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Fed directs big banks to hold US$200b extra capital

GE Capital was under scrutiny because US regulators in 2013 judged its failure could hurt the broader US economy and designated it “systemically important”, a label created under Dodd-Frank that brings stricter oversight to such firms from the Fed.

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Fed Governor Daniel Tarullo said the Fed’s version went in a different direction to give the banks more incentive to improve their scores, making their risk levels “based on a fixed measure of each firm’s systemic importance, rather than – as in the Basel method – on a measure relative to that of other firms of global systemic importance”.

These kinds of restrictions on banks have prompted worries about unintended consequences, such as volatility in financial markets that a few ascribe to banks being less willing to take on risk.

Altogether, the policy would require more than $200 billion in reserves from eight banks that the Fed expects will be identified as globally systemically important. The biggest difference is how much more the Fed’s rule penalizes banks for relying on volatile forms of short-term funding such as overnight loans.

Banks would have to meet the additional capital requirement with common equity, considered the most stable source of funding because shareholders can not withdraw their money in a panic.

The Fed rules for GE Capital would be phased in over more than two years. A bank’s surcharge can grow or shrink depending on changes such as size, complexity and entanglements with other big firms. Citigroup (NYSE:C) gets 3.5%.

Fed critics, though, argue that intervening in the market to identify the most important financial insitutions signals investors that the same banks would be so-called too-big-to-fail in a crisis.

The Wall Street Journal reported in late February that J.P. Morgan would begin charging large institutional customers fees for certain deposits, known as nonoperational, citing new rules that make holding money for clients too costly, including the pending capital surcharge.

Tarullo said the central bank will also “need to consider whether and, if so, how to incorporate the surcharges” into the minimum capital levels required in the Fed’s annual stress tests. GE said Monday it was “grateful” for the Fed’s action.

The Fed governors also unanimously adopted standards for new supervision by the Fed of General Electric Co.’s finance arm, which will be subject to rules similar to those governing big banks.

The other banks subject to the capital requirements are Goldman Sachs, Wells Fargo, Morgan Stanley, Bank of New York Mellon and State Street Bank.

The surcharges have been controversial because US banks are being held to higher standards than their global competitors. By January 1, 2016, the finance unit must comply with risk-based and leverage capital, liquidity and reporting requirements.

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However, GE has announced plans to reduce the size of its capital unit by 70%. That could lead to the “systemically important” designation being removed as the financial company shrinks.

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