A key backer of the stricter leverage requirement for banks proposed by U.S regulators earlier this year said he’s open to softening it.
Thomas Hoenig, vice chairman of the Federal Deposit Insurance Corp., said in an interview that he’ll consider allowing banks to exclude cash from their total assets when calculating how much equity they must hold to absorb potential losses. He said he would consider the change if the industry’s build-up of cash was returned at some point to bank balance sheets as monetary policy became “more normalized.”
“It deserves discussion, but I don’t think it deserves immediate exemption without some careful thought,” Hoenig, 67, said yesterday. He still opposes excluding U.S. Treasury securities from the asset count because they’ll lose value as interest rates rise, he said.
Banks have sought the cash exemption, arguing that otherwise they’d be encouraged to replace cash with riskier assets, undermining the rule’s purpose. Hoenig has been a champion of the leverage rule, which proposes a flat ratio of equity to assets and complements other capital regulations that factor in the risk of various asset classes.
The FDIC, the Federal Reserve and the Office of the Comptroller of the Currency proposed the new leverage standard in July. The U.S. went further than the 3 percent minimum approved by the global Basel Committee on Banking Supervision by asking the nation’s eight largest lenders to hold as much as 6 percent of equity capital in relation to their total assets.
Banks have pushed for exemptions, saying that the ratio as proposed contradicts other regulations. The liquidity coverage ratio, another Basel rule, would require the biggest banks to hold enough easy-to-sell assets, including cash and Treasuries, to cover 30 days of stress. That seeks to ensure the companies can survive a credit crisis like the one in 2008.
Citigroup Inc. Chief Financial Officer John Gerspach and Brian Leach, its head of franchise risk and strategy, wrote in a comment letter that the proposed leverage ratio functioned as an “explicit penalty” against holding cash.
“A binding leverage ratio also would penalize banking organizations for holding risk-free or very low-risk assets, such as cash and government securities,” a group of seven lenders including Capital One Financial Corp. and PNC Financial Services Group Inc. wrote in a comment letter. “There would be a disincentive to hold more than the required minimum amount of high-quality liquid assets under the liquidity coverage ratio.”
Goldman Sachs Group Inc. analysts including Richard Ramsden estimated in a July research note that excluding cash from the ratio would boost the average leverage ratio of seven of the largest U.S. banks by 0.5 percentage point. Excluding Treasuries and other government-related assets would boost the ratio by another 0.7 percentage point.
“One of the obvious limitations of a leverage ratio is it doesn’t distinguish between liquid assets and illiquid assets,” Morgan Stanley CFO Ruth Porat said in a conference call with investors in August. She met with FDIC officials to discuss the rule that month.
Last week three senators led by Sherrod Brown, Democrat of Ohio, wrote to the FDIC and other regulators working on the leverage ratio urging them not to exclude cash reserves from the calculation. The senators also supported Hoenig’s call for a strong leverage ratio.
Some of the largest U.S. banks said the leverage proposal is arbitrary and would put them at a disadvantage against non-U.S. lenders facing easier requirements. In comment letters last month, New York-based Citigroup, the third-biggest U.S. bank, said the idea could worsen an uneven global playing field, and State Street Corp., the Boston-based custody bank, said the regulators’ proposal showed “no evidence” that they studied the potential impact on lenders.
Hoenig has advocated a 10 percent straight leverage ratio and found fault in the complicated formulas used in risk-weighted capital ratios.
As U.S. regulators aim for a final leverage rule by year end, the Basel committee is still working on what should be factored into a banks’ assets -- the denominator of the leverage ratio. Hoenig said the U.S. agencies shouldn’t wait for their international counterparts.
“I’m very open to a more comprehensive denominator, but let’s see it first,” he said. Meanwhile, the U.S. effort shouldn’t be postponed. “It’s been proposed for several months now. We should proceed with that.”
Hoenig said the July proposal should be adopted as written and then changes to the calculation of assets -- either the new Basel definitions or the exclusion of cash as banks demand -- could be discussed later.
The former Federal Reserve Bank of Kansas City president also said he would argue against lowering the proposed ratios.
“It would not be something I would even vaguely entertain,” Hoenig said.