Simplicity and Complexity in Capital Regulation

by Eric S. Rosengren, President & Chief Executive Officer
The Financial Stability Institute of the Bank for International Settlements: Program for Financial Sector Supervisors
Abu Dhabi, United Arab Emirates
November 18, 2013

Summary

In a speech today, Boston Fed President Eric Rosengren discussed bank capital regulation.

Eric called the increased attention on sufficient high-quality capital for banking organizations extremely important, and a "lesson learned and applied" from the financial crisis.

Bank capital requirements are, however, an area of increasing complexity, stemming from several factors. For example, today some firms report on their positions relative to Basel I, Basel II, and Basel III requirements. Separately, there are a variety of ways to measure capital.

"At least some of the complexity could, and probably should, be reduced" in the interest of market discipline, said Eric.

Delving into capital regulation techniques in some detail, Eric made the point that both risk-based capital requirements and leverage-based capital requirements are likely to continue to be needed.

A number of the largest global banking organizations have significant broker-dealer operations, and are highly dependent on wholesale funding – ushering in the risk that their short-term financing might dry up with a financial shock.

Eric pointed out that these concerns are far from just theoretical – many difficulties in the fall of 2008 stemmed from runs on institutions that depended on wholesale funding.

This suggests that "larger capital positions for firms with a business model reliant on wholesale funding will help to further reduce the likelihood of a liability run."

Eric explained, "Large global banking organizations with large broker-dealers are organizations where leverage ratios and capital charges on wholesale funding are particularly appropriate."

In short, "global banks with significant investment banking and broker-dealer activities pose significant potential risk to the financial system, and should be among the best capitalized large banking organizations."

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