The Federal Reserve announced Tuesday the approval of new regulations aimed at Wall Street’s biggest banks and the practices that led to the 2008 financial crisis.
With the international Basel III accord, banks will be required to maintain a significantly larger level of capital assets to act as a cushion to help absorb losses like those the banks began to sustain in 2007, leading to the nation’s worst financial crisis since the Great Depression.
Basel III, which is part of regulations called for in the Dodd-Frank Wall Street Reform, prevents banks from leveraging, or lending or investing, large, unsafe amounts of money — a gambling practice that played a large part in crashing the housing market.
After leveraging, trading and insuring vast amounts of investor’s money in mortgage assets the nation’s largest banks knew to be toxic and faulty, Wall Street was unable to recoup the losses when the investments became worthless.
The banks had leveraged far more money than they possessed in capital, crashing the market and leaving taxpayers to pick up the check in the form of government stimulus.
“This framework requires banking organizations to hold more and higher quality capital, which acts as a financial cushion to absorb losses, while reducing the incentive for firms to take excessive risks,” Chairman Ben Bernanke said in a statement released by the Fed.
“With these revisions to our capital rules, banking organizations will be better able to withstand periods of financial stress, thus contributing to the overall health of the U.S. economy,” Bernanke said.
Both the quantity and quality of capital held by banks will be increased, and globally connected financial organizations will be equally mandated to comply with the rule. Banks will have until the beginning of 2014 to comply, with smaller institutions having one extra year to meet the requirements.
“Adoption of the capital rules today is a milestone in our post-crisis efforts to make the financial system safer,” Daniel Tarullo, a member of the Fed Board of Governors, said.
“Along with the stress testing and capital review measures we have already implemented, and the additional rules for large institutions that are on the way, these new rules are an essential component of a set of mutually reinforcing capital requirements,” Tarullo said.
Banks have responded critically to the rule, citing it as overly complex, bad for the economy and without realistic time constraints to implement the new regulations. The American Bankers Association (ABA), which represents and speaks for the nation’s $13 trillion banking industry, has asked for more time to comment on and examine the rule.
“Basel III exists because Basel I and II didn’t get it right. For that reason, we shouldn’t expect this rule to be perfect either — it’s clear that more needs to be done,” ABA president and CEO Frank Keating said in a statement released Tuesday.
“While each iteration brings us closer to optimal capital rules, we won’t know if we’ve achieved that goal without having a much more thorough understanding of Basel III’s real-world impact. The Federal Reserve has conducted ‘pro forma’ economic analysis, but the fragile nature of our economy demands better understanding.”
According to the ABA, Basel III will make it much harder for banks to approve mortgages and lend loans — crucial components to the slow-recovering national economy.
Basel III is only the start, according to the Fed, which went on to say it plans to consider even greater regulation and management of capital holdings in the future.