(Bloomberg) -- Michael Barr’s signature bank capital overhaul has faced one of Wall Street’s fiercest lobbying campaigns, stark opposition from congressional Republicans and even TV attack ads.

But for the Federal Reserve’s vice chair for supervision, it’s rare resistance from the central bank’s governing board that may prove trickier to navigate. 

Barr in July unveiled a long-awaited plan that would require the biggest lenders to increase the amount of capital they set aside by almost 20%, a move aimed at preventing future failures and another financial crisis. The Fed’s unusually close 4-2 vote to advance the rule came as a surprise from an organization that prides itself on consensus. Two Republican-appointed Fed governors voted no, and Chair Jerome Powell — whose approval came with reservations — signaled that the final version would need “broad support” from the board.

To get the 1,087-page package across the finish line, Barr will make changes to address any substantive gaps in the proposal and try to reach consensus within the Fed, according to two people familiar with his thinking. Fed observers have pointed to Powell’s skepticism as a sign that Barr will have to make compromises — not only to avoid further internal dissent but also to circumvent potential legal challenges and complete the rule before the US elections.

“There is no precedent that we can recall of a significant regulatory matter that has had this level of disagreement at the Fed,” said Ian Katz, financial-policy analyst at Capital Alpha Partners in Washington. “I don’t think they will pass a final rule without Powell’s support, so he will need to do some things to appease Powell.”

In an attempt to build consensus, Barr started conversations with the Fed governors long before the regulators’ proposal was publicly introduced. Briefings were held with individual governors starting in February 2023, and a committee first discussed the plan in April, according to a spokesperson for the vice chair.

Bank executives hope the proposal will be watered down. “I think this is a highly aggressive proposal that will be materially wound back when it finally becomes law or regulation,” Morgan Stanley Chairman James Gorman said in a Bloomberg Television interview. 

Bigger Buffers

The draft rules are tied to Basel III, an international regulatory accord that came in response to the global financial crisis. If approved, they would force a 19% jump in the required capital for the biggest lenders.

Banks argue that the mandates would make them less competitive and home and business loans less affordable. But supporters of the beefed-up requirements say the plan would have minimal impacts on borrowing and that most lenders have enough capital to meet them. The industry looks set to break its own annual profit record in 2023 — a year that saw three of the four biggest bank failures ever.

Barr and other top bank watchdogs stress that the rule is aimed at only larger banks and that the stakes go far beyond firms’ bottom lines.

“One of the things that we saw in the global financial crisis is that it really crushed the American economy,” Barr said in a November interview with Bloomberg’s Tracy Alloway and Joe Weisenthal, hosts of the Odd Lots podcast, at an event hosted by The Clearing House, a banking association and payments firm. “It caused millions of households to lose their homes ... That financial crisis shuttered American businesses. It caused massive unemployment, huge harm to the economy.”

Lobbying Blitz

The pushback came fast and furious, expanding when the Goldman Sachs 10,000 Small Business Voices initiative in October announced a campaign to encourage the Fed to abandon its plan. In the following weeks, dozens of entrepreneurs paraded through the US Capitol, holding signs that read “Stop the Squeeze on Small Businesses.” Their treks to Washington have been covered by local media. Photos of sign-carrying small-business owners have popped up on social media.

During a Senate Banking Committee hearing in December, Wall Street CEOs made their case against the stiffer capital rules. Executives and lawmakers referred to small business a total of 37 times, and farmers, eight. Similar messaging has been used to lobby against rules required by the 2010 Dodd-Frank Act.

NFL Ad

One surprise for Barr was a Sunday Night Football ad that claimed the Fed wanted to impose “unnecessary capital rules” that would hurt small businesses, increase the costs on “everything” Americans buy and make it more difficult to purchase a home. The ad and a similar one were funded by the nonprofit Center Forward, which isn’t required to disclose its donors. However, its ties to industry have included millions of dollars in funding from a pharma lobbying group. 

“Normally we issue a proposal and then we get very detailed comment letters back, and we take those comment letters into account and we finalize our rule,” Barr said in the November interview in New York. “That’s sort of the normal process. So seeing ads at football games, that’s kind of unusual.”

The two people familiar with his thinking said the vice chair believes the reaction to the capital proposal has been wildly disproportionate to the reality of the rule’s impact. 

Fed Dissent

The regulators’ plan has drawn criticism from Fed Governor Christopher Waller, who has argued that additional capital allocations tied to operational risks — which include losses due to fines and lawsuits — seemed excessive and unnecessary. Governor Michelle Bowman said the proposal would “impose real costs on banks, their customers and the economy without commensurate benefits to safety and soundness or financial stability.”

In an unusual move for the panel’s chairman, Powell supported issuing the proposal for comment but withheld his full-throated endorsement, emphasizing the need to consider several potential downsides to the plan. “This is a difficult balance to strike, and striking it will require public input and thoughtful deliberation,” he said in a statement at the time.

Asked in November whether he would be willing to accept finalizing the proposal without significant changes, Powell demurred. “We’ll come to a package that has broad support on the board,” he said.

Barr’s internal troubles may be partly rooted in his style of coming to the full board with blueprints that weren’t widely vetted with the governors, according to two other people familiar with the situation. His approach differed from his predecessor, Randal Quarles, whose vetting process included circulating memos on early proposals to the Fed board’s Committee on Supervision and Regulation and then allowing time for back-and-forth discussion on policy options, they said.

Independent Review

The criticism has extended beyond regulatory proposals. The Fed’s post-mortem of the supervisory failures behind Silicon Valley Bank’s collapse publicized conclusions without much input from other governors, according to one person with knowledge of the situation. Some governors had about 30 minutes to view the report before it was published, the person said. 

Bowman had called for an independent review of SVB’s failure, and, in her dissents, has rebuked Barr for continuing to pursuing a regulatory agenda instead of focusing on identifiable risks such as liquidity. 

All the governors and their advisers received the text of the entire bank-capital proposal in June 2023, more than a month before the proposal being published, according to the spokesperson for Barr.

Arthur Wilmarth, who was a consultant to the Financial Crisis Inquiry Commission created by Congress, said he was puzzled by some of the criticism.

It’s the vice chair’s job to develop regulatory recommendations, and even then, Barr has a reputation as a consensus builder who takes a reasonable, measured approach, he said. He and other academics have described the cost-benefit argument as a red herring because it’s far more difficult to quantify the enormous benefits of preventing a financial crisis with precision than it is to calculate banks’ compliance costs.

Bowman’s points struck Wilmarth as similar to those of bank trade groups.

“Given Governor Bowman’s background in community banking, I would have expected her to be more skeptical about claims made by big banks,” said Wilmarth, a professor emeritus at the George Washington University Law School.

Swings in Regulation

Barr’s proposals have seen eight individual dissents from governors since he took office in July 2022, while he has had 45 unanimous votes on regulatory matters. Quarles, a Trump administration appointee, had more than 20 dissents on proposals, though over a four-year term and chiefly from one governor, Lael Brainard, who now works in the Biden White House as an economic adviser.

The dissents are less important than the shifts in regulatory policy when a new party takes control of the White House, casting a negative light on the Fed’s independence, said Christina Parajon Skinner, an assistant professor at the Wharton School of the University of Pennsylvania.

“I do think these pendulum swings are really bad,” she said. “We are seeing partisan viewpoints imported into the supervisory and regulatory framework of the Fed, and it is not good.”

--With assistance from Hannah Levitt.

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