US's Geithner: Raising Capital Levels Too Fast Dangerous

First Published Wednesday, 22 September 2010 03:23 pm - © 2010 Need to Know News

WASHINGTON (MNI) - The following is the first part of the prepared testimony by U.S. Treasury Secretary Timothy Geithner for the hearing on the recent progress on international capital standards before the House Financial Services Committee Wednesday afternoon:

Chairman Frank, Ranking Member Bachus, and members of the Financial Services Committee, thank you for the opportunity to testify before you today about international regulatory issues relevant to the implementation of the Dodd-Frank Act, particularly reform of global capital standards.

Last week the Federal Reserve, the OCC, and the FDIC reached agreement with their principal foreign counterparts to substantially increase the levels of capital that major banks will be required to hold. As a result of this agreement, banks will have to hold substantially more capital. The new standards are designed to ensure that major banks hold enough capital to withstand losses as large as what we saw in the depths of this recession and still have the ability to operate without turning to the taxpayer for extraordinary help.

This agreement will make our financial system more stable and more resilient. By forcing financial institutions to hold more capital, we will both constrain excessive risk-taking and strengthen banks' abilities to absorb losses. This agreement is designed to allow banks to meet these more stringent standards gradually over time, so that they can continue to perform their essential function of providing credit to households and businesses.

These standards will help establish a more level playing field around the world. By moving quickly to recapitalize our financial system, we have been in a strong position to insist on tough standards abroad.

The Importance of Capital and Liquidity

Excess leverage, a term that describes the amount of risk firms take relative to the financial reserves they hold against those risks, has played a central role in virtually all financial crises.

Capital requirements determine the amount of losses firms can absorb and the magnitude of the risks they can take without risking failure. They help the market provide discipline by forcing shareholders who enjoy profits in good times to be exposed to losses in bad times.

Capital requirements are the financial equivalent of having speed limits on our highways, antilock brakes and airbags in our cars, and strong building codes in communities prone to earthquakes.

Failures in our system of capital requirements were major contributors to the severity of this crisis. Where we had capital requirements, they were too low and they were not supplemented with complementary liquidity requirements. Furthermore, there were no systematic capital requirements in the rapidly emerging "shadow banking" system. Finally, capital standards were not applied consistently around the world. Banks in many parts of the world were allowed to operate with low levels of capital relative to the risks they took on.

At last year's Pittsburgh Summit, the G-20 Leaders, led by the Obama Administration, called for financial institutions to raise the quality and quantity of capital, strengthen liquidity standards and implement rules to limit leverage. Strengthening capital requirements for major financial institutions was also an important objective in the legislative debate on reforming U.S. financial regulation. Both the Dodd-Frank Act and the Basel process are designed to ensure that major financial institutions are subject to rigorous and consistent capital requirements. The agreement just reached in Basel is an important step towards realizing that goal and fulfilling the G-20's call, and it will be presented to G-20 Leaders at their November Summit in Seoul.

The New Standards

The work of the Basel Committee

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