Regulatory Practice Letter #15-02 | February 24, 2015

Regulatory Practice Letter #15-02 | February 24, 2015

Federal Reserve Requests Comment on a Risk-Based Capital Surcharge Proposal for GSIBs

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Executive Summary

On December 9, 2014, the Federal Reserve Board (“Federal Reserve”) issued a proposed rule to establish a capital surcharge for the largest, most interconnected U.S.-based bank holding companies (“BHCs”) in accordance with its authority to establish enhanced riskbased capital standards under Section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”).

The proposal would also revise the terminology used to identify firms subject to the enhanced supplementary leverage ratio requirement1 to ensure consistency in the scope of application for both rulemakings. The proposed rule, which would amend the Federal Reserve’s regulatory capital rule, is largely consistent with the international framework adopted by the Basel Committee on Banking Supervision (“BCBS”) in July 2013, but contains certain modifications to the BCBS’s calculation methodology to reflect systemic risk concerns specific to the funding structures of large U.S. BHCs.

As proposed, the rule would establish a methodology for determining whether a U.S. BHC with at least $50 billion in total consolidated assets that is not a subsidiary of a non-U.S. banking organization is a global systemically important bank holding company (“GSIB”).U.S. BHCs meeting the asset threshold would be required to calculate a measure of their systemic importance based on five broad categories that would include size, interconnectedness, substitutability, complexity, and cross-jurisdictional activity.

Based on this measure, a subset of these U.S. BHCs would be identified as GSIBs and subject to a risk-based capital surcharge that would increase their capital conservation buffer under the Federal Reserve’s regulatory capital rule. Under the proposed methodology, the Federal Reserve estimates that eight U.S. BHCs would currently be identified as GSIBs. These institutions would be required to calculate their GSIB capital surcharge using two methods and be subject to the higher of the two calculations, defined as:

  • The sum of the GSIB’s systemic indicator scores reflecting its size, interconnectedness, substitutability, complexity, and crossjurisdictional activity (“Method 1”); and
  • The sum of the GSIB’s systemic indicator scores reflecting its size, interconnectedness, complexity, and cross-jurisdictional activity, as well as a measure of the GSIB’s use of short-term wholesale funding that replaces the substitutability systemic indicator scores ("Method 2"). The Federal Reserve states this method would usually result in a higher surcharge than Method 1.

The proposed rule states that the calibration of the measurements is designed to (1) induce a GSIB to reduce its risk of failure and internalize the negative externalities it poses, (2) correct for competitive distortions created by the perception that a GSIB may be too big to fail, (3) place additional private capital at risk before either the Federal Deposit Insurance Fund or the federal government’s resolution mechanisms would be called upon, and (4) reduce the likelihood of economic disruptions owing to a GSIB’s financial distress. Consistent with the punitive measures of the capital conservation buffer, failure to maintain the capital surcharge would subject the GSIB to restrictions on capital distributions and discretionary bonus payments.

The proposed rule would be phased in beginning January 1, 2016, through year-end 2018, and become fully effective on January 1,2019. Comments on the proposal must be submitted to the Federal Reserve no later than March 2, 2015.

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