U.S. Boosts Bank Capital Demands Above Global Standards

Capital standards at the biggest U.S. lenders would rise to 5 percent of assets for parent companies and 6 percent for their banking units under a proposal by regulators to bolster financial firms.

Leverage ratios would be pegged 2 percentage points above the 3 percent international minimum for holding companies, the Office of the Comptroller of the Currency said today in a statement. Capital at U.S.-backed deposit and lending units must be twice the world standard at 6 percent, the OCC said.

The U.S. plan goes beyond rules approved by international regulators to prevent a repeat of the 2008 crisis that almost destroyed the financial system. The changes would make lenders fund more assets with capital that can absorb losses instead of using borrowed money. Bankers say this could trigger asset sales and pinch profit, and some may slow dividends and buybacks.

“U.S. regulators have upped the ante on bank capital, making the leverage ratio a significant constraint for large banks here and daring the rest of the world to match,” said Frederick Cannon, director of research at Keefe, Bruyette and Woods Inc.

The OCC and Federal Deposit Insurance Corp. adopted the 3 percent benchmark today set by the 27-nation Basel Committee on Banking Supervision in 2010. The Federal Reserve gave its approval last week. The U.S. agencies also proposed boosting the domestic ratio, giving banks until Jan. 1, 2018 to comply.

Who’s Affected

The changes would affect the eight U.S. institutions already tagged as globally important, the Federal Reserve and FDIC said. The Financial Stability Board, a group of international central bankers that coordinates regulation, identified them as JPMorgan Chase & Co., Citigroup Inc., Wells Fargo & Co., Goldman Sachs Group Inc., Bank of America Corp., Morgan Stanley, State Street Corp. and Bank of New York Mellon Corp.

Based on the largest banks’ September data, the holding companies fell short of the new leverage requirement by $63 billion, FDIC staff said in a meeting with reporters today. Insured lending units would need $89 billion more in capital. All the firms can fill their gaps by retaining earnings and without selling new stock, the regulators said today.

Lenders in the KBW Bank Index were little changed at noon in New York, with none of the 24 companies moving more than 1.5 percent up or down. Spokesmen for the lenders declined to comment or didn’t immediately respond to inquiries.

Profit Impact

Firms that miss the target face limits on bonuses and dividends. Bankers have resisted new measures, saying that lending might be impeded and that changes put in place after the financial crisis should be given time to work.

“If the regulatory pendulum swings too far in the opposite direction, it will stunt the American economy just as it is starting to improve,” said Rob Nichols, president of the Financial Services Forum, a lobbying group for the largest financial institutions. “We urge regulators to be mindful of the fact that ever-higher capital requirements, while a critically important element of safety and soundness, can become prohibitive and actually lead to reduced capability to lend.”

The new Basel leverage ratio expands what gets counted as assets and thus intensifies the demand for capital. It includes more of the derivatives contracts that are kept off balance sheet under accounting rules and recognizes unused credit lines granted to companies and consumers.

Falling Behind

The dual ratios in the U.S. plan may help some lenders comply, since five of the six largest U.S. banks, including No. 1-ranked JPMorgan, would fall under a 6 percent level at the holding company level, according to estimates by KBW last month. Only Wells Fargo and Bank of America would meet the 5 percent holding company requirement, according to KBW estimates. KBW didn’t say how they would fare under a separate ratio for the banking units.

“The higher requirement for bank subsidiaries does have significance for the shareholders of their parent companies,” Cannon said. The units would have to retain earnings at least temporarily to comply, which would prevent the holding company from distributing dividends since most profit comes from those units, he said.

JPMorgan Chase NA, the insured depositary arm of JPMorgan, held $70 trillion of the lender’s total $71 trillion notional value derivatives contracts at the end of March, according to the latest OCC data. Citibank NA held all $58 trillion of Citigroup contracts. Bank of America’s lending unit held $45 trillion of the firm’s $61 trillion.

Morgan Stanley

Morgan Stanley Bank NA had just $3 trillion of the firm’s $47 trillion total. Holding the bulk at the parent, with its lower capital requirement, might help Morgan Stanley since it has the lowest Basel leverage ratio among the top U.S. banks, according to six analyst estimates compiled by Bloomberg. Those range from 3.6 percent to 4.6 percent.

The leverage ratio measures capital as a flat percentage of assets, eschewing formulas that let banks hold less capital for assets deemed less risky. While the Federal Reserve adopted the international standard last week, Fed Governor Daniel Tarullo said 3 percent was too low.

“A 3 percent minimum supplementary leverage ratio would not have appreciably mitigated the growth in leverage among these organizations in the years preceding the recent crisis,” FDIC Chairman Martin Gruenberg said today.

Risk Weighting

To guarantee against failures in another crisis, “the amount of equity that they hold relative to total assets has to be a lot higher than 3 percent,” said Marc Jarsulic, chief economist at nonprofit advocacy group Better Markets, adding that even a moderate increase will help. “It’ll be an improvement, but it’ll still be inadequate to ensure the stability of the large bank holding companies.”

The debate revolves around the Basel committee’s 2010 revision of how minimum capital levels are set for the world’s lenders, known as Basel III. The panel includes central bankers and regulators from some of the biggest economies, and each nation must enact local laws to carry out the plan.

In addition to bolstering the leverage ratio, Basel III strengthened risk-weighting formulas that tie the amount of capital to the level of danger in a bank’s holdings. The panel set this capital threshold at 7 percent of risk-weighted assets.

The process allows large lenders to calculate the likelihood of losses using their own formulas, and thus how much capital they need. As the models became more complex and harder to understand, regulators such as former FDIC Chairman Sheila Bair questioned their credibility.

‘Meaningful Reform’

Bair pushed Basel to add the leverage ratio, a simpler and more transparent gauge that measures capital as a simple percentage of assets regardless of the risk. FDIC Vice Chairman Thomas Hoenig has advocated a 10 percent ratio, and said today before his solitary “no” vote on Basel that its risk weighting is “unduly difficult.”

“This is real, meaningful reform of the kind the public has a right to expect after suffering through the worst financial crisis since the Great Depression,” Bair said in an e-mailed statement. “This proposal also sends a strong signal to European regulators who have dragged their feet.”

Bundesbank Vice President Sabine Lautenschlaeger has said the leverage ratio shouldn’t be the main gauge because it doesn’t demand more capital to back the more loss-prone investments, and thus can give bankers “unhealthy incentives” to take on more risk.

Higher Ante

Hitting the ratio targets would be easier if safer holdings such as cash and government debt were excluded from the tally of assets. Bankers say this would be fair since those holdings aren’t likely to sour and have less need for a backstop. Today’s proposal didn’t grant such an exclusion.

Without it, Morgan Stanley and BNY Mellon have the lowest ratios of capital to assets, Goldman Sachs analysts estimated in a report last month. The industry has been lobbying for the exclusions and may renew efforts to narrow the definition of assets before the rule becomes final.

Getting rid of assets is another way banks can improve their ratios, said Ernest Patrikis, a former Federal Reserve Bank of New York general counsel and now partner at White & Case LLP. Bank of America, the second-largest U.S. lender by assets after New York-based JPMorgan, has sold more than $60 billion of holdings since 2010 as Chief Executive Officer Brian T. Moynihan sought to rebuild the Charlotte, North Carolina-based company’s balance sheet following a $45 billion bailout during the financial crisis.

(Updates with vote and stock reaction, starting in the fifth paragraph.)
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