Kashkari, Minnesota Fed Chief, Has Plan to End Too-Big-to-Fail Banks

1. Dramatically increase common-equity capital, substantially reducing the chance of bailouts.

Require covered banks to issue common equity equal to 23.5% of risk-weighted assets, with a corresponding leverage ratio of 15%. This level of capital nearly maximizes the net benefits to society from higher capital levels. This first step substantially reduces the chance of public bailouts relative to current regulations from 67% to 39%. This substantial improvement in safety comes at a relatively low cost of gross domestic product. Covered banks will have five years to come into compliance with this requirement.

2. Call on the U.S. Treasury Secretary to certify that covered banks are no longer systemically important, or else subject those banks to extraordinary increases in capital requirements, leading many to fundamentally restructure themselves.

Once the new 23.5% capital standard has been implemented, we will call on the Treasury Secretary to certify that each covered bank is no longer systemically important. Our proposal gives the Treasury Secretary the discretion to make this determination so that it can rely on the best information and analysis available. 

3. Prevent future TBTF problems in the shadow financial sector through a shadow banking tax on leverage.

Discourage the movement of activity from the banking to shadow banking sector by levying a shadow bank tax, which equalizes the funding costs between the two sectors.  The tax will have two rates. To equalize funding costs with a 23.5 minimum equity requirement, we would levy a tax on shadow bank borrowing of 1.2%. This tax rate would apply to shadow banks that do not pose systemic risk as judged by the Treasury Secretary. A tax rate equal to 2.2% would apply to the shadow banks that the Treasury Secretary refuses to certify as not systemically important.

Nonbank financial firms that fund their activities with equity do not pay the tax. Shadow banks will have five years from enactment of the Minneapolis Plan before they begin paying the shadow bank tax. The Treasury Secretary will start making certifications as to the systemic importance of shadow banks at that point.

4. Reduce unnecessary regulatory burden on community banks.

Ending TBTF means creating a regulatory system that maximizes the benefits from supervision and regulation while minimizing the costs. The Minneapolis Plan would allow the government to reform its current supervision and regulation of community banks to a system that is simpler and less burdensome while maintaining its ability to identify and address bank risk-taking that threatens solvency.

— Related on ThinkAdvisor: The 'Big Trump Rethink' on Economy: HFE Economists