from Birch Gold Group:
After several major bank failures that ended the first quarter of last year, regulators are supposedly seeking to minimize the odds of another banking crisis.
(Hint: They weren’t very successful preventing what happened last year, the Fed’s cure ended up being worse than the disease.)
Their proposal currently goes by the name of Basel III, and it aims to force banks to set aside enough cash to handle major losses:
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U.S. regulators are expected to significantly reduce the extra capital banks must hold under a proposed rule that has drawn aggressive pushback from Wall Street, said eight industry executives in regular contact with the agencies and regulatory officials.
Bank regulators led by the Federal Reserve in July unveiled the “Basel III” proposal to overhaul how banks with more than $100 billion in assets calculate the cash they must set aside to absorb potential losses.
But according to some bank executives, banks don’t want to comply with the Basel III regulations, because they say they can’t afford it:
Banks have loudly complained about the proposal, which overhauls how banks gauge their risk and require them to set aside more capital. Industry executives said the draft rules would force them to raise costs and potentially curb lending.
Michael Barr, the Fed’s vice chair for supervision, attempted to rebut those views with what turned out to be a disturbing comment: “If the proposal is adopted, the average loan would only see a cost increase of 0.03%, assuming banks passed all the new lending costs on to the borrower.”
Now, 0.03% is not very much! Even if banks passed along 100% of the costs to customers, that makes a $10,000 transaction cost $3 more.
So what’s the big deal?
Amazingly, this Basel III proposal highlights 3 much more urgent issues with the U.S. banking system. They legitimately might not be able to afford an extra $3…
#1: A brief overview of bank reserves reveals a BIG problem
Trying to thoroughly explain bank reserves without writing an 800-page textbook can be a complicated situation.
With that in mind, let’s try a simplified overview from 30,000 feet. There are two basic components to bank reserves:
- The reserves which are liquid, like cash or cash equivalents.
- The capital which includes all assets that could be turned into cash. Everything from buildings to the photocopier in the CEO’s office (and everything in between).
You might be surprised to learn that U.S. banks are not currently required to have liquid cash reserves at all. You can see this reflected on the table below (source):
via Federal Reserve
That’s a bit unexpected, isn’t it?
Here’s a quote from the Federal Register that confirms banks do not have to keep liquid cash reserves on hand:
…a zero percent reserve requirement ratio shall apply at each depository institution to total reservable liabilities that do not exceed a certain amount, known as the reserve requirement exemption amount.
That’s right, ZERO!
Highlights added to original image via Federal Register
According to the “stress test” section of the Fed website, DO need to have some 7-8% capital reserves:
- a minimum CET1 capital ratio requirement of 5 percent, which is the same for each bank;
- the stress capital buffer (SCB) requirement, which is determined from the supervisory stress test results and is at least 2.5 percent; and
- if applicable, a capital surcharge for global systemically important banks (G-SIBs), which is at least 1.0 percent.
(Don’t worry about the complex language being used to describe each requirement, the important part is that the total capitalization requirement adds up to 8%.)
