Fed Vice Chair for Supervision Michael S. Barr Proposes Major Banking Regulation Overhaul.
Proposed changes aim to make banks more cautious in lending and trading practices by requiring them to hold more capital & wouldn't be able to use their own models for certain hard-to-model market risks.
Source: https://www.federalreserve.gov/newsevents/speech/barr20230710a.htm
Highlights:
Barr's speech gets into the importance of capital (money that banks have on hand) for the safety and soundness of large banks.
- He emphasizes that the financial system is complex and constantly changing, and it's impossible for regulators or bank managers to anticipate all emerging risks.
- Therefore, the focus should be on resilience, making sure that banks can withstand challenges and continue to serve their role in the economy.
Barr's review of capital standards focused on large banks with more than $100 billion in assets. He engaged with a wide range of parties to understand how the Federal Reserve's capital standards interact with each other.
- He also highlighted the importance of resilience when a sudden bank run caused three large banks to fail, leading to significant stress in the banking system.
Barr proposes several changes to regulation and supervision in response to the recent banking stress, including how they regulate and supervise liquidity, interest rate risk, and incentive compensation.
- He also plans to improve the speed, agility, and force of the Federal Reserve's supervision.
The capital requirements use multiple measures of risk, including risk-based requirements, non-risk-sensitive backstops, and stress testing.
- These measures work together to achieve an overall level of resilience. Barr believes that having multiple approaches to measuring risk is beneficial as it makes it harder for banks to game the system.
Barr concludes that the existing approach to capital requirements is sound, but he proposes updates to better reflect credit, trading, and operational risk.
- For risk-based requirements, the standards should be updated to better reflect credit, trading, and operational risk.
- He also suggests that the stress test should continue to evolve to better capture risk.
- No fundamental changes are recommended for the other capital buffers, namely the global systemically important bank (G-SIB) surcharge and the countercyclical capital buffer (CCyB).
- For the G-SIB surcharge, improvements should be made in the measurement of systemic indicators, reduction of "cliff effects," and increasing the sensitivity of the surcharge to changes in a bank's risk profile.
Basel III Endgame:
Currently, big banks use their own internal models to estimate credit risk, which is the risk that a borrower will default on a loan. Barr suggests that these models are flawed because banks have an incentive to underestimate their risk to lower their capital requirements.
- The proposed changes would stop banks from using their own models and instead use a standardized approach that applies the same requirements to each bank. This would make the process more transparent and consistent.
Barr also proposes changes to how banks measure market risk, which is the risk of loss from changes in market prices.
- While banks would still be allowed to use internal models for most market risks, they wouldn't be able to use their own models for certain hard-to-model market risks.
- The proposal would also require banks to model risk at the level of individual trading desks for specific asset classes, rather than at the firm level.
- Barr recommends that the new risk-based capital rules should apply to banks and bank holding companies with $100 billion or more in assets. This is a significant decrease from the current threshold of $700 billion.
- Barr also mentions that banks with assets of $100 billion or more would need to account for unrealized losses and gains in their available-for-sale (AFS) securities when calculating their regulatory capital.
- Barr supports introducing a long-term debt requirement for all large banks. This would improve a bank's ability to be resolved upon failure and reduce losses borne by the Federal Deposit Insurance Corporation's (FDIC) Deposit Insurance Fund.
Barr's conclusions:
- Barr argue that these changes would significantly strengthen the financial system and prepare it for emerging and unanticipated risks.
- He disagrees with industry representatives who claim that inadequate capital had nothing to do with recent bank failures, such as Silicon Valley Bank (SVB) and says that it was an unsuccessful attempt by SVB to raise capital that caused uninsured depositors to scrutinize the bank's capitalization.
- Barr disagrees with claims that raising capital requirements will push activity outside of the regulated financial sector arguing the answer is not lower capital requirements for banks, but more attention to nonbank risks.
- He ends by emphasizing that it's critical for banks to have enough capital to remain resilient to stresses in nonbank financial markets.
How could this impact GameStop?
The proposed changes to banking regulations primarily focus on strengthening capital requirements and risk management practices for large financial institutions. These changes could potentially impact GameStop in several ways:
- Reduced Market Volatility: Barr's changes aim to make banks more cautious in their lending and trading practices by requiring them to hold more capital and use standardized risk models. This could potentially reduce the volatility in GameStop's stock price, as banks might be less likely to engage in risky trading strategies, such as short selling, that can cause significant price swings.
- Potential Impact on Lending: If banks are required to hold more capital, they might become more selective in their lending practices. This could potentially make it more difficult for companies like GameStop to obtain loans or could increase the cost of borrowing--good thing they have $1+ billion on hand, right?!?!!?
- Increased Transparency: Barr's proposed changes aim to increase transparency in banks' risk management practices.
TLDRS:
- Barr's proposed changes include updating capital requirements to better reflect credit, trading, and operational risk. He suggests moving away from banks using their own models to estimate credit risk, towards a standardized approach. He also proposes changes to how banks measure market risk and suggests that risk should be modeled at the level of individual trading desks for specific asset classes.
- Barr recommends that the new risk-based capital rules should apply to banks and bank holding companies with $100 billion or more in assets. He also suggests that these banks should account for unrealized losses and gains in their available-for-sale (AFS) securities when calculating their regulatory capital. Furthermore, he supports introducing a long-term debt requirement for all large banks.
These changes could potentially impact GameStop in several ways:
- Reduced Market Volatility: Barr's changes aim to make banks more cautious in their lending and trading practices by requiring them to hold more capital and use standardized risk models. This could potentially reduce the volatility in GameStop's stock price, as banks might be less likely to engage in risky trading strategies, such as short selling, that can cause significant price swings.
- Potential Impact on Lending: If banks are required to hold more capital, they might become more selective in their lending practices. This could potentially make it more difficult for companies like GameStop to obtain loans or could increase the cost of borrowing--good thing they have $1+ billion on hand, right?!?!!?
