To Basel’s Defenses, the Fed Adds a To-Do List

After overlooking so many excesses before the financial crisis, bank regulators have spent the last five years trying to regain credibility.

The public got an important opportunity to assess their progress on Tuesday when the Federal Reserve approved a sweeping new set of rules intended to reduce the riskiness of banks’ activities and make them more resilient to losses. While an important step, the rules, which stem from an international agreement known as Basel III, go only so far, something the Fed seemed to go out of its way to acknowledge.

It is easy to get lost in the weeds of Basel. Like most financial regulations these days, the new rules are dizzyingly complex. Adding to the confusion, they will exist alongside the Dodd-Frank overhaul of the financial system, passed by Congress in 2010.

But boiled down, the Basel III measures approved on Tuesday focus on strengthening capital, the cushion that banks must maintain against losses. It’s hard to overstate the importance of capital. The banks that had the least going into the 2008 crisis, like Citigroup, were the most problematic.

The cornerstone of the new rules is that banks must maintain high-quality capital, like stock or retained earnings, equal to 7 percent of their loans and assets. The biggest banks may be required to hold more than 9 percent. According to industry estimates, the six largest American banks have met or are close to meeting! the 9 percent level. After the crisis, the banks were required to increase capital substantially.

The Basel approach to capital has drawn criticism, however.

For one thing, it uses something called risk weighting, which means less capital can be held against loans or bonds that are perceived to be less risky even though they may end up producing higher-than-expected losses. Basel may also give banks too much leeway when calculating how much capital they have to hold, because the banks get to apply the risk weightings. Finally, for some, Basel’s capital ratios are simply too low to protect a bank from a real shock.

“They are certainly going in the right direction, but there’s still more to be done,” said Sheila C. Bair, a former chairwoman of the Federal Deposit Insurance Corporation, another bank regulator.

The approval of the Basel III rules, which were subject to intense lobbying from the banking industry, comes at a crucial moment in the debate over bank size. Some lawmakers and consumer advocates say they think neither the new Basel rules nor changes in the 2010 Dodd-Frank overhaul do enough to protect taxpayers in a crisis. They argue that even with the new measures, the authorities may still bail out failing banks if they feel it is necessary to protect the wider financial system. This is called the too-big-to-fail problem.

It appears that the Fed is not yet satisfied that this threat has been removed.

Daniel K. Tarullo, the Fed governor who oversees regulation, made it clear on Tuesday that the largest banks need to be subject to some stricter measures, which he ! outlined.! One proposal is for higher capital at banks that rely heavily on short-term borrowing, which can evaporate during crises, causing a cash squeeze. Another requires the biggest global firms to hold even more capital to cover the risks of their size and complexity.

These initiatives could set off another wave of resistance from the financial industry. Still, Mr. Tarullo suggested the stakes were high. He said that the Fed’s mission would be complete only after the extra measures were in place.

“This regime would conform to the mandate given us by Congress to apply to large banking organizations more exacting regulatory and supervisory requirements that become progressively stricter as the systemic importance of a firm increases,” Mr. Tarullo said in a statement.

Another of these added measures could offset the problems caused by Basel’s risk weighting. It concerns something called a leverage ratio. This approach requires banks to hold capital at a fixed percentage of total assets witout taking into account risk weightings. In other words, a leverage ratio effectively treats government bonds the same as, say, credit card loans. Regulators are close to setting a leverage ratio in excess of the Basel minimum, which is 3 percent of assets.

Ms. Bair thinks it makes sense to raise it to 8 percent.

While the Fed is taking a tougher stance in some areas, it opted for a softer approach to mortgages, even though bad home loans played a central role in the crisis.

The concessions it made are arcane but could be significant. The Fed’s first draft of the Basel rules suggested that banks hold more capital for mortgages with features that might make them more likely to default. One crucial metric is loan to value, which measures a mortgage as a percentage of the house price. Loans in excess of 90 percent of the house’s value are theoretically riskier than ones at 75 percent, which have a bigger down payment. Using risk weighting conservatively, the Fed initially proposed ! increasin! g capital as the loan-to-value ratio rose.

But that approach was taken out of the final rules. One reason the Fed pulled back was that the mortgage industry pointed out that some loans with riskier features performed well in the crisis. Also, rules unrelated to Basel III prevent lenders from writing loans that the borrower might find it hard to repay.

Some consumer advocates supported the Fed’s move.

“There is ample evidence that lenders can extend mortgage credit to low-wealth households in a safe and sound manner, even with low-down-payment mortgages,” Roberto G. Quercia, a professor at the University of North Carolina at Chapel Hill, said. “It is good to see a regulator recognizing the risks of overcorrection.”

Still, other banking specialists say they think tha high loan-to-value ratios were partly responsible for the flood of foreclosures during the crisis and that the Fed should have singled out such loans in its new Basel rules.

“It is hard to understand how regulators could ignore loan-to-value ratios in risk-weighting mortgages,” Ms. Bair said. “They clearly influence the likelihood and size of mortgage losses.”