Last week, Michael Barr, the Federal Reserve’s vice chair for banking supervision resigned. This was unexpected – at least to most people. His resignation is also consequential for capital markets. This was evidenced by the rise in US banking stocks (+2.4%) on the day of his resignation. Barr was a public supporter of new bank capital rules for US banks under what is known as the Basel III Endgame (sometimes known as B3E). His resignation probably signals a retreat in support for B3E by the US. If so, then US banks likely add to their profitability advantage over international peers – boosting attractions of the dollar, and dollar assets. There will be market implications well beyond the existing bump in bank stock values. It is likely to underpin asset price funding more widely and promote further balance sheet commitment of banks to leveraged investment. It is also likely to lead to significant expectation of M&A among smaller US banks, further entrenching the dominance of large banking entities. The main question is how much of the new rules in current market prices across a range of products? That is extremely difficult to know. But the implications cannot possibly already have been fully discounted. Banks have been preparing and adjusting for B3E for years. It follows that a relaxation of the timetable may release a good deal of lending (of all types) into the US economy. Much more than just a 2.4% bump in bank stocks.
The proposals currently under discussion for Basel III Endgame would impose a wide array of restrictions and changes in policy on banks, affecting capital, IT systems, relationships with clients. Among other things the measure would require additional capital to cover credit risk, market risk, operational risk, and financial derivatives risk. It would penalise large banks (over $250 billion in assets). Barr is on record as supporting Basel III measures which would add nearly $100bln capital needs to US banking – though at the time of this interview this was framed as ‘easing’ the proposals. Since election day, easing the proposals has taken on a whole new meaning. The days of adding any capital requirements to banks may be over. Regulatory retreat is more likely. A new fun time may be upon us.