The Federal Reserve Bank of Minneapolis has released its final Minneapolis Plan to End Too Big to Fail
(TBTF).The final Plan makes a stronger case than did the draft Plan for raising capital requirements for the largest banks, while drastically reducing burden on the smallest. Leaving capital requirements at current levels leaves taxpayers at risk of a future crisis and bailout. Enacting the Minneapolis Plan would reduce the 100-year chance of a crisis from the current risk of 67 percent to only 9 percent, while generating substantial benefits relative to costs.
“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,” said 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.”
Today’s release is the culmination of a two-year initiative launched by the Minneapolis Fed in February 2016 to address the continuing risk presented by TBTF financial institutions. In late 2016, the Bank released a draft Plan and invited public and expert review and feedback.
The final Plan reflects the comments and subsequent analysis in three ways:
- The comments confirm that the fundamental analysis and recommendations were correct. The Minneapolis Fed received many comments from academics, industry critics and concerned citizens, which are summarized and addressed in the final Plan. None of the comments changed the fundamental conclusion that large banks do not have enough capital to protect taxpayers.
- New analyses by experts (who are unrelated to the Minneapolis Plan effort) during the review period also support and call for capital requirements similar to those recommended in the Minneapolis Plan. The final Plan cites six new independent studies by government and academic economists, whose methods are different from our own, that also support much higher capital requirements for large banks. Federal Reserve Chair Janet Yellen summarized some of this same research recently, noting that “this research points to benefits from capital requirements in excess of those adopted.”
- The final Plan provides significantly more detail on the recommendation to right-size the supervision and regulation of community banks. The Plan would fundamentally change the nature of community bank supervision, effectively limiting supervision to those aspects of community banking that pose real risk. The Plan brings that same approach to bank regulation, changing community bank rules around capital requirements, appraisals, data collection, some Dodd-Frank requirements and other areas.
Summary: The Minneapolis Plan to End Too Big to Fail
After the Great Recession of 2008, policymakers moved swiftly to reform and strengthen the financial system, including adopting higher capital requirements. The Minneapolis Plan finds, however, that such immediate measures only reduced the chance of a 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 a public bailout 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 the bank 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 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. Specifically, the Plan would:
- Make the capital risk-weighting regime for community banks much less complicated, so that it largely mirrors Basel I.
- Create a default mode for supervision of community banks where supervisors would only review subject to an exception process, (a) how banks comply with specific laws passed by Congress (and the rules and guidance issued to implement those laws) or (b) operations, policies or procedures of a bank for which the banking agencies have empirical evidence supporting a correlation with materially weaker bank conditions.
- Impose a wide range of specific risk-focused reforms including but not limited to a longer exam cycle, appraisal reform, reductions in call report collections and a review of the Current Expected Credit Loss accounting standard.
- Repeal solvency and other noncompliance-related provisions of the Dodd-Frank Act that apply to community banks and that do not have a strong link to their chance of failure.
“With today’s strong economy, now is the perfect time to act to strengthen our financial system. 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,” added Kashkari.
The full Minneapolis Plan
Summary for Policymakers
Comments and Responses
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.