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Kashkari, Minnesota Fed Chief, Has Plan to End Too-Big-to-Fail Banks

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Minneapolis Fed President Neel Kashkari on Wednesday released his plan to end too-big-to-fail banks, advocating for “much higher capital levels” for large banks and a tax on leverage for shadow banks.

Kashkari released his four-step plan in comments before the Economic Club of New York.

A former assistant secretary of the Treasury who oversaw the Troubled Asset Relief Program (TARP) that was part of the government’s response to the 2008 financial crisis, Kashkari said that while he supported Congress moving quickly to institute the Dodd-Frank financial reform act in 2010, and that “significant progress” has been made to strengthen the U.S. financial system under the act, the “biggest banks are still” too-big-to fail “and continue to pose a significant, ongoing risk to our economy.”

Many experts agree, he said, that TBTF still exists today “because current plans to address it have not been fully implemented. More importantly, we believe that the current plan, even when fully implemented, will not sufficiently minimize the threat of TBTF.”

The current plan under Dodd-Frank, Kashkari said, “fundamentally rests on the belief that the government will, through a complicated scheme, force debt holders of TBTF banks to absorb losses—even when the economy and financial markets appear weak.”

Yet, he continued, “our experience in the 2008 crisis teaches us that when markets show weakness, even debt holders of TBTF financial firms who were informed that they would bear losses in such times of distress do not actually incur any hit.”

Much higher capital levels for large banks and a tax on leverage for shadow banks “will lead covered banks to break themselves up to become non-systemically important while funded with much more capital,” Kashkari said, which will result in a financial system with “smaller banks with a much lower chance of failure.”

The current proposed resolutions aren’t “viable,” he continued, because they focus on imposing losses on creditors during a crisis. We also do not support breakup plans that merely separate investment banking from commercial banking.”

While President-elect Donald Trump has been vocal about wanting to dismantle Dodd-Frank, he has only weighed in on too-big-to fail banks by stating he “disagrees” with breaking up big banks.  

Kashkari recommended in his blue-print four steps to end too-big-to-fail banks:

1. Dramatically increase common-equity capital, substantially reducing the chance of bailouts.

Require covered banks to issue common equity equal to 23.5% of risk-weighted assets, with a corresponding leverage ratio of 15%. This level of capital nearly maximizes the net benefits to society from higher capital levels. This first step substantially reduces the chance of public bailouts relative to current regulations from 67% to 39%. This substantial improvement in safety comes at a relatively low cost of gross domestic product. Covered banks will have five years to come into compliance with this requirement.

2. Call on the U.S. Treasury Secretary to certify that covered banks are no longer systemically important, or else subject those banks to extraordinary increases in capital requirements, leading many to fundamentally restructure themselves.

Once the new 23.5% capital standard has been implemented, we will call on the Treasury Secretary to certify that each covered bank is no longer systemically important. Our proposal gives the Treasury Secretary the discretion to make this determination so that it can rely on the best information and analysis available. 

3. Prevent future TBTF problems in the shadow financial sector through a shadow banking tax on leverage.

Discourage the movement of activity from the banking to shadow banking sector by levying a shadow bank tax, which equalizes the funding costs between the two sectors.  The tax will have two rates. To equalize funding costs with a 23.5 minimum equity requirement, we would levy a tax on shadow bank borrowing of 1.2%. This tax rate would apply to shadow banks that do not pose systemic risk as judged by the Treasury Secretary. A tax rate equal to 2.2% would apply to the shadow banks that the Treasury Secretary refuses to certify as not systemically important.

Nonbank financial firms that fund their activities with equity do not pay the tax. Shadow banks will have five years from enactment of the Minneapolis Plan before they begin paying the shadow bank tax. The Treasury Secretary will start making certifications as to the systemic importance of shadow banks at that point.

4. Reduce unnecessary regulatory burden on community banks.

Ending TBTF means creating a regulatory system that maximizes the benefits from supervision and regulation while minimizing the costs. The Minneapolis Plan would allow the government to reform its current supervision and regulation of community banks to a system that is simpler and less burdensome while maintaining its ability to identify and address bank risk-taking that threatens solvency.

— Related on ThinkAdvisor: The ‘Big Trump Rethink’ on Economy: HFE Economists


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