WASHINGTON — Federal Reserve Bank of San Francisco president John Williams Friday said additional capital requirements for banks considered to be “systemically important financial institutions” must be high enough to prevent their failure and, as a result, protect the broader economy.

In remarks prepared for the Symposium on Asian Banking and Finance in San Francisco, Williams limited his comments to banking regulation, noting that the global financial system “is experiencing great stress as it adapts to the new, post-crisis rules of the game.”

One of the more contentious areas of the new regulations surrounds the proposed higher capital rules, especially those for the aforementioned systemically important financial institutions that has been labeled the “SIFI surcharge.”

Williams argued that, for these institutions, “we must set capital requirements high enough to ensure that failure is extremely unlikely while still allowing enough leverage for banks to provide reasonable returns to shareholders.”

Also, he said the additional capital charge would remove the advantage the banks enjoy in their funding costs by being perceived as too big to fail.

“The surcharge makes the playing field between SIFIs and smaller organizations more even. And it provides disincentives for firms to become extremely large, increasing their systemic footprint,” Williams said.

He did acknowledge that setting an appropriate surcharge for large banks is a tough balancing act.

As for how management within the large banks will adjust in the face of more stringent capital standards, Williams predicted that either expectations will shift regarding appropriate levels of risk and reward, or business practices will change in ways that accommodate the additional capital charge.

“For their part, supervisors will have to judge whether such changes are consistent with micro-prudential standards of safety and soundness for individual institutions and macro-prudential standards for containing systemic risk,” he said.

Looking ahead to how regulators will fare in this new world of heightened financial regulatory oversight, Williams cautioned that managing systemic financial risk is a challenge “of the first order.”

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.