US bank regulators will release sweeping capital rule overhaul plans next week. The latest draft goes beyond international standards for large lenders’ residential mortgages.
The changes are part of the US version of Basel III, a post-financial crisis global accord. The Federal Reserve, Federal Deposit Insurance Corp., and Office of the Comptroller of the Currency will unveil the plans on July 27.
Three unidentified sources familiar with the proposal shared the information. The sources requested anonymity when discussing details before the official announcement.
Regulators have suggested a 20% increase in overall capital requirements for big Wall Street banks. The focus on large lenders’ residential mortgages had not been mentioned before.
The US intended to align these mortgages with the international framework. The agencies aimed to surpass global standards for large banks’ residential mortgages and some business loans.
This move aimed to prevent giving an advantage to larger lenders over smaller ones. An anonymous source familiar with the proposal shared this information.
The Federal Reserve wanted equal treatment for comparable residential loans across banks of different sizes. The proposal sought to maintain a level playing field among lenders.
The industry will likely criticize the proposal as “gold plating” US requirements beyond global standards. Banks complained reforms after the 2008 crisis favored less-regulated nonbank lenders unfairly.
They warned additional requirements might raise borrowing costs amid the elusive American dream of homeownership.
Spokespeople for the FDIC, Fed, and OCC declined to comment.
Significance of Risks in Residential Mortgages
The measure under consideration raises risk weights for many residential mortgages compared to international standards. This change means mortgages play a more significant role in determining overall capital requirements.
Risk weights represent percentages assigned to account for the risk of different asset types. Regulators apply higher risk weights to assets they consider more risky. Risk weights are not the amount of capital banks must hold; they reflect risk levels. The proposal aims to address the risk associated with residential mortgages.
First-lien residential mortgage loans in the US have a 50% risk weight assigned. Federal regulators consider 40% to 90% risk weights for large banks based on the loan-to-value ratio.
Higher LTV ratios result in higher risk weights for riskier loans, as per the proposal.
The proposed risk weights are 20 percentage points higher than Basel III international framework. US change won’t affect residential mortgage-backed securities guaranteed by government-sponsored enterprises.
Banks with $100 bn assets will face higher capital limits
The package of US capital requirements will include banks with at least $100 billion in assets.
The new threshold is lower than the existing $250 billion, affecting dozens of regional US banks.
Midsize banks, like the failed Silicon Valley Bank, must disclose unrealized losses on available-for-sale securities. Once sold, these losses will be recognized in the capital.
The measure aims to improve transparency and risk management in banks’ balance sheets. With these changes, regulators seek to strengthen oversight and stability in the banking sector.
Michael Barr’s Proposal about the Threshold
Federal Reserve Vice Chair for Supervision Michael Barr’s proposal subjects banks with $100 billion+ in assets to similar regulation as $700 billion+ banks. The regulations require two additional percentage points of capital or $2 more for every $100 risk-weighted asset.
Barr’s remarks at the Bipartisan Policy Center emphasized these banks’ need for greater resilience. Recent experience showed that even $100 billion+ banks could cause stress to spread to other institutions.
The risk of contagion necessitates higher resilience than previously assumed. Barr proposes $100 billion+ banks account for unrealized losses and gains in available-for-sale securities when calculating regulatory capital.
Silicon Valley Bank faced criticism for not accounting for unrealized losses on long-term Treasury notes, impacting its capital. This led to insufficient assets to back liabilities during a bank run when asset values fell drastically.