Capital standards at the biggest U.S. lenders would rise to 5% of assets for parent companies and 6% for their banking units under a plan proposed today by federal regulators.
The Office of the Comptroller of the Currency proposed a leverage ratio that’s 2 percentage points more than the 3% international minimum for holding companies, the agency said in a statement. Capital at U.S.-backed deposit and lending units must be twice the global standard at 6%, according to the OCC. The Federal Deposit Insurance Corp. is set to vote on the proposal later today.
The U.S. plan goes beyond rules approved in 2010 by the 27-nation Basel Committee on Banking Supervision 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 with borrowed money. Bankers say this could force asset sales and pinch profit.
“A 3% minimum supplementary leverage ratio would not have appreciably mitigated the growth in leverage among these organizations in the years preceding the recent crisis,” said FDIC Chairman Martin Gruenberg in a statement.
The changes would affect the eight U.S. institutions already tagged as globally important, according to the Federal Reserve. The Financial Stability Board, a group of international central bankers that coordinates financial rules, 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. The insured lending units would need $89 billion more in capital.
Banks would have until Jan. 1, 2018 to comply, according to today’s statement. The proposal faces a 60-day public comment period and needs final approvals from the three agencies.
Regulators behind the proposal include the Fed, and firms that miss the target face limits on bonuses, dividends and stock buybacks. 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.
“As the economy starts to move, it’ll bite,” said Ernest Patrikis, a former Federal Reserve Bank of New York general counsel and now partner at White & Case LLP, in an interview before the announcement. A higher floor will “make the U.S. banks a little less competitive, a little less profitable,” Patrikis said.
The leverage ratio measures capital as a flat percentage of assets, eschewing formulas that let banks hold less capital for assets deemed less risky. The Basel panel added the leverage ratio to buttress bank safety, and U.S. regulators must sign off before Basel’s decree applies to domestic lenders. While the Federal Reserve adopted the international standard last week, Fed Governor Daniel Tarullo said 3% is too low and that a U.S. boost was close to being proposed.
To guarantee against bank failures in another crisis, “the amount of equity that they hold relative to total assets has to be a lot higher than 3%,” 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 U.S. must enact local regulations to carry out 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.
In addition to bolstering the leverage ratio, Basel III strengthened formulas that tie the amount of capital to the level of risk in a bank’s holdings, a process known as risk weighting. The panel set this threshold at 7% of risk- weighted assets.
Under risk weighting, large banks are allowed to use their own models to calculate the likelihood of losses and thus how much capital they need. As the formulas became more complex and harder to understand, regulators such as former FDIC Chairman Sheila Bair questioned their credibility.
Bair pushed Basel to add the leverage ratio, a simpler and more transparent gauge that measures capital against assets regardless of the risk. FDIC Vice Chairman Thomas Hoenig has said this ratio should be more than tripled to 10%.
European regulators such as Bundesbank Vice President Sabine Lautenschlaeger have said the leverage ratio shouldn’t be the main gauge because it doesn’t demand more backing for loss- prone investments and thus can give bankers “unhealthy incentives” to take on more risk. Bair and other advocates say the leverage ratio works as a strong backstop when used along with risk weighting.
Five of the six largest U.S. lenders, including No. 1- ranked JPMorgan, would fall under a 6% level at the holding company level, according to estimates by Keefe, Bruyette & Woods Inc. last month. Only Wells Fargo and Bank of America would meet the 5% holding company requirement, according to KBW estimates. KBW didn’t say how they would fare under a separate ratio for the banking units.
The enhanced leverage requirement would also cover BNY Mellon and State Street. Those two would also fall below the 5% level proposed today, according to KBW estimates.
“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 KBW.
Hitting the ratio targets will be easier if safer assets such as cash and government debt are exempted, something bankers say would be fair since those holdings aren’t likely to sour and have less need for a backstop. Without the exclusion, Morgan Stanley and BNY Mellon have the lowest ratios of capital to assets, Goldman Sachs analysts estimated in a report last month.
Getting rid of assets may be one way that banks seek to improve their ratios, according to Patrikis.
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.