By Brai Odion-Esene

WASHINGTON (MNI) – San Francisco Federal Reserve President John
Williams Friday said additional capital requirements for banks
considered to be ‘systemically important financial institutions’ must be
high enough to prevent their failure and, as a result, protect the
broader economy.

In remarks prepared for the Symposium on Asian Banking and Finance
in San Francisco, Williams limited his comments to banking regulation,
noting that the global financial system “is experiencing great stress as
it adapts to the new, post-crisis rules of the game.”

One of the more contentious areas of the new regulations surrounds
the proposed higher capital rules, especially those for the
aforementioned systemically important financial institutions that has
been labelled the ‘SIFI surcharge’.

Williams argued that, for these institutions, “we must set capital
requirements high enough to ensure that failure is extremely unlikely
while still allowing enough leverage for banks to provide reasonable
returns to shareholders.”

Also, he said the additional capital charge would remove the
advantage these banks enjoy in their funding costs by being perceived as
too big to fail.

“The surcharge makes the playing field between SIFIs and smaller
organizations more even. And it provides disincentives for firms to
become extremely large, increasing their systemic footprint,” Williams
said.

William did acknowledge that setting an appropriate surcharge for
large banks is a tough balancing act.

As for how management within these large banks will adjust in the
face of more stringent capital standards, Williams predicted that either
expectations will shift regarding appropriate levels of risk and reward,
or business practices will change in ways that accommodate the
additional capital charge.

“For their part, supervisors will have to judge whether such
changes are consistent with microprudential standards of safety and
soundness for individual institutions and macroprudential standards for
containing systemic risk,” he said.

As for the potential effects that stricter risk management
standards as well as higher capital and liquidity requirements will have
on the economy, Williams simply said “further analysis is needed to sort
out the economic crosscurrents stemming from the forthcoming stricter
risk management standards.”

Looking ahead to how regulators will fare in this new world of
heightened financial regulatory oversight, Williams cautioned that
managing systemic financial risk is a challenge “of the first order.”

A macroprudential supervision framework has now been created with
the goal of preventing future events that are “inherently uncertain,” he
said, but in which decisions could have far-reaching consequences.

“With today’s interconnected global markets, macroprudential
supervisory action in the United States will have repercussions in
financial markets around the world,” Williams said.

The challenge, he said, is to craft a regime of macroprudential
supervision that maintains financial stability while maximizing
long-term economic growth.

This is why Williams said he is convinced that timely communication
by regulators about their policies and practices is critical any time
they observe risky behavior within the financial system.

“We must explain to the financial sector and the public in clear
language when we believe an unsafe situation is developing and how it
could potentially lead to a crisis,” he said.

And given that there also are economic costs of macroprudential
supervision — such as less credit availability due to tighter lending
standards — Williams stressed the importance of regulators talking
“about both sides of the coin — the threat represented by a buildup of
systemic risk and the cost of policies and practices that contain that
risk.”

** Market News International Washington Bureau: 202-371-2121 **

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