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The Fed's memo to big banks: Let's get small

Aaron Task
Editor in Chief

In the aftermath of the financial crisis, a heated debate emerged over how to regulate America's biggest banks. Four years after Dodd-Frank legislation passed Congress, it appears the banks' lobbying efforts have failed to stem a tide of oversight that's even tougher than global standards.

On Tuesday, Daniel Tarullo, the Fed governor who oversees regulatory policies is expected to announce new capital requirements for what the central bank calls global systemically important banks (GSIBs) that exceed the international standards set by the Basel accords. Specifically, the Fed will require America's biggest banks to hold as much as 2.5 percentage points more capital than the 8% to 9.5% of assets required by Basel III, effective in 2018.

Notably, this is in addition to the new liquidity requirements the Fed imposed last week and totally separate from the parade of fines and settlements the industry has reached with the DOJ and various state attorneys general. But they're all variations on a theme: An effort to ensure the American taxpayer (and the Federal Reserve) will never again be compelled to bail out the banks.

In testimony prepared for the Senate Banking Committee today, Tarullo says:

"The financial crisis made clear that policymakers must devote significant attention to the potential threat to financial stability posed by our most systemic financial firms. Accordingly, the Federal Reserve has been working to develop regulations that are designed to reduce the probability of failure of a GSIB to levels that are meaningfully below those for less systemically important firms and to materially reduce the potential adverse impact on the broader financial system and economy in the event of a failure of a GSIB."

The Fed appears to be fighting the last war -- i.e. trying to prevent another 2008-style crisis -- when it's highly unlikely the next crisis (and there will be one) will look like the last one. Then again, what else would you expect the Fed (or any other regulator) to do but to try to prevent a re-occurrence of what Ben Bernanke recently called "the worst financial crisis in global history, including the Great Depression”?

Other subplots to this story:

  • By requiring capital standards above Basel III the Fed is going to test the industry's common complaint that tougher regulations will make America's biggest banks uncompetitive vs. international peers, i.e. will the Fed stifle innovation and economic growth?
  • By making life tougher for America's largest financial institutions, will the Fed ultimately compel GSIBs to break up?

These and related questions will only be answered in the fullness of time. What we do know now is that major U.S. financial institutions like JPMorgan have been anticipating these new rules and are already in compliance, years ahead of when new regulations take effect. We also know that bank profits are back to within earshot of their pre-crisis peak -- despite the 'onslaught of overzealous regulation' -- so it's hard to feel much sympathy for an industry that taught us all what the phrase "privatizing profits and socializing losses" really means. 

Aaron Task is Editor-in-Chief of Yahoo Finance. You can follow him on Twitter at @aarontask or email him at altask@yahoo.com.