Top officials at the International Monetary Fund on Tuesday challenged financial regulators imposing far-reaching reforms on the biggest banks, arguing that the global benefits of reform efforts must outweigh their costs.
Officials including José Viñals, financial counsellor and director of the IMF’s monetary and capital markets department, said in a paper that initiatives such as the Volcker rule in the U.S. and similar proposals in Europe could impose significant costs on the global economy, such as reduced liquidity in financial markets. They could also increase the risk that financial activity will migrate to institutions, sectors or jurisdictions subject to less supervision, the paper said.
The warning comes as U.S. regulators attempt to finalize various proposals, including the one named after Paul Volcker, the former Federal Reserve chairman, which bans banks from trading for their own profit and significantly restricts their investments in risky ventures such as hedge funds and private-equity firms. Another pending rule threatens to raise costs for foreign banks by ratcheting up their capital requirements.
The IMF staff paper may buttress arguments made by foreign regulators and officials who have complained about proposals they say could harm foreign banks or drive up sovereign borrowing costs because leading U.S. banks may limit their activities.
But the IMF paper stops short of fully endorsing claims made by these authorities, including those from Germany and Japan. Instead, the IMF officials said that national proposals to restructure large banks, limit their activities or heighten requirements on foreign banks may be justified if regulators are unable to effectively supervise complex financial institutions or if foreign officials refuse to rein in banks considered to be “too important to fail”.
For example, IMF officials pointed to the $6 billion loss suffered by JPMorgan Chase last year due to a group of traders led by the so-called “London Whale” as an episode that “highlights the challenges supervisors continue to face in ensuring that their capability is not outstripped by financial sector complexity”.
U.S. regulators have said they are concerned that large European institutions operating in the U.S. benefit from an unfair advantage because U.S. banks have tougher regulatory requirements, and their European peers refuse to make their banks safer.
Fed officials, under assault from foreign peers for suggesting more stringent rules for big banks, may find comfort in the note from the IMF. Fund officials cautioned in their paper that their views do not necessarily represent those of the IMF.
Separately, recommendations from the Bipartisan Policy Center, a Washington think tank, appeared to endorse U.S. initiatives to end the perception that some banks are considered either too big or too important to fail.
The BPC report, led by industry executives and former regulators, supported a Federal Deposit Insurance Corporation proposal to resolve big, global banks nearing failure. The agency’s approach involves taking over the parent company of a big bank, imposing losses on shareholders and parent-company creditors, and keeping the operating subsidiaries alive.
In the coming months the FDIC and the Fed will propose a rule requiring big banks to fund themselves with enough equity capital and parent-company debt to cover losses if the banks were nearing failure and needed to be taken over by regulators.
For the FDIC’s approach to work, the BPC said that banks should have enough capital and loss-absorbing debt to cover losses greater than those forecast under a worst-case scenario used by the Fed in its annual stress tests of banks’ balance sheets. The Fed estimates how banks would cope if U.S. unemployment rose to 12 percent, economic output fell by 5 percent, equity prices were slashed by 50 percent and home prices declined more than 20 percent.
The amount of loss-absorbing debt and equity that the BPC recommends may resemble a proposal by Sens. Sherrod Brown (D-Ohio) and David Vitter (R-La.), who introduced legislation to require banks with at least $500 billion in assets to fund themselves with at least 15 percent in equity capital.