Michael S Barr: Holistic capital review

Speech by Mr Michael S Barr, Vice Chair for Supervision of the Board of Governors of the Federal Reserve System, at the Bipartisan Policy Center, Washington DC, 10 July 2023.

The views expressed in this speech are those of the speaker and not the view of the BIS.

Thank you to the Bipartisan Policy Center for the opportunity to speak today. I'm here to report on my holistic review of capital for large banks and to outline steps that I believe are appropriate to update our capital standards so that banks can continue to serve our communities, households, and businesses.1

The review was a top priority because capital is fundamental to safety and soundness. I approached the task with humility. We need to be skeptical about the ability of bank managers or regulators to anticipate all emerging risks. Events over the past few months have only reinforced the need for humility and skepticism, and for an approach that makes banks resilient to both familiar and unanticipated risks.

Our dynamic financial system is complex and constantly evolving. Regulators and bank managers are limited in our ability to comprehensively identify risks and to measure them. We cannot fully appreciate how a specific vulnerability can interact with other vulnerabilities to amplify and propagate risk in the face of a shock, or multiple shocks. It is extremely difficult to identify shocks in advance. And we also cannot fully predict how firms and markets adapt to changes in the environment or to the behavior of regulators or other participants.

So, instead of trying to design rules to address every conceivable risk, regulators must focus broadly on resilience-ensuring that banks and the financial system can withstand challenges, wherever they emerge and however they are transmitted through the system. Fortunately, there is a component of bank funding-equity capital-that is well suited to building resilience.2 Banks rely on both debt and capital to fund loans and other assets, but capital is what allows the bank to take a loss and keep on operating. The beauty of capital is that it doesn't care about the source of the loss. Whatever the vulnerability or the shock, capital is able to help absorb the resulting loss and, if sufficient, allow the bank to keep serving its critical role in the economy. Higher levels of capital also provide incentives to a bank's managers and shareholders to prudently manage the bank's risk, since they bear more of the risk of the bank's activities.