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Minneapolis Fed Releases Plan to End “Too Big to Fail”

Minneapolis, November 16, 2016

Minneapolis Fed Releases Plan to End “Too Big to Fail”

Federal Reserve Bank of Minneapolis President Neel Kashkari today announced the release of the Minneapolis Plan to End Too Big to Fail (TBTF), a policy solution that will enable the U.S. economy to flourish without exposing it to large risks of financial crises and taxpayer bailouts.

In February 2016, Kashkari announced a year-long initiative to explore policy solutions to address the continuing risk presented by TBTF financial institutions. As part of the initiative, the Minneapolis Fed organized four policy symposiums that brought together leading economists, academics and policymakers in an open and transparent process that also helped engage and educate the public about the risks posed by TBTF banks. Fulfilling the pledge to release a proposal by the end of the year, the Minneapolis Plan is designed to reduce the risk of financial crises and bailouts to less than 10 percent, while passing a benefit and cost test.

“I have seen the damage that a deep financial crisis can inflict on Main Street and am committed to making sure it never happens again. The Minneapolis Plan dramatically increases safety within the financial system. It is now up to policymakers and the American people to decide the level of safety they want to protect against a future crisis,” said Kashkari.

The Minneapolis Plan to End Too Big to Fail

The TBTF problem is one of the most serious long-term risks to the U.S. economy. In 2008, TBTF banks were at the center of the financial crisis that triggered the Great Recession. Soon after, policymakers moved swiftly to approve reforms that have indeed strengthened the financial system, particularly with higher capital requirements. The Minneapolis Plan’s analysis shows, however, that these efforts have only reduced the chance of bailout over the next 100 years from 84 percent to 67 percent.

The Minneapolis Plan includes four steps to strengthen the financial system:

Step 1:
Dramatically increase common equity capital for banks with assets exceeding $250 billion. The plan requires the largest banks to issue common equity equal to 23.5 percent of risk-weighted assets, with a corresponding leverage ratio of 15 percent. This first step substantially reduces the chance of public bailouts relative to current regulations from 67 percent to 39 percent.

Step 2:
Call on the U.S. Treasury Secretary to certify that individual large banks are no longer systemically important or else subject those banks to extraordinary increases in capital requirements—up to 38 percent over time. Once the new 23.5 percent capital standard has been implemented, the plan charges the Treasury Secretary with certifying that individual large banks are no longer systemically important. If the Treasury Secretary refuses to certify a large bank as no longer systemically important, that bank will automatically face increasing common equity capital requirements, an additional 5 percent of risk-weighted assets per year. The bank’s capital requirements will continue increasing either until the Treasury Secretary certifies it as no longer systemically important or until the bank’s capital reaches 38 percent, the level of capital that reduces the 100-year chance of a crisis to 9 percent.

Step 3:
Prevent future TBTF problems in the shadow financial sector by imposing a tax on the borrowings of shadow banks with assets over $50 billion. The Minneapolis Plan levels the cost of funding between banks subject to a 23.5 percent capital requirement and shadow banks through a tax on borrowings of shadow banks larger than $50 billion of at least 1.2 percent (120 basis points). This tax rate will apply to shadow banks that are not systemically important as certified by the Treasury Secretary. A tax rate equal to 2.2 percent will apply to the shadow banks that the Treasury Secretary refuses to certify as not systemically important.

Step 4:
Reduce unnecessary regulatory burden on community banks. The final step of the Minneapolis Plan allows the government to reform its current supervision and regulation of community banks to a simpler and less burdensome system while maintaining its ability to identify and address bank risk-taking that threatens solvency.

“We believe the Minneapolis Plan does a much better job of reducing risks at reasonable costs to society than current regulations. Ultimately, the public needs to make their own determination. We hope this process will equip them with the data and analyses they need to make an informed judgment,” he added.

The Minneapolis Plan will be open for a 60-day comment period so that the public can respond to the Plan with comments, suggestions, and feedback. A Summary for Policymakers can be found here and the Full Proposal can be found here.

The Federal Reserve Bank of Minneapolis is one of 12 regional Reserve Banks that, with the Board of Governors in Washington, D.C., make up the Federal Reserve System, the nation’s central bank. The Federal Reserve Bank of Minneapolis is responsible for the Ninth Federal Reserve District, which includes Montana, North and South Dakota, Minnesota, northwestern Wisconsin and the Upper Peninsula of Michigan. The Federal Reserve Bank of Minneapolis participates in setting national monetary policy, supervises numerous banking organizations, and provides a variety of payments services to financial institutions and the U.S. government.