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Statement by Governor Lael Brainard
The crisis taught us that the distress of large complex banking institutions can pose risks to financial stability. Whereas our pre-crisis regulatory framework focused on the safety and soundness of individual institutions, the regulatory framework we are putting in place also addresses the risks posed by individual institutions to the safety and soundness of the system. The first line of defense is to require that systemic banking institutions maintain a very substantial stack of common equity to provide loss absorbency and compel them to internalize the risks to the system posed by their activities.
Today's rule would impose capital surcharges proportional to the systemic riskiness of the eight U.S. systemic banking institutions. The capital surcharges for these institutions are estimated to range from 1.0 percent to 4.5 percent of risk-weighted assets over and above the Basel III seven percent minimum and capital conservation buffer, and in addition to any countercyclical capital buffer.
The capital surcharge is calibrated so that the expected costs to the system from the failure of a systemic banking institution are equal to the expected costs from the failure of a sizeable but not-systemic banking organization. For instance, if the failure of a systemic banking institution would have five times the system-wide costs as the failure of a sizeable but not-systemic banking organization, the systemic banking institution would be required to hold enough additional capital that the probability of its failure would be one-fifth as high.
Importantly, the surcharge is calibrated in proportion to how an institution scores on specific metrics that capture the risks it poses to the system--risks associated with size, interconnectedness, complexity, cross-border activities, and substitutability. It also reflects the risks associated with greater reliance on short-term wholesale funding which can contribute to creditor runs and asset fire sales and spark contagion. By calibrating the capital surcharge in direct proportion to clearly specified measures of each institution's systemic impact, this approach provides clear, quantifiable incentives to the systemic banking institutions to reduce their systemic footprints.
The crisis also provided a stark reminder that what may seem like thick capital cushions in good times may prove uncomfortably thin at moments of stress. I look forward to future discussions about the appropriate role, if any, of a GSIB surcharge in the supervisory stress tests.
