General Information & Client Service
  • Americas: +1.212.553.1653
  • Asia: +852.3551.3077
  • China: +86.10.6319.6580
  • EMEA: +44.20.7772.5454
  • Japan: +81.3.5408.4100
Media Relations
  • New York: +1.212.553.0376
  • London: +44.20.7772.5456
  • Hong Kong: +852.3758.1350
  • Tokyo: +813.5408.4110
  • Sydney: +61.2.9270.8141
  • Mexico City: +001.888.779.5833
  • Buenos Aires: +0800.666.3506
  • São Paulo: +0800.891.2518
August 04, 2017

IMF published a working paper that compares the regulatory capital requirements under the Dodd-Frank Act and the 10% leverage ratio, as proposed by the U.S. Treasury and the U.S. House of Representatives' Financial CHOICE Act (FCA). The paper also highlights the potential for regulatory arbitrage by banks and the associated moral hazard problem that arises due to the option of the FCA qualifying banking organizations.

The paper undertakes certain exercises to assess the qualifying banks option. It uses balance sheet data on the types of banks (by asset size) that would qualify for the off-ramp under the FCA and estimates how much capital banks would need to add to qualify for the “off-ramp” regulation. Then, to surmise whether there could be a self-selection of more risk-prone banks in the off-ramp, the paper analyzes the balance sheet characteristics of banks with a relatively small capital gap to the 10% leverage ratio. The analysis identifies an important moral hazard problem that arises due to the qualifying banks' optionality, where banks are likely to increase the riskiness of their asset portfolio and qualify for the FCA “off-ramp” relief, with unintended effects on financial stability. This moral hazard problem would manifest through banks increasing the RWA imprint in their balance sheet through increased risk taking, thereby qualifying for the “off-ramp” regulatory relief, under which banks hold 10% leverage ratio while enjoying higher expected returns and lower regulatory costs. This would make the banks riskier and, due to smaller capital buffers, less resilient to adverse shocks.

 

However, the results show that small banks (total assets below USD 3 billion) with capital gaps to the qualifying banks threshold would tend not to opt for the “off-ramp.” Despite the stated intention of policymakers to provide regulatory relief for small banks under the proposed FCA, this paper concludes that these banks would opt to stay under the existing Dodd-Frank Act regime. Investors and the market would expect large and globally active banks to meet modern regulatory standards. Also, banks that can have large maturity mismatches and a fewer share of highly liquid assets than demanded under the Dodd-Frank Act or Basel III would be less attractive as a counterpart in the interbank market. Finally, it is also clear that reliance on regulation alone (Pillar 1) cannot be sufficient. Supervisors (Pillar 2) need to continue to increase market discipline (Pillar 3) and transparency, and help financial institutions increase internal risk management capacity and capital planning.

 

Related Link: Working Paper (PDF)

Keywords: Americas, United States of America, Banking, Dodd Frank Act, Basel III, Capital Requirements, Regulatory Arbitrage, IMF

Related Insights
News

FSB Report Examines Financial Stability Implications of Fintech

FSB published a report that assesses fintech-related market developments and their potential implications for financial stability.

February 14, 2019 WebPage Regulatory News
News

US Agencies Amend Regulatory Capital Rule to Allow Phase-In for CECL

US Agencies (FDIC, FED, and OCC) adopted the final rule to address changes to credit loss accounting under the U.S. generally accepted accounting principles; this includes banking organizations’ implementation of the current expected credit losses (CECL) methodology.

February 14, 2019 WebPage Regulatory News
News

OCC Consults on Company-Run Stress Test Requirements for Banks

OCC proposed amendments to its company-run stress testing requirements for national banks and Federal savings associations, consistent with section 401 of the Economic Growth, Regulatory Relief, and Consumer Protection (EGRRCP) Act.

February 12, 2019 WebPage Regulatory News
News

CFTC Extends Comment Periods for Trade Execution Requirement Proposals

CFTC announced that it is extending comment period for the proposed amendments related to the regulations on swap execution facilities (SEF) and trade execution requirement.

February 12, 2019 WebPage Regulatory News
News

OCC Proposes to Renew Information Collection Under Stress Test Rule

OCC is proposing to renew its information collection titled “Annual Stress Test Rule” (OMB Control No: 1557-0311). Comments must be received on or before March 13, 2019.

February 11, 2019 WebPage Regulatory News
News

OSFI Consults on NSFR Disclosure Requirements for D-SIBs

OSFI proposed the draft guideline on the net stable funding ratio (NSFR) disclosure requirements for domestic systemically important banks (D-SIBs).

February 11, 2019 WebPage Regulatory News
News

EC Amends Its Regulation to Clarify Impairment Requirements for IFRS 9

EC published the EU Regulation 2019/237 that amends Regulation (EC) No 1126/2008 adopting certain international accounting standards, in accordance with Regulation (EC) No 1606/2002 regarding International Accounting Standard (IAS) 28 on Investments in Associates and Joint Ventures.

February 11, 2019 WebPage Regulatory News
News

FSB Chair Randal Quarles Speaks About the Upcoming Work of FSB

While speaking at the BIS Special Governors Meeting in Hong Kong, Randal K. Quarles, the Chair of FSB and Vice Chair of FED, discussed his views on how the work of FSB must evolve and the key principles that, he believes, should inform that work.

February 10, 2019 WebPage Regulatory News
News

OSFI Proposes to Amend the Liquidity Adequacy Requirements for Banks

OSFI proposed revisions to the Liquidity Adequacy Requirements (LAR) Guideline for banks. OSFI published the proposed drafts (with proposed changes highlighted in yellow) of Chapters 1,2, 4, and 5 of the LAR guideline.

February 08, 2019 WebPage Regulatory News
News

HKMA Publishes FAQs on Local Implementation of IRRBB Framework

HKMA published the frequently asked questions (FAQs) related to the local implementation of the interest rate risk in the banking book (IRRBB).

February 08, 2019 WebPage Regulatory News
RESULTS 1 - 10 OF 2593