The biggest US banks should be prepared to break themselves up if they struggle to adjust to new rules designed to ensure they could withstand the most severe of shocks to the system, the most powerful US banking regulator has suggested.
In a speech on Monday, Daniel Tarullo, the lead bank supervisor at the Federal Reserve, outlined sweeping changes to the Fed’s annual stress test, including the introduction of specific capital surcharges for the biggest banks and a significant easing of the test for banks with less than $250bn in assets.
If the biggest banks fail to deliver acceptable returns to shareholders as a result of the increased capital requirements, then they may look to exit certain lines of business, Mr Tarullo said, during a speech at the Yale University School of Management.
“If that entails changes in the structure of the company . . . we do recognise that could be an outcome of what we’ve put in place,” he said.
The proposed measures represent the Fed’s first effort to review the supervisory framework it put in place after the financial crisis, when taxpayers found themselves on the hook for bailouts of hundreds of banks. Since then, the two-part test — known as the Comprehensive Capital Analysis and Review, or CCAR — has put firm caps on distributions of capital through dividends and buybacks, while prompting banks to invest billions of dollars in improving the way they monitor risks.
During his speech, which confirmed plans that the Fed has been signalling for months, Mr Tarullo said the Fed would offer some concessions to the banks, such as dropping the assumption that they would continue to pay dividends throughout the nine-quarter planning horizon. Banks had criticised that assumption as unrealistic, given that the Fed was imagining scenarios of extreme distress which would naturally prompt banks to cut payouts.
But Mr Tarullo said the effects of the proposal would “generally result in a significant increase” in capital for the eight banks considered most important to the financial system: Bank of America, Bank of New York Mellon, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street and Wells Fargo. The banks were among the biggest fallers on the S&P 500 on Monday.
The proposal — which the Fed should present formally early next year — comes as many of the biggest US banks are under pressure from shareholders to find ways to boost returns weighed down by post-crisis regulations. Only two of the top eight banks — State Street and Wells — are on course to produce a double-digit return on equity over the next 12 months, according to analysts’ forecasts.
Mr Tarullo denied that the Fed was setting out to cut the banks down to size, but suggested that smaller, leaner banks could be one outcome.
“We certainly don’t have some blueprint for how we see the industry evolving, or where we want it to see it evolving,” said Mr Tarullo, during questioning by Yale students. “How they respond is really and truly up to them, which is the way it should be. If they can change the nature of some things in order to reduce the riskiness, while still engaging in the activity, that’s good. If they say some of these activities may not be worth it for us, given the risk that is associated with them, that is OK too.”
We certainly don’t have some blueprint for how we see the industry evolving . . . How [the banks] respond is really and truly up to them, which is the way it should be
– Daniel Tarullo, Federal Reserve
At the same time, he said, banks with less than $250bn in assets should be exempt from the second part of the stress test, which gauges whether their capital-planning processes are robust enough. Many banks in that size bracket had complained of being swept up in regulations that had been designed to rein in the likes of Citi and Goldman Sachs.
Matt Well, a spokesperson for the Regional Bank Coalition, which includes banks such as Capital One, PNC and SunTrust, said he was pleased that Mr Tarullo recognised the principle that financial regulation should be progressively more stringent for companies of greater importance, and thus potential risk, to the system.
But that “drives home the point that additional . . . reforms are necessary”, he said. “Stricter rules should be applied to the riskiest banks but, simultaneously, the firms that present little or no risk should see significant regulatory reductions.”