By Pete Schroeder

WASHINGTON (Reuters) -The Federal Reserve’s regulatory chief on Tuesday outlined a plan to raise big banks’ capital by 9%, significantly easing an earlier proposal after intense Wall Street opposition but disappointing bank investors and some critics of the rule.

In a speech to the Brookings Institution, Fed Vice Chair for Supervision Michael Barr said regulators will re-issue watered-down drafts of the “Basel Endgame” rule and a separate capital rule for global banks, bowing to Wall Street lenders which have aggressively lobbied to weaken them.

The draft Basel rule, first unveiled in July 2023, overhauls how banks with more than $100 billion in assets calculate capital they must put aside to absorb potential losses.

The other draft rule aims to make a capital surcharge levied on global systemically important banks (GSIBs) more risk-sensitive. Reuters reported in July that the Fed was considering tweaking that rule to give banks including JPMorgan Chase, Bank of America <BAC.N and Citigroup a capital break.

Overall, the plan will raise big banks’ capital by 9% compared with 19% originally, Barr said. It would increase capital for banks with less than $250 billion in assets, such as KeyBank, M&T and Fifth Third, by 3% to 4% after accounting for unrealized gains and losses on their securities portfolios, an issue which sparked last year’s banking sector turmoil. Those smaller lenders would otherwise be mostly exempt from Basel, Barr said.

“There are benefits and costs to increasing capital requirements. The changes we intend to make will bring these two important objectives into better balance, in light of the feedback we have received,” Barr told the audience of academics, industry officials and reporters.

Despite those major concessions, a drop in bank shares and a lukewarm reaction by bank lobby groups, which mostly said they would review the changes carefully, suggested investors and the industry had been hoping for a smaller capital hike.

A Barclays Investor banking conference on Tuesday, during which some banks tempered expectations for third-quarter earnings, also weighed on the outlook for bank stocks including JPMorgan Chase.

The S&P 500 banks index fell 3.5% to near a one-month low, with shares of JPMorgan, Morgan Stanley, and Citigroup down between 2% and 6%.

“It’s disappointing to see the negative bank stock price reaction. The Street may have been looking for a greater reduction from the original proposal,” said Stephen Biggar, banking analyst at Argus Research.

The changes, which will be subject to more public feedback, are likely to spark another round of industry lobbying which could ultimately result in the rules being further weakened.

“Obviously 10 is better than 20. So that’s good. The issue is we have no idea what they have changed,” JPMorgan Chase President Daniel Pinto said at the Barclays conference, adding that the bank would be closely examining changes to how the draft weighs markets risks.

LITIGATION THREAT

Regulators say the rules will make the banking system safer, especially after three big lenders failed last year. Some Democrats criticized the Fed for being too soft on the industry following the changes.

“The revised bank capital standards are a Wall Street giveaway … the Fed caved to the lobbying of big bank executives,” U.S. Democratic Senator Elizabeth Warren said in a statement.

In public campaigns and conversations with Washington lawmakers and regulators, Wall Street banks have argued more capital is unnecessary and will hurt the economy. They have threatened to sue to kill the final rule on grounds the U.S. central bank and other agencies did not follow the proper procedure.

In response, Fed Chair Jerome Powell said this summer regulators will make “broad and material” changes and that the new draft should be re-proposed for public feedback.

But U.S. central bank officials have been at loggerheads with their counterparts at the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC), who have wanted to finalize the rule before the election, Reuters reported in June.  

The key questions are now whether Barr’s plan will do enough to avert litigation and whether the OCC and FDIC will back it. Jonathan McKernan, a Republican member of the FDIC board, which votes on rule changes, told Reuters he would not support Barr’s plan because it did not go far enough to fix all the problems. FDIC Chairman Martin Gruenberg and acting Comptroller Michael Hsu said in separate statements that Barr’s plan reflect their joint work revising the proposal, and both were committed to ensuring the Basel work is completed.

The FDIC is expected to hold a board meeting later this month to consider the plan, according to a person with knowledge of the matter.

The prolonged fight means Basel will not be finalized before the Nov. 5 presidential election and could be weakened further or shelved if Republican candidate Donald Trump, who has pledged to ease burdensome rules, wins back the White House.

(Reporting by Pete Schroeder in Washington; Additional reporting by Nupur Anand, Saeed Azhar, and Caroline Valetkevitch in New York and Lisa Pauline Mattackal in Bengaluru; Editing by Michelle Price, Matthew Lewis, Paul Simao and Nick Zieminski)

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