Basel III Endgame: Where Things Stand

This week we learned that bank regulators may re-propose their rule to implement the Basel III Endgame in the United States.  The potential changes were outlined in a speech by Federal Reserve Vice Chair for Supervision Michael Barr and were the first public explanation of the “broad and material” changes announced by him and Fed Chair Powell earlier in the year.

As we await a re-proposal, it is worth considering some initial observations.

First, it is important to consider the potential capital impact of 9 percent.  In a world in which the largest U.S. banks are demonstrably very highly capitalized and strong, and in which the U.K. has announced its Basel III Endgame will result in an impact of less than 1 percent and the EU stands at 5.6 percent, we still fundamentally question why this proposal raises capital for U.S. banks, and why our policymakers would choose that outcome for the U.S. economy.  Basel III Endgame was never intended to increase capital requirements. Given the array of strong prudential safeguards that have been enacted over the past 15 years, it is entirely unclear as to why any measurable increase in large bank capital is needed. 

Second, the process for reconsidering the proposal is an unusual one.  We expect to see revisions that have been agreed by the Fed, the OCC, and the FDIC, but we will not see potential revisions of areas that are still being considered. Commenters will have to determine if their concerns were addressed and to what extent, or completely unaddressed.  In addition, the re-proposal likely will be complex and lengthy.

Third, the original proposal lacked critical economic analysis, including cost-benefit analysis, that is essential for the public to have and consider.  Many decisions in the original proposal lacked justification, and for us, defied explanation.  Hopefully, a re-proposal will address these serious shortcomings.

The most meaningful changes previewed would alter the imposition of higher capital charges for certain credit exposures, equity exposures, and operational risk.  What appears to be largely unaddressed, however, are very significant and higher charges for exposures associated with trading, market making, and underwriting.  These activities are already subject to additional, stringent regulation post-financial crisis, including capital requirements.  And they are no less important for the wide range of large companies, mid-market businesses, pensions, state and local governments and other institutions, like universities, which use the services of major banks to access capital, invest, grow and contribute to society. These bank customers serve people and businesses across the country, so not addressing these issues could, as experts have found, increase the costs or reduce the availability of the services they provide.

In addition, the re-proposal appears to fall short of providing sensible capital requirements for lending to a wide swath of creditworthy businesses in the United States. The proposal of July 2023 provided a lower capital charge to corporates deemed to be “investment grade” if they are publicly traded (think General Motors), but would apply higher capital charges for companies that are arguably equally credit worthy but privately held (think Chick-fil-A).  As we have pointed out, there are a relatively small number of publicly traded companies in the U.S., and many more private ones that would be subject to higher capital charges that are not justified by elevated credit risk.  The re-proposal would carve out companies that are “regulated entities” like pensions and mutual funds, but everyone else – essentially non-financial companies – would still be subject to a higher capital treatment.  There is no connection between whether a company is high risk or low risk and whether it issues publicly traded securities.  If the re-proposal affirms this observation, we believe there will be significant interest in further work on this issue.

We look forward to reviewing the re-proposal.  It is important we get this right.