“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%.