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The quality of capital is substantially improved, with firms holding higher amounts of the types of capital best able to absorb losses. Today, industrywide Tier 1 common capital levels are more than $1 trillion – up 70 percent, or $420 billion, from three years ago. Banks have also curtailed their reliance on short-term funding, reducing their vulnerability to losses of liquidity in the financial markets.

Neal S. Wollin

Washington

Op-Ed
By deputy secretary of the U.S. Treasury Neal S. Wolin

Capital Can’t Be The Only Line Of Defense

July 16, 2012

The recent trading losses at JPMorgan Chase have highlighted a bright spot of bipartisan consensus on financial reform: strong capital requirements are essential for preventing future financial crises.

This was one of the central – and simplest – lessons of the 2008 financial crisis, one the Obama administration took to heart from the beginning. In June 2009, President Obama called for financial firms to hold more capital to increase their ability to withstand potential losses. In the three years since, the administration has worked with Congress, the Federal Reserve and other financial regulators to put stronger capital requirements at the core of our efforts to strengthen the financial system.

Those efforts began by requiring the largest, most complex banking institutions to substantially improve their capital cushions. They continue as we implement heightened capital, leverage and liquidity standards under the Dodd-Frank Wall Street Reform and Consumer Protection Act and through the Basel and G-20 new global standards.

As a result of these efforts, our financial system is more stable, and our nation’s banks are in a far stronger position.

The quality of capital is substantially improved, with firms holding higher amounts of the types of capital best able to absorb losses. Today, industrywide Tier 1 common capital levels are more than $1 trillion – up 70 percent, or $420 billion, from three years ago. Banks have also curtailed their reliance on short-term funding, reducing their vulnerability to losses of liquidity in the financial markets.

In recent weeks, opponents of the Wall Street Reform Act have discovered newfound enthusiasm for strong capital requirements, while attacking other crucial elements of reform, which they continue to attempt to delay, weaken or roll back.

While improving capital standards at banks is necessary for building a stronger, more stable financial system, it is not sufficient. Addressing the flaws in our financial system that the crisis brought to light entails substantially more than bolstering banks’ reserves.

First, other financial institutions – not just traditional banks – must hold capital, too. Without the Wall Street Reform Act, banks would still be the only financial institutions subject to federal capital and prudential standards. Large financial companies that could become tomorrow’s versions of Lehman Brothers or Bear Stearns would continue to operate without them. Nor would many of the largest firms trading in the $700 trillion derivatives market, as American International Group did in the years before the crisis, be required to hold capital to protect themselves against potential losses.

Second, in a free-market economy, mistakes are part of risk-taking, and even a well-capitalized firm is not immune to failure. Without the additional protections in the Wall Street Reform Act, however, taxpayers rather than managers and investors would remain at risk of bearing the cost of the failure of a major financial firm. Even in good times, banks could continue to risk taxpayer dollars by making high-risk investments with federally insured consumer deposits.

Third, strengthening bank balance sheets against unexpected losses will not protect American families from unfair, deceptive or abusive business practices. Without the Wall Street Reform Act, consumers would continue to lack an effective advocate to help ensure financial institutions treat them fairly and transparently.

The Wall Street Reform Act improves capital standards, while also addressing these additional flaws in our financial system, each of which played a role in worsening the crisis.

The law subjects large, interconnected financial firms to the same comprehensive oversight and capital standards as traditional banks. It brings oversight and transparency into derivatives markets and sets new standards for the firms that trade in them. It allows regulators to safely unwind a large firm if it faces failure, so that investors and management, not taxpayers, will be responsible for bearing the costs. It prevents banks, through the Volcker Rule, from undertaking high-risk proprietary trading while simultaneously managing consumer deposits. And it establishes the Consumer Financial Protection Bureau, which is helping consumers gain access to honest, straightforward information about financial products, while also making sure consumer laws are implemented and enforced.

Although opponents suggest that increased capital can do the bulk of the work necessary to protect our financial system from the next crisis, capital alone is not enough to achieve lasting change.

Recent events, from JPMorgan’s trading losses to continued uncertainty in Europe, only increase our determination to finish the job of translating the lessons of the financial crisis into comprehensive protections for American taxpayers and consumers.

Mr. Wolin is deputy secretary of the U.S. Treasury.

Source: Treasury Department