On March 28, the Fed released a report titled “Outlining and Measuring the Benefits of Risk Sensitivity in Bank Capital Requirements” evaluating the integration of risk regarding bank capital requirements. The report asserted banks, particularly the largest banks, have incentives to operate with “lower capital ratios than would be socially optimal” due to deposit insurance and government guarantees, which can lead to adverse outcomes.
As described in the report, regulatory capital requirements are designed to set expectations that banks maintain adequate “loss-absorbing equity” to contribute to financial stability. The report argued that risk-sensitivity improves efficiency of capital requirements and ensures that banks undertaking greater risk hold more capital, thereby mitigating the “externalities their failure or distress may cause.” The report also introduced a conceptual framework to assess the impact of risk sensitivity on the net benefits of capital requirements, suggesting that it can “increase the net benefits of capital requirements” and potentially lower the optimal capital level. Finally, the report addressed criticisms of risk-based capital requirements, such as difficulty in measuring risk accurately and opportunities for “regulatory arbitrage.”
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