Boston Fed Study Examines Impact of Recent Financial Crisis on Capital Positions of Large U.S. Financial Institutions
BOSTON - Capital depletion during the recent financial crisis at large U.S. financial institutions was extensive and often rapid, underscoring the continued importance of pursuing the Basel III capital agenda in the United States, according to a study from the Federal Reserve Bank of Boston.
Co-authors Scott Strah, Jennifer Hynes, and Sanders Shaffer used the experience of the recent financial crisis to analyze and measure the potential risk to capital at large U.S. financial institutions during a period of severe stress. They analyzed financial data from 26 large U.S. bank holding companies, thrifts, and broker-dealers over the period from 2007:Q1 to 2012:Q2 to estimate the erosion of capital during each institution's most stressful period. Of the 26 institutions examined in this study:
- 13 had losses that would deplete capital ratios by at least 200 basis points,
- 12 institutions had capital ratio erosion in excess of 300 basis points, and
- 8 institutions had capital ratio erosion in excess of 450 basis points.
Many regulatory changes have been and are being implemented to respond to the systemic vulnerabilities identified during the financial crisis, including bank holding company status for holding companies of the major remaining broker-dealers, resolution plans, stress testing, and enhanced liquidity and capital planning requirements. While the multi-pronged enhancements to regulation should mitigate some future risk, the authors point out that the adequacy of these enhancements is unknown, as these policies are untested. In particular, while the evolving approach to capital regulation is a significant improvement over the pre-crisis approach, key elements related to the largest U.S. institutions remain in the proposal stage. Our results highlight the importance of the continued progress of capital requirements including considering additional options such as implementing a meaningful supplementary leverage ratio minimum and G-SIFI buffers (global systemically important financial institution), as well as the proactive use of the countercyclical buffer.
Eric Rosengren, President and CEO of the Federal Reserve Bank of Boston said in a February 2013 speech at a Bank for International Settlements Forum that the results summarized in this paper "highlight that capital depletion during the financial crisis was extensive, and occurred relatively quickly, for many of the largest financial institutions in the United States - which is why it is critically important to examine whether large financial institutions are holding sufficient capital." He added that "contrary to arguments put forth by some commenters, our results suggest that even under the current multi-pronged approach, the current calibration of the SIFI surcharge does not appear excessive."