US regulators poised for significant cut in Basel capital demands amid intense Wall Street opposition

US regulators are reportedly gearing up for a huge reduction in the additional capital requirements that banks must maintain under the proposed "Basel III" rule.

The proposal, unveiled by bank regulators led by the Federal Reserve in July, aims to overhaul how banks with assets exceeding $100 billion calculate the cash reserves needed to absorb potential losses.

However, Wall Street has launched an aggressive pushback against the rule, prompting regulatory officials to consider significant alterations.

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Anticipated capital reduction

Industry insiders, comprising eight executives in regular contact with regulatory agencies, revealed that discussions are underway to significantly decrease the proposed capital burden.

The initial proposal suggested an aggregate capital increase of around 16 per cent for the affected lenders.

However, this figure is expected to see a sharp decline as regulators delve into a comprehensive revision of the draft.

The focus is on recalibrating the calculation of potential losses from operational risks, particularly in fee income related to lending services.

Operational risk and mortgage adjustments

The most highest capital savings are expected to arise from adjustments in how banks calculate potential losses from operational risks, a costly aspect of the proposal.

Wall Street has been advocating for reduced risk weights for fee income linked to lending services.

Additionally, regulators are contemplating the elimination or reduction of higher risk weights on mortgages for low-income borrowers and renewable energy tax credits.

These potential changes are part of the ongoing rewriting led by Fed Vice Chair for Supervision Michael Barr, in collaboration with Fed Chair Jerome Powell.

Regulatory response and opposition

Regulatory discussions, still in their early stages, indicate a willingness to address concerns raised by industry players.

Powell, during congressional testimony, acknowledged the intense opposition, stating that "broad, material" changes are anticipated in the rewritten rule.

The unprecedented intensity of Wall Street's efforts to quash the proposal involves advertising, grassroots campaigns, lobbying, and potential legal action.

Despite the opposition, officials have not confirmed whether the rule will be reproposed, leaving the timeline for its completion uncertain.

Dissent and legal challenges

The Basel III proposal, aligning with international capital standards, has encountered dissent from within the Fed's board.

Governors Michelle Bowman and Christopher Waller, along with Vice Chair Philip Jefferson, expressed reservations about the potential adverse impact on borrowers.

The Bank Policy Institute has even hired former Labour Secretary Eugene Scalia to explore the possibility of a lawsuit, highlighting the unexpected intensity of opposition faced by regulators.

This dissent may play a crucial role in any legal battles, showcasing divisions among experts.

Industry engagement and timeline concerns

Federal Reserve officials, including Powell and Barr, have engaged in over 50 meetings or calls with hundreds of industry executives since September.

Despite these discussions, a consensus has not been reached, and challenges remain in reaching an agreement with the FDIC, chaired by Martin Gruenberg, a known Wall Street critic.

While some hope to finalise the rule by summer, concerns linger that the timeline may prove overly ambitious.

(With inputs from Reuters)