BPI and ABA Comment on Basel Endgame Proposal

Ladies and Gentlemen:

The Bank Policy Institute[1] and the American Bankers Association[2] appreciate the opportunity to comment on the joint notice of proposed rulemaking issued by the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency that would amend the capital requirements applicable to large banks[3] and those with significant trading activity.[4]

Executive Summary

If adopted, the proposed rule would have a profound effect on the availability and cost of credit for nearly every American business and consumer, as well as on the resiliency of U.S. capital markets. The U.S. economy would suffer a significant, permanent reduction in GDP and employment; U.S. capital markets would become less liquid, and therefore more dependent on non-bank intermediation in normal times and on governmental support when those non-banks step away from financial markets during times of stress. The precise potential impact on capital market liquidity is extremely complex to assess but would likely be significant for several segments of the market, with resulting harm to U.S. businesses, consumers and Americans saving for their retirement. Moreover, given the stakes involved, the proposal is remarkable for its conclusory assertions and lack of analysis, including its failure to consider both its costs and benefits, not just to banks but to all corners of the U.S. economy.

At a macro level, the proposal contains no standard by which to determine what an appropriate risk weight should be for credit risk and operational risk, and therefore makes it impossible to determine whether a proposed risk weight is too high or too low or whether the costs of higher capital outweigh the benefits. The absence of a standard is significant on two levels. On the one hand, if the agencies articulated a standard with a specific and particularly high probability that capital would be able to absorb any losses experienced over the course of a year, commenters might acknowledge that the proposed risk weights were consistent with that standard but object to the standard itself on the grounds that its economic and market functioning costs were too high. On the other hand, if the agencies articulated a specific standard with a lower probability that capital would be able to absorb losses over the same period, then commenters might acknowledge that such a standard represented a reasonable balance of costs and benefits but cite data to show that the risk weights in the proposal are, in fact, inconsistent with that standard. The current proposal leaves the public unable to do either: we cannot assess the appropriateness of a standard that was never disclosed, and we cannot assess the calibration of individual risk weights against a non-existent standard.

At a micro level, in almost every case the proposed risk weight for a given asset is based on no data or historical experience and no economic analysis. In most cases, the proposal simply takes as given the risk weights negotiated by agency staff in Basel over many years, resulting in the capital mandates released in 2017 and 2019, which, in turn, are lacking in data or analysis, or at least any that has been made public. In other cases, the agencies purport to rely on data they have not disclosed or on unverifiable “supervisory experience.” Also, in many cases, the agencies not only take Basel risk weights as a basis for the proposal but they then add arbitrary surcharges on top of the Basel weights, again with very little explanation. In all these cases, respondents are denied any meaningful opportunity to comment, as they do not know the standard used to develop the risk weights and the proposal generally provides them with no data or analysis on which to comment.

Because of the lack of supporting data and analysis for the policy choices in the proposal, we (and other members of the public) lack a meaningful opportunity to assess and comment on the methodology and the basis for many elements of the proposal.[5] In this letter, we attempt where possible to provide the data and analysis that we would have expected the agencies to include in the proposal – such as data and analysis that can be used to produce risk weights based on risk of loss that reflects actual experience and other quantifiable standards. Where the agencies have access to the relevant data and we do not, we suggest analysis that could be undertaken to produce a coherent and empirically grounded proposal.

The proposed rule covers four categories of risk: credit risk, operational risk, market risk and credit valuation adjustment (“CVA”) risk. The risk weights applicable to each risk are substantially and unjustifiably overstated based on all historical experience of which we are aware. Since major reforms were instituted in the wake of the Global Financial Crisis, we have had over a decade of experience with the existing capital framework. By 2017, when the Basel agreement was reached, its authors concluded that no further increases in capital were required; rather, a key purpose of the revisions to the Basel framework finalized in 2017 was to reduce the variability of risk-weighted assets (“RWAs”) across banks. Since 2017, there has been no evidence that U.S. banks hold insufficient capital against the four risks addressed in the proposal. Much attention has focused, since March 2023, on the case of Silicon Valley Bank, but it did not fail due to credit, operational, market or CVA risk: its borrowers repaid their loans; it suffered no cyber-attack or other operational loss; and it did not trade derivatives or securities. Indeed, agency officials have acknowledged that its failure is not a basis for the significant increase in proposed capital requirements.[6]

Furthermore, with respect to operational, CVA and market risk, the proposal fails to acknowledge the existence of the Stress Capital Buffer (“SCB”) set by the Federal Reserve, which, in part, was designed to cover the same risks and results in higher capital charges with respect to operational, CVA and market risk. By not considering all components of the framework that determines bank capital requirements, the proposal effectively treats the calculation of RWAs as entirely distinct from the aspects of the framework establishing numerical ratio requirements, such as the SCB and Global Systemically Important Bank (“GSIB”) surcharge. But they are not distinct. Rather, RWA calculations and ratio requirements are inextricably linked in establishing bank capital requirements. RWAs also determine how much capital a bank must have to satisfy both minimum requirements and buffer requirements. Looking at and revising only one aspect of the bank capital framework, while effectively ignoring the interrelationship with the other, as the proposal would do, is a flawed and fragmented approach to the design and calibration of the bank capital framework.

To read the full comment letter, please click here, or click on the download button below.

[1] BPI is a nonpartisan public policy, research and advocacy group, representing the nation’s leading banks and their customers. BPI’s members include universal banks, regional banks and major foreign banks doing business in the United States. Collectively, they employ almost two million Americans, make nearly half of the nation’s small business loans, and are an engine for financial innovation and economic growth.

[2] The American Bankers Association is the voice of the nation’s $23.5 trillion banking industry, which is composed of small, regional and large banks that together employ more than 2.1 million people, safeguard $18.6 trillion in deposits and extend $12.3 trillion in loans.

[3] In this letter, the term “bank” includes all banking organizations as defined in the proposal. See 88 Fed. Reg. at 64,030, note 1.

[4] See Regulatory Capital Rule: Large Banking Organizations and Banking Organizations With Significant Trading Activity, 88 Fed. Reg. at 64,028 (Sept. 18, 2023).

[5] The substantial legal problems, both procedural and substantive, with the proposal are described in a separate comment letter and are not discussed here.

[6] See, e.g., Statement by Travis Hill, Vice Chairman, FDIC, on the proposal to Revise the Regulatory Capital Requirements for Large Banks (July 27, 2023), available at https://www.fdic.gov/news/speeches/2023/spjul2723b.html (“It’s worth noting that implementation of the new Basel agreement was expected to result in no increase in required capital at any of the three banks that failed, but would result in major increases at several other Category IV banks.”).