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January 30, 2019

In a letter to the FED Governors, the U.S. Senator Sherrod Brown, who is a member of the U.S. Senate Committee on Banking, Housing, and Urban Affairs, called on the FED to use its prudential authorities, including the countercyclical capital buffer (CCyB) for the biggest banks, to strengthen the resilience of the financial system and protect against the next economic downturn. Referring to the fact that the largest banks in the U.S. reported record profits to the tune of USD 100 billion, Senator Brown highlighted that the "systemic vulnerabilities are becoming more apparent."

He mentioned that now is the time to require additional capital buffers that large banks could draw on to mitigate a large adverse financial shockThe FED last considered the CCyB requirements in December 2017 and, at that time, voted to leave it at 0%. According to the FED, “circumstances in which the Board would most likely use the CCyB … would be to address circumstances when systemic vulnerabilities are somewhat above normal.” Under the policy statement, FED will consider a number of financial system vulnerabilities, including asset valuation pressures and risk appetite and leverage in the nonfinancial sector. These systemic vulnerabilities are becoming more apparent. The letter also mentioned that, recently, the former FED Chair Yellen urged FED "to carefully consider raising the CCyB at this time.” She noted elevated asset valuations in the real estate sector, the large volume of leveraged lending with a significant weakening of underwriting standards, and the high debt burdens of nonfinancial companies as threats to economic stability during the next downturn.

Senator Brown also cited the credit rating agency Moody’s Investor Service, stating that weak lending practices and increased lending to lower quality corporate borrowers “are creating credit risks that portend an extended and meaningful default cycle once the current expansion ends.” and that "Moody’s envisions more defaults than the last downturn and lower recoveries." According to Senator Brown, while capital quality and levels have increased since the crisis, capital levels are below the optimal amount needed to insulate American taxpayers from future bailouts. A comprehensive examination by FED economists found that current Basel capital surcharges for global systemically important banks (G-SIBs) are less than half the size than would be economically justified by an “expected impact” framework based on the economic effect of large bank failure. The same study also suggests that U.S. large bank surcharges currently set by FED, while larger than the Basel surcharges, are likely still considerably lower than the economically optimal level. "Instead of increasing capital, it appears the FED is heading in the wrong direction as it has started to take steps to reduce certain capital requirements."

 

Related Link: Press Release and Letter

Keywords: Americas, US, Banking, Systemic Risk, G-SIB, CCyB, Capital Buffer, FED, US Senate Committee

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