The biggest U.S. banks including JPMorgan Chase & Co. and Citigroup Inc. may face tougher capital standards than global peers under a plan set for a vote today by the Federal Deposit Insurance Corp.
The agency could set leverage ratios of 5 percent and 6 percent, one for parent companies and another for their U.S.- backed lending units, said a person with knowledge of the plans. That would be as much as twice the international standard of 3 percent. The person, who asked for anonymity ahead of today’s vote, didn’t specify which rate would apply to which entity.
The U.S. plan would go beyond rules approved in 2010 by the 27-nation Basel Committee on Banking Supervision to prevent a repeat of the 2008 financial crisis. The changes would make lenders keep more funds as a buffer against losses, which bankers say could mean lower profits and more asset sales.
“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. 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 percent is too low and that a U.S. boost was close to being proposed.
Who’s Affected
The changes would affect the eight U.S. institutions already tagged as globally important, according to Tarullo. The Financial Stability Board, a group of international central bankers that coordinates global financial rules, identified them as JPMorgan, Citigroup, Wells Fargo & Co., Goldman Sachs Group Inc., Bank of America Corp., Morgan Stanley, State Street Corp. and Bank of New York Mellon Corp.
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 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 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. The final U.S. version will be set once the FDIC and Office of the Comptroller of the Currency sign off.
Risk Weighting
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 percent 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 percent.
‘Unhealthy Incentives’
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.
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. Morgan Stanley analysts led by Betsy Graseck said the global lenders they follow would have to shrink lending commitments and derivatives by about $3.23 trillion, or 55 percent, to meet a 6 percent ratio by 2016. Given the potential harm to the economy, regulators probably will soften their proposal after hearing public comments, the analysts wrote in a July 4 note.
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.