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Key Words: Fed’s Kashkari says U.S. is doomed to more bank bailouts unless Congress makes key reform

Minneapolis Fed President Neel Kashkari wants bank ownership to put more of its own money on the line so that U.S. taxpayers don’t have to cover the cost of the next bank failure.

Kashkari, who helped administer the 2008 bank-bailout fund in his role as a senior U.S. Treasury official, published an essay Monday arguing that Congress should consider new legislation that would require U.S. banks to fund themselves with more equity from shareholders and less debt.

“Our financial system has required three massive government interventions in 15 years, starting with the Global Financial Crisis in 2008, followed by a near-collapse of markets in 2020 as the COVID crisis erupted, and now, yet again, in 2023 when Silicon Valley Bank, Signature Bank and First Republic collapsed, triggering strains in the regional banking sector KRE, +2.04%, ” Kashkari wrote in a post on the Minneapolis Fed website.

He argued that this series of banking crises shows that the current regulatory approach is inadequate because it incorrectly assumes that bank managers will avoid unwise investments, while regulators will be able to flawlessly anticipate emerging risks to the sector.

“But the only guarantee we have is that humans make mistakes and will continue to do so,” he wrote. “Central bankers, including me, and most market participants, didn’t see high inflation coming. Our traditional stress-test models assumed rising rates were actually good for banks because they raise deposit rates slowly so their margins go up when rates rise. Key banking regulators assumed that government bonds carried no risk.”

These failures show that a complex regulatory system can’t save banks from inevitable missteps, but Kashkari argued that simply requiring banks to fund themselves with more shareholder equity and less debt will allow them to absorb significant losses when the next crisis arrives.

“We can design a regulatory system that will withstand this inevitable human failure,” he wrote. “We can’t predict the next shock: Where will it come from? How broad will it be? Which firms will be most at risk? Sufficient capital can protect against virtually all those scenarios.”

Kashkari has long lobbied for regulations that would require banks to fund themselves with less debt and more shareholder equity, with the Minneapolis Fed issuing a report in 2018 calling for regulations that would roughly double the share of bank funding from issuing common stock to 23.5%.

His recommendations never gained steam, in part because banks lobbied hard against the plan, he said Monday.

“Banks hate higher levels of capital because the amount of capital inversely affects their stock prices, and they will thus fight higher capital requirements with all their mighty influence,” Kashkari wrote.

“I urge us to have the courage to take the hard path and address the underlying fragility of the banking sector,” he added. “If the conclusion is that we simply can’t achieve meaningful increases in capital given political constraints .. .then let’s tell the public that is the trade-off we are being forced to make.”

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