The Federal Reserve on Monday approved large surcharges on some of the biggest U.S. banks in an effort to offset risk and reduce the likelihood of another financial crisis similar to the one that threatened the global economy in 2008.
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At a board of governors meeting this afternoon, the Fed adopted final rules on capital surcharges for the nation's biggest banks, as well as for the U.S. units of big foreign banks.
In effect, the surcharge is an incentive for banks deemed “too big to fail” to avoid taking on too much risk or downsize their operations. The larger the bank’s global economic impact, the bigger threat it poses in the event of another crisis. Consequently, the larger the surcharge that bank will be required to pay under the new regulations.
“A key purpose of the capital surcharge is to require the firms themselves to bear the costs that their failure would impose on others,” Fed Chairwoman Janet Yellen said in a written statement. “They must either hold substantially more capital, reducing the likelihood that they will fail, or else they must shrink their systemic footprint, reducing the harm that their failure would do to our financial system.”
The surcharge applies to eight of the biggest U.S. banks and is set to take full effect in 2019. It requires the firms to hold more capital than their smaller peers to better protect them—and the economy as a whole—against big losses. Among the bank’s impacted by the surcharge are J.P. Morgan Chase (JPM), Citigroup (C) and Bank of America (BAC).
Under the rule, J.P. Morgan, as the largest U.S. bank by assets, would be required to pay the largest surcharge, totaling 4.5% of risk-weighted assets. Goldman Sachs (GS), Wells Fargo (WFC), State Street (STT) and Bank of New York Mellon (BNY) would also face surcharges.
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The rules establish a criteria for identifying “too big to fail banks” based on five categories: size, interconnectedness, cross-jurisdictional activity, substitutability and complexity, according to materials released Monday by the Fed.
The Fed had previously proposed these surcharges as part of authority granted to the central bank under the Dodd-Frank banking reform legislation adopted in the wake of the 2008 crisis. The new rules reflect similar changes recommended by international bank regulation bodies, but take them a step farther.
The surcharge imposed by the U.S. central bank would be even larger than those imposed on foreign banks under the Basel Committee requirements initiated for non-U.S. banks a few years back.
Under the new rules, each U.S. bank deemed “too big to fail” under a criteria established by the Dodd-Frank laws would be required to calculate a measure of its economic importance. Using that calculation, the banks would then be required to pay a surcharge based on their economic importance.
"A set of graduated capital surcharges for the nation's most systemically important financial institutions will be an especially important part of the strengthened regulatory framework we have constructed since the financial crisis," Governor Daniel K. Tarullo said.
The Fed hasn’t decided whether to include the surcharges to the stress tests given to the largest U.S. bank’s each year to determine how well the banks will fare in the event of another sharp economic downturn.