So, what does this imply when we consider revisions to the Dodd-Frank Act and other aspects of reform? Capital and Liquidity Standards It is important to maintain appropriate capital and liquidity standards for large, complex firms to mitigate external shocks and the risks they pose to the economy. In particular, we need to maintain our focus on firms whose impairment would have significant negative consequences for the rest of the financial system. Effective capital and liquidity standards help to limit these adverse consequences. At the same time, they work against conferring a competitive advantage to large banks from a perception that they may be too big to fail. Accordingly, large financial firms have had to more than double their stock of high-quality capital since the crisis. Prior to the financial crisis, large financial firms were not required to hold sufficient high-quality liquid assets to protect against runs, and, as a result, several would have failed if not for extraordinary government intervention. Today, the liquidity buffers for large financial firms have dramatically improved in terms of both their size and quality. This is due in part to investors’ demands, but also to the efforts by regulators and supervisors in the United States and abroad to develop appropriate liquidity standards for large banking institutions. Some have argued that capital standards alone would be sufficient to mitigate the risks of failure. I am not convinced.
As I just noted, the crisis clearly demonstrated the added importance of liquidity, as the firms that failed appeared to have been appropriately capitalized based on traditional regulatory metrics at the time. Moreover, I strongly favor a system of capital and liquidity requirements that is harmonized on a global basis. Some believe that the United States should no longer participate in international forums—such as the Basel Committee on Banking Supervision—that discuss and recommend minimum capital and liquidity standards for global banking institutions. The argument is made that these international bodies are dictating to and constraining the choices of the United States. That is simply not the case. The Basel standards and other international efforts actually benefit the United States and its banks. In the preponderance of cases, agreements struck in these forums raise international standards closer to existing U.S. standards. Establishing a more level playing field enhances the competitiveness of internationally active U.S. firms. It also makes the global financial system safer by ensuring that foreign banks are subject to appropriate standards that cover their global operations. This protects the U.S. households and businesses that transact with these banks in the United States and abroad.2 Also, it is important to note that the recommendations of these international standard-setters are not automatically legally binding in the United States. They do not go into effect unless they are adopted by a U.S. authority acting under U.S. laws following an administrative process. They are also subject to a period of public notice and comment.