U.S. Banks to Face Tougher Leverage Caps Than Competitors

The biggest U.S. bank holding companies will need to round up as much as $68 billion more in loss-absorbing capital under supplemental leverage ratio rules adopted by regulators in Washington.

Eight lenders, including JPMorgan Chase & Co. and Bank of America Corp., face greater restrictions on borrowing power than their overseas competitors as they meet a demand to hold capital equal to at least 5 percent of total assets. The rules approved yesterday to curtail financial-system risk surpass the 3 percent minimum set in a global agreement by the Basel Committee on Banking Supervision.

“The leverage ratio serves as a critical backstop to the risk-based capital requirements -- particularly for the most systemic banking firms,” Daniel Tarullo, the Federal Reserve governor responsible for financial regulation, said in a statement.

The leverage rule, which also affects Citigroup Inc., Wells Fargo & Co., Goldman Sachs Group Inc., Morgan Stanley, Bank of New York Mellon Corp. and State Street Corp., is meant to work alongside risk-based capital standards approved by U.S. regulators last year and a pending rule that would require banks to keep a high level of ready-to-sell assets to weather a crisis.

The rule was approved by the Federal Reserve, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency.

Dominant Standard

Bankers had argued that the leverage demand -- often described by the agencies as a backstop -- would become the dominant capital standard, and Tarullo agreed that it will be the most binding constraint for some banks.

Fed Governor Jeremy Stein said he had “misgivings” about possible “unintended consequences” of the rule. “I do think it is possible to go too far with a simple leverage ratio if it gets raised to the point where it is binding or near-binding rather than being a backstop.” Fed Chair Janet Yellen said regulators should “watch carefully” for such consequences.

Most of the banks have said they already or soon will meet the demand for 5 percent capital at the bank holding company level and 6 percent at banking units. The holding companies are about $68 billion short, and the banking subsidiaries face a $95 billion shortfall, regulators said.

“The shortfall is generally in line with the figures banks have been talking about and should be manageable,” said Brian Kleinhanzl, an analyst at Keefe, Bruyette & Woods Inc. in New York. He estimated they’d hit the minimums next year. “Bank of New York Mellon and Morgan Stanley had the most work to do before the Basel changes came along and will probably still have more work than their peers after the changes.”

Basel Committee

Yesterday’s final rule is accompanied by a new proposal to revise the leverage calculations based on an agreement earlier this year by the 27-nation Basel Committee.

Those changes, which will be open for public comment until June 13, will add about 8 percent on the asset side of the ratio, regulators said. That would swell the asset base by 50 percent to about $15 trillion, according to estimates compiled by Bloomberg. The ratio will be measured using daily averages over each quarter.

The proposed approach reaches beyond the eight firms under the tougher leverage rule to also affect institutions with more than $250 billion in assets or major foreign exposure. Those banks still have to meet a lesser leverage ratio of 3 percent -- a standard that may be toughened by this new way to tally assets.

U.S. regulators developed the rules in response to the 2008 credit crisis that saw the collapses of Bear Stearns Cos. and Lehman Brothers Holdings Inc., and prompted lawmakers to provide billions of dollars in bailouts to keep other big banks afloat. The companies have until 2018 to comply.

Snubbing Treasuries

As they tailor their capital strategies based on the final leverage ratio rule, banks may snub Treasuries and pursue higher-risk assets, according to industry analysts.

“Leverage ratios punish low-risk assets,” Oliver Ireland, a banking lawyer at Morrison & Foerster LLP in Washington, said in an interview. “To the extent that they do a constraining rule, it tends to discourage you from holding things like Treasury securities.”

Using the Basel agreement for calculating a bank’s assets was a welcome change for banks after the global panel dialed back the approach.

It’s a “less draconian” approach than previously discussed by the international group and met the industry halfway, said Coryann Stefansson, a managing director at PricewaterhouseCoopers LLP, said in an interview.

Before it's here, it's on the Bloomberg Terminal.