Fed releases capital buffer plan for containing US banks' credit risk

WASHINGTON (BLOOMBERG) - The Federal Reserve is seeking public comment on the standards it would use in requiring the biggest banks to set aside additional capital as a buffer in periods when market risks raise the threat of future losses.

The countercyclical capital buffer is meant to ensure that internationally active financial institutions have enough capital to absorb shocks without threatening the broader economic system. It will apply to banks with more than US$250 billion in assets such as JPMorgan Chase & Co, Citigroup and Goldman Sachs, and those with more than US$10 billion in foreign exposure.

The Fed said it is setting the buffer at zero for now, but in times of elevated risk that level could go up to 2.5 per cent of risk-weighted assets. Regulators would give institutions a year to phase in any increase, which would be in addition to already required required minimum total risk-based capital levels banks must meet.

Banks unable to meet the buffer would face restrictions on dividend distributions and payment of discretionary bonuses.

In deciding whether to raise capital levels in the future, the Fed will take into account leverage in the financial and non-financial sectors, liquidity transformation and asset valuation pressures. The regulator also could consider risk- taking, performance and the financial condition of large banks and trends in real estate.

The Fed said the capital buffer is "designed to increase the resilience of large banking organizations when policymakers see an elevated risk of above-normal losses." That should improve the overall financial system, the central bank said.

Regulators had suggested the capital buffer in 2010 but had not laid out the framework. The US guidance follows international rules from the Basel Committee on Banking Supervision.

The Basel committee allowed member countries to set their own framework for triggering the buffer and suggested that the level be guided by a calculation of credit to gross domestic product. The Fed's announcement provided additional factors to assess risk.

"The US approach has many different triggers and therefore is a more effective countercyclical buffer and one big banks may be subjected to more frequently," said Karen Shaw Petrou, managing director of Washington-based research firm Federal Financial Analytics Inc.

Banks have until Feb 19 to comment on the proposed capital buffer.