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Fed Considers New Tool for a Downturn

By Lalita Clozel 

WASHINGTON -- Federal Reserve officials are weighing whether to use a tool that could reduce the risk of a credit crunch in a downturn.

The tool is known as the countercyclical capital buffer. It allows the Fed to require banks to hold more loss-absorbing capital should the economy show signs of overheating, or to keep less of it during bad economic times. The buffer applies generally to banks with more than $250 billion in assets, including firms such as JPMorgan Chase & Co., Bank of America Corp. and Citigroup Inc.

The Fed's board of governors so far hasn't used the tool, approved in 2016. Its rule on the buffer says it should turn it up when economic risks are "meaningfully above normal" and reduced when they "abate or lessen."

Now, some Fed officials are debating whether it is time to use the tool, which could provide banks with additional lending firepower in a subsequent downturn. It isn't clear when they might make a decision.

"The idea of putting it in place so you can cut it, that's something some other jurisdictions have done, and it's worth considering," Fed Chairman Jerome Powell said at a late July press conference.

Deciding whether to use the buffer is somewhat fraught, though. Banks are reluctant to hold even more capital than they do today as this could hamper their profitability. That is already under strain due to low interest rates.

Plus, it isn't clear how markets would interpret such a move by the Fed, especially since this would be a first. Investors could find the buffer reassuring, believing the Fed is giving itself additional room to fight a downturn. Or they could be unsettled by it, fearing the Fed believed a slowdown is imminent.

Fed officials have been debating about whether to use the tool since last year. Now, they are raising another question: how it should be used.

Some officials have suggested turning it on without increasing capital levels -- signaling the Fed is prepared to use the tool, even if not right away. Others think higher capital requirements should be applied now.

Either move would give the central bank the option of lowering the requirement during a downturn.

Fed Gov. Lael Brainard, an Obama appointee, favors turning on the buffer now and raising capital requirements for big banks. She dissented from a March Fed vote to leave the buffer dormant.

"Turning on the [buffer] would build an extra layer of resilience and signal restraint, helping to damp the rising vulnerability of the overall system," she said in a May speech.

Others say capital levels are already high enough, and that the tool could be used instead as a release valve for bad times.

"We rely on through-the-cycle, always on, high capital and liquidity requirements," Mr. Powell said. "I view the level of capital requirements and the level of capital in the system as being about right."

Randal Quarles, the Fed's vice chairman for bank supervision, at a July Fed conference in Boston said, "The overall risk to financial stability is swamped by the extremely low leverage in the financial sector. "

Messrs. Quarles and Powell have cited the Bank of England's approach as a possible model for the U.S. In the U.K., the countercyclical capital buffer is set at 1% of risk-weighted assets when risks are "neither subdued nor elevated," allowing the central bank to dial it down if the economy is thrown a curveball.

Banks have argued the buffer shouldn't be turned on now because they are already subject to regulations, including other capital requirements, that ensure they are prepared for bad times. One example is the Fed's annual stress tests that banks must pass to prove they would continue lending in a recession.

At the same time, they have encouraged the Fed to reduce other capital requirements. The central bank would likely have to do that if it activated the countercyclical capital buffer while maintaining the same amount of capital in the banking system, as suggested by Messrs. Powell and Quarles.

The countercyclical capital buffer was created in 2010 by international regulators through the Basel Committee on Banking Supervision. It is being used in other parts of the world, including Sweden and Hong Kong.

Write to Lalita Clozel at lalita.clozel.@wsj.com

 

(END) Dow Jones Newswires

August 12, 2019 09:14 ET (13:14 GMT)

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