JPMorgan Chase & Co. (JPM), Wells Fargo & Co. (WFC) and Goldman Sachs Group Inc. are among eight U.S. banks facing new domestic rules on capital and debt that would be even stricter than global standards approved yesterday.
Lenders will be forced to maintain a ratio of capital to assets that exceeds the 3 percent floor set by the Basel Committee on Banking Supervision, Federal Reserve Governor Daniel Tarullo said yesterday. Another measure would compel banks to hold a minimum amount of equity and long-term debt to help authorities dismantle failing lenders, Tarullo said.
The remarks show U.S. regulators plan to ratchet up demands for bigger buffers against losses to prevent a repeat of the 2008 credit crisis, ignoring bankers who say lending and profit will suffer. The measures would come on top of toughened global standards known as Basel III that Fed governors approved unanimously, even as Tarullo said parts remain too weak.
“We’re in the first few chapters of a horror story for the big banks, with the worst to come,” said Coryann Stefansson, a managing director at PricewaterhouseCoopers LLP. “It’s clear that the U.S. is willing to push for stronger capital.”
People with knowledge of the matter have said U.S. regulators may want to double Basel’s 3 percent capital threshold, known as the leverage ratio. The Federal Deposit Insurance Corp. said a proposal may be published next week.
“If the leverage ratio is raised to six, that would be a major tightening by the U.S. above and beyond the global agreement,” said Stefan Walter, the Basel committee’s secretary general until October 2011 and now a principal at Ernst & Young LLP. “In Basel, the leverage ratio was seen as a backstop, but at such a high level, it can become a new restraint on banks.”
The added measures would affect the eight U.S. institutions already tagged as globally important, according to Tarullo. The Financial Stability Board, which monitors the world’s banking system, has identified those as JPMorgan, Wells Fargo, Goldman Sachs, Bank of America Corp. (BAC), Citigroup Inc. (C), Morgan Stanley (MS), State Street Corp. (STT) and Bank of New York Mellon Corp.
Other changes may include higher capital requirements for banks that rely on short-term market funding, which proved to be unreliable in the financial crisis, and capital surcharges that the Basel panel is preparing to impose on firms whose failure might bring down the entire system, according to Tarullo.
The U.S., along with 26 other members of the Basel Committee, must enact local regulations to carry out a 2010 revision of how minimum capital levels are set for the world’s banks. The FDIC and Office of the Comptroller of the Currency, which check banks for safety and soundness, are scheduled to vote on the Basel standards by July 9.
When finalizing the rule, the U.S. eased requirements for some of the smallest firms while tightening for the biggest ones. Bankers have argued that more regulations and higher capital ratios will inhibit lending and erode profit. The American Bankers Association, the biggest lobbying group for the industry, repeated its warnings.
“The real test for Basel III is whether the rule makes it easier or more difficult for banks to serve their customers,” the ABA said in a statement. “If it makes it harder, that’s not what our still-recovering economy needs.”
The leverage ratio proposed by the Basel panel adds a stricter standard for measuring capital. Traditional rules allowed bankers to sort their assets according to risk and set aside less money to cover the ones they judged to be less dangerous.
Regulators became skeptical of the complex formulas behind those risk weightings after the financial crisis and instead demanded a minimum amount of capital to back assets regardless of the perceived risk.
Banks will still have to meet the old risk-based standard. The Basel agreement of 2010 raised the risk-based capital minimum to 7 percent for all banks. The largest banks in the world, including the eight in the U.S., face a surcharge that ranges from 1 percent to 2.5 percent.
The measures outlined by Tarullo could be costly, said William Sweet, a former Fed lawyer and a partner at Skadden, Arps, Slate, Meagher & Flom LLP in Washington. “Any change of the leverage would be so far outside what Basel III proposed that it would be a dramatic impact,” Sweet said, with U.S. banks at a “distinct disadvantage” when competing head-to-head against lenders based in other nations and governed by the weaker global standard.
The U.S. rules narrow the definition of what counts as capital, in line with Basel’s revisions after the 2008 crisis, and reclassify derivatives and mortgage-based securities as more risky than in previous versions.
“This framework requires banking organizations to hold more and higher-quality capital, which acts as a financial cushion to absorb losses, while reducing the incentive for firms to take excessive risks,” Fed Chairman Ben S. Bernanke said in prepared remarks. “Banking organizations will be better able to withstand periods of financial stress, thus contributing to the overall health of the U.S. economy.”
Regulators surprised banks and analysts last year by imposing the new Basel framework on most community lenders. Lawmakers and lobbyists said the smallest companies shouldn’t be included because they didn’t cause the 2008 crisis, couldn’t raise capital as easily and might have to reduce lending.
Some of the rules, such as the non-risk-based leverage threshold, apply only to the biggest institutions or a smaller sub-group of the top six.
The final version released yesterday allows almost all but the biggest firms to opt out of requirements that they take capital charges as the market valuation of their trading assets fluctuates. It also simplifies the risk calculation for mortgages, a process that community banks had argued was too cumbersome and expensive.
The original proposal had called for eight categories of risk for home loans and would assign 200 percent risk weights to the worst ones. The final version goes back to two categories and 100 percent risk weighting for the worst.
A 100 percent risk weighting means a $100 loan would be fully taken into consideration. So if the minimum ratio is 7 percent, the bank must hold $7 of equity for the $100 loan. A 200 percent weighting would double that to $14.
That change would help regional banks that hold mortgages on their balance sheet as well as San Francisco-based Wells Fargo, the largest U.S. home lender. In turn, those benefits could be more than erased by new measures Tarullo outlined, Guggenheim Partners LLC said in a note to investors.
“We are still reviewing the new regulations, yet are confident that we are very well-positioned from a capital perspective,” said Ancel Martinez, a spokesman for Wells Fargo. Spokesmen for the other banks declined to comment about Tarullo’s remarks.
Banks with less than $15 billion in assets were also allowed to retain some hybrid securities that otherwise would no longer count as capital under Basel III. Hybrid securities are debt instruments that have partial characteristics of equity or convert to stock under certain conditions.
About 90 percent of bank holding companies with less than $10 billion in assets already meet the new minimum capital requirements, the Fed said in a staff memo. The rest would need about $2 billion in added capital to comply. That shortfall was $3.6 billion in June 2012 when the rules were announced.
Almost 95 percent of firms with assets of more than $10 billion meet the requirements and the shortfall is $2.5 billion, down from $6 billion last year. The Fed didn’t say which banks fell below the standard. The almost decade-long transition should give banks time to comply, the Fed said.
The Basel framework has a stage-by-stage compliance schedule, with requirements for capital going up every year until full levels are reached. The phase-in begins Jan. 1 for the largest banks that use internal risk models to calculate capital needs while others get an extra year to start.
The Basel rules were created in 2010 by a committee of central bankers and regulators to improve and standardize safety guidelines that govern the world’s lenders. Regulators in member nations have since customized the rules to reflect conditions in their own markets. Only half of the Basel members have completed their local rules so far.
The European Union, which has accused the U.S. of dragging its feet, just completed its internal approval process last week. Banks have eight more years to fully comply.