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U.S. Banks’ Leverage Should Be Halved to Cut Risks, Bair Says

Banks should be required to reduce by half the amount they can borrow against equity to make the financial system safer, according to former Federal Deposit Insurance Corp. Chairman Sheila Bair.

Bair called for a “hard-and-fast” leverage ratio of 8 percent in “Bulls by the Horns,” her memoir of the financial crisis published this month. That’s double the 4 percent ratio U.S. banks must adhere to currently and more than twice the 3 percent called for by new global rules on bank capital.

Lenders could borrow about 13 times their equity, based on Bair’s suggestion, compared with 25 times under existing U.S. rules. Bair, 58, who stepped down from the FDIC last year, was a proponent of the Basel Committee on Banking Supervision introducing a simple leverage ratio, which ignores the riskiness of different loans in setting minimum capital requirements. While the Basel committee agreed on including such a ratio, European countries have balked at implementation.

“Right now, the regulators are mostly unified on the need to raise capital requirements,” Bair wrote in her book. “However, looking back at the battles I fought before the crisis, when it seemed as though everyone except the FDIC wanted to lower capital requirements, I’m wary that this regulatory resolve will hold.”

Bair said the leverage cap should apply to any financial institution with assets exceeding $50 billion, including hedge funds, insurance companies and brokerages. While the book doesn’t specify how this ratio should be calculated, Bair clarified in an e-mail that the new Basel standards of capital and total assets should be used.

Narrowed Definition

The Basel committee narrowed the definition of what counts as capital. It also devised a method of tallying assets for calculating leverage ratio that puts aside the different accounting standards used in the U.S. and Europe. The new method would increase the balance sheets of U.S. banks because of differences in how derivatives are treated.

Using Basel’s narrower capital definition, the two largest U.S. banks would have to raise about $100 billion of capital to comply with Bair’s leverage recommendation. JPMorgan Chase & Co. (JPM) would have a leverage ratio of 5.8 percent under the new capital definition, and No. 2 Bank of America Corp.’s would be 5.9 percent. Neither bank has yet reported what their ratios would be under the new Basel method of calculating assets.

Simple Leverage

Thomas Hoenig, appointed to FDIC’s board after Bair’s departure, has called for scrapping Basel capital rules completely. In a speech this month, Hoenig offered a way of calculating simple leverage ratios that ignores risk weightings and suggested 10 percent as a reasonable minimum. To reach Hoenig’s requirements, the four largest U.S. banks would have to sell more than $300 billion of new stock, or not distribute dividends for the next five and a half years.

The FDIC, the Federal Reserve and the Office of the Comptroller of the Currency are implementing the new Basel rules. While the Basel committee brings together regulators and central bankers from 27 countries, its rules aren’t binding on member countries. Each nation will have to translate the internationally agreed standards into their own regulatory frameworks.

Senators’ Letter

In a letter to the Fed last month, U.S. Senators David Vitter, a Republican from Louisiana, and Sherrod Brown, an Ohio Democrat, urged regulators to go beyond Basel’s minimum ratios and demand higher capital from the largest banks. They said that in the 1920s and 1930s, big banks funded their assets with 15 percent to 20 percent equity.

The European Union, as it moves to implement the Basel rules, has wavered on leverage, saying it needs to study the potential impact before committing. The leverage ratio would force European banks to raise additional capital at a time when they’re struggling with a sovereign-debt crisis.

“Europeans’ failure to have a leverage ratio is why they’ve had more problems than us,” Bair said in an interview last week. “How much leverage French and German banks have is astounding.”

To contact the reporter on this story: Yalman Onaran in New York at yonaran@bloomberg.net or @yalman_bn on Twitter

To contact the editor responsible for this story: David Scheer in New York at dscheer@bloomberg.net.

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