The Federal Reserve Bank of Minneapolis (Minneapolis Fed) released its final plan to reduce the chances of a major final crisis, which calls for raising capital requirements for the largest banks while reducing the burden on the smallest institutions.
The Minneapolis Plan to End Too Big to Fail contends that leaving capital requirements at current levels would put taxpayers at risk of a future crisis and bailout. Additionally, the plan would fundamentally change the nature of community bank supervision, limiting supervision to those aspects of community banking that pose a real risk. Specifically, it would change community bank rules around capital requirements, appraisals, data collection, some Dodd-Frank requirements and other areas.
The plan, which is the culmination of two years of research by the Minneapolis Fed, would reduce the 100-year chance of a crisis from the current risk of 67 percent to only 9 percent.
“We have repeatedly learned that it is almost impossible for governments to spot financial crises before they strike. But the data tell us that American taxpayers are still on the hook today,” Minneapolis Fed President Neel Kashkari. “After witnessing the economic devastation from the 2008 financial crisis, I am committed to working with other policymakers to strengthen our financial system and reduce the danger of a future crisis. There is no excuse for inaction, and history will judge us poorly if we so soon forget the lessons we just learned.”
After the 2008 recession, policymakers moved to strengthen the financial system, in part, by adopting higher capital requirements. But the Minneapolis Fed found that this only reduced the chance of a bailout over the next 100 years from 84 percent to 67 percent. To reduce it further, the plan lays out a four-step process.
First, it calls for a dramatic increase in common equity capital for banks with assets exceeding $250 billion. The largest banks would have to issue common equity equal to 23.5 percent of risk-weighted assets, with a corresponding leverage ratio of 15 percent. This would reduce the chance of a public bailout from 67 percent to 39 percent.
Second, it calls upon the U.S. Treasury Secretary to certify that individual large banks are no longer systemically important or else subject those banks to large increases in capital requirements—up to 38 percent over time. This would reduce the 100-year chance of a crisis to 9 percent.
Third, the plan would impose a 1.2 percent tax on the borrowings of shadow banks with assets over $50 billion. A 2.2 percent tax would apply to the shadow banks that the Treasury Secretary refuses to certify as not systemically important.
Finally, the plan would reduce unnecessary regulatory burden on community banks. Among other things, it would make the capital risk-weighting regime for community banks much less complicated, so that it largely mirrors Basel I.
“With today’s strong economy, now is the perfect time to act to strengthen our financial system,” Kashkari said. “We must not wait, and we must not go backwards. If we wait until the next crisis to implement these reforms, it will be too late.”