FED May Place Margin Calls on TBTF's

House · Jul 6, 2013

If it actually happened, this would be very interesting...

This has been a long time coming since the introduction of the Dodd-Frank law back in 2010 but it is a game changer. Remember all macro paradigm shifts come from policy impulses, often mistakes.

Fed approves step one in a three step plan;
Under the final rule, minimum requirements will increase for both the quantity and quality of capital held by banking organisations. Consistent with the international Basel framework, the rule includes a new minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.5 percent and a common equity tier 1 capital conservation buffer of 2.5 percent of risk-weighted assets that will apply to all supervised financial institutions. The rule also raises the minimum ratio of tier 1 capital to risk-weighted assets from four percent to six percent and includes a minimum leverage ratio of four percent for all banking organisations. In addition, for the largest, most internationally-active banking organisations, the final rule includes a new minimum supplementary leverage ratio that takes into account off-balance sheet exposures. (See the press release here)

I know you are thinking: Wow, this is the most interesting thing I have seen in years but alas it is - because it is in fact a major margin call on the US holding banks.

Note how this adoption is only the first set of a series of new rules. Let me introduce you to: Daniel Tarullo, The Federal Reserve Governor in charge of regulation after the implementation of the Dodd-Frank law in 2010. (As a consequence of Dodd-Frank, the Fed got a permanent regulatory governor.)

Governor Daniel K. Tarullo

At the Peterson Institute for International Economics, Washington, D.C.
May 3, 2013 Evaluating Progress in Regulatory Reforms to Promote Financial Stability

The speech considers the "additional charges" which are coming and today's Basle III was only item number one:

First, the basic prudential framework for banking organisations is being considerably strengthened, both internationally and domestically. Central to this effort are the Basel III changes to capital standards, which create a new requirement for a minimum common equity capital ratio. This new standard requires substantial increases in both the quality and quantity of the loss-absorbing capital that allows a firm to remain a viable financial intermediary. Basel III also established for the first time an international minimum leverage ratio which, unlike the traditional US leverage requirement, takes account of off-balance-sheet items.

Second, a series of reforms have been targeted at the larger financial firms that are more likely to be of systemic importance. When fully implemented, these measures will have formed a distinct regulatory and supervisory structure on top of generally applicable prudential regulations and supervisory requirements. The governing principle for this new set of rules is that larger institutions should be subject to more exacting regulatory and supervisory requirements, which should become progressively stricter as the systemic importance of a firm increases.

This principle has been codified in Section 165 of the Dodd-Frank Act, which requires special regulations applicable with increasing stringency to large banking organizations.1 Under this authority, the Federal Reserve will impose capital surcharges on the eight large US banking organizations identified in the Basel Committee agreement for additional capital requirements on banking organisations of global systemic importance. The size of surcharge will vary depending on the relative systemic importance of the bank. Other rules to be applied under Section 165including counterparty credit risk limits, stress testing, and the quantitative short-term liquidity requirements included in the internationally-negotiated Liquidity Coverage Ratio (LCR)will apply only to large institutions, in some cases with stricter standards for firms of greatest systemic importance.

An important, related reform in Dodd-Frank was the creation of orderly liquidation authority, under which the Federal Deposit Insurance Corporation can impose losses on a failed systemic institution's shareholders and creditors and replace its management, while avoiding runs and preserving the operations of the sound, functioning parts of the firm. This authority gives the government a real alternative to the Hobson's choice of bailout or disorderly bankruptcy that authorities faced in 2008. Similar resolution mechanisms are under development in other countries, and international consultations are underway to plan for cooperative efforts to resolve multinational financial firms.

A third set of reforms has been aimed at strengthening financial markets generally, without regard to the status of relevant market actors as regulated or systemically important. The greatest focus, as mandated under Titles VII and VIII of Dodd-Frank, has been on making derivatives markets safer through requiring central clearing for derivatives that can be standardised and creating margin requirements for derivatives that continue to be written and traded outside of central clearing facilities. The relevant US agencies are working with their international counterparts to produce an international arrangement that will harmonise these requirements so as to promote both global financial stability and competitive parity. In addition, eight financial market utilities engaged in important payment, clearing, and settlement activities have been designated by the Financial Stability Oversight Council as systemically important and, thus, will now be subject to enhanced supervision.

Conclusion
Why is this important? Because part of the Fed's new remit since Dodd-Frank makes it responsible for bubbles in banking it is even more interesting because clearly, to me at least, this is a major part of why Bernanke and Dudley at the FOMC are willing to ignore the lower inflation. This low inflation has both monetarist and Keynesians up in arms, and as it is often the case, the REAL reason for major macro paradigm shifts comes from policy mistakes in this case pro-cyclical regulation.
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FED May Place Margin Calls on TBTF's

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FED May Place Margin Calls on TBTF's

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