US banks are calling on the Federal Reserve to change the way it calculates its capital surcharge for global systemically important banks (G-Sibs), in order to avoid a spike in capital requirements under its proposed stress capital buffer.
Banks are concerned that adding the G-Sib surcharge in its current form to the stress capital buffer (SCB) will raise post-stress minimum capital requirements. The surcharge does not take into account the fact that banks are better capitalised than they were when the Fed adopted the methodology in 2015, banks say, as well as other aspects of post-crisis reform.
“The G-Sib surcharge is being doubled down on,” says David Wagner, head of finance, risk and audit affairs at the Bank Policy Institute, an industry group. “It is becoming a much more critical part of the capital framework since it is being integrated with the CCAR requirements, which are in many cases the binding capital constraint. The need to recalibrate it, look at post-crisis reforms and the un-level playing field is heightened by the stress capital buffer proposal.”
The SCB would replace the current capital conservation buffer, set at 2.5% for large and complex banks, with a new buffer equal to the decrease in a firm’s CET1 capital under CCAR, plus four-quarters of planned dividends. A bank’s capital requirement would be equal to the sum of the G-Sib surcharge, the SCB, and the 4.5% minimum CET1 capital.
Banks say the Fed’s current method of calculating the G-Sib surcharge, known as Method 2, is more stringent than the one used by other international regulators, known as Method 1. They are asking the Fed to recalibrate the surcharge by switching from Method 2 to Method 1.
“The US should implement requirements consistent with international standards to ensure a level playing field,” said Bank of America in a comment letter. “Consequently, we recommend that the Federal Reserve require banks to calculate their G-Sib surcharges using only the current Method 1 methodology.” Other banks expressed similar views in comment letters.
Goldman Sachs went further, advocating in its comment letter that the SCB should “serve as an alternative to the existing Basel buffers”. Under its approach, the overall capital conservation buffer would be equal to the greater of either a bank’s stress losses plus four quarters of dividends, or the G-Sib surcharge plus 2.5%.
Method 1 measures a bank’s G-Sib score based on five components: size, interconnectedness, complexity, cross-jurisdictional activity and substitutability. Method 2 replaces the substitutability component with a measure of a firm’s reliance on short-term wholesale funding. Short-term wholesale funding accounts for a large portion of a bank’s G-Sib score.
Some believe short-term wholesale funding is already captured by other liquidity requirements, such as the liquidity coverage ratio, and therefore including it in the G-Sib surcharge is redundant.
“If the G-Sib methodology stays, it’s a big part of the problem, because it’s not the only place where liquidity funding is accounted for in the regulatory framework,” says an industry consultant and former Federal Reserve official. “You’re doubling or even tripling up on that, because liquidity is accounted for in the liquidity coverage ratio. That’s something the G-Sibs are really concerned about.”