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Hoenig Says Basel Capital Standards Too Lax to Avert Crises

Federal Reserve Bank of Kansas City President Thomas Hoenig said international capital requirements are too lax to prevent another U.S. banking crisis.

Standards set by the Basel Committee on Banking Supervision require “far too little capital,” Hoenig said today in a speech in Charlotte, North Carolina. “That will not prevent the next crisis and will not adequately prepare institutions for the next crisis.”

The rules drawn up by the Basel Committee and endorsed by the Group of 20 leaders last year will require lenders to more than triple the highest-quality capital they hold to cushion against losses by 2019. The regulations may trim the return on equity of European banks, on average, by 4 percentage points, and U.S. banks by 3 percentage points, according to estimates by McKinsey & Co. consultants.

In the years prior to the financial crisis, capital ratios “systematically declined,” Hoenig said, adding that he believes such an erosion may recur.

Large U.S. commercial banks should be broken up with their activities restricted to lower-risk businesses, Hoenig, the U.S. central bank’s longest-serving policy maker, said during a panel discussion sponsored by the National Association of Attorneys General.

“We really do need to think about redefining the scope of legitimate financial activities of the commercial banks,” Hoenig said, voicing a previously stated view. “That means to break them up, in essence.”

End Bailouts

Some Fed officials, including Hoenig, Philadelphia Fed President Charles Plosser and Richmond Fed’s Jeffrey Lacker, say the Dodd-Frank law enacted last year won’t necessarily end bailouts because it gives regulators discretion to provide such rescues. Plosser has called for a bankruptcy law that would set rules for how a large financial company is to be wound down.

The Dodd-Frank Act gave the Fed and other regulators powers to take over and wind down failing institutions, mandated that the central bank look for evidence of emerging risks to financial stability and required annual stress tests of the largest U.S. banks.

The largest banks have essentially become government-sponsored enterprises or “a public utility” because of the implied federal safety net, Hoenig said.

Dodd-Frank will fail to solve the problem because it doesn’t adequately restrict risks, he said.

‘Great Risk’

“Right now it is the American taxpayer” that is supporting the institutions, Hoenig said. “We need to be very mindful we are putting our citizens, our public, at great risk,” he said. “We need to understand the safety net, the incentives of the safety net, or we will repeat the mistakes of the past.”

Because the largest banks operate with a safety net and are deemed “too big to fail,” they have a competitive advantage compared with the nation’s community banks, Hoenig said.

“They are terribly disadvantaged from too big to fail,” he said. “I think they are at risk.”

Hoenig’s view was echoed by Mark Zandi, chief economist at Moody’s Analytics Inc. in West Chester, Pennsylvania, on the same panel. Zandi cautioned that too much regulation could hurt risk-taking by smaller banks.

“Over-regulation will hurt our smaller institutions,” he said. “I view the fact we have 8,000 banks as a strength of our system and we need to preserve that. Any regulatory change should be done through the prism of what it means for smaller institutions.”

Hoenig is retiring Oct. 1 after a 20-year career as leader of the Kansas City Fed. He has repeatedly urged the central bank to tighten monetary policy to prevent inflation from accelerating and asset price bubbles from developing. He voted eight straight times last year against record monetary stimulus led by Chairman Ben S. Bernanke, tying former Governor Henry Wallich’s record in 1980 for most dissents in a single year.

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