Sound The Trumpet : Large Banks Face U.S. Tougher

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“Large Banks Face U.S. Tougher - Than-global Capital Rule”
by Bloomberg Business Week
December 9th, 2014

Daniel Tarullo, Federal Reserve Board of Governors member, has said the U.S. requirement should be more stringent than the international standard and take into account how banks borrow money to determine how much more capital they need. Photographer: Alex Wong/Getty Images

Eight of the biggest U.S. banks are about to find out just how risky the Federal Reserve thinks they really are.

Global regulators have already agreed that the world’s biggest banks, including JPMorgan Chase & Co. (JPM:US) and Citigroup Inc. (C:US), need to have extra capital to absorb losses in a crisis. Fed Governor Daniel Tarullo has said the U.S. requirement should be more stringent than the international standard and take into account how banks borrow money to determine how much more capital they need.

The Fed proposal, to be announced today, may lower returns for shareholders of U.S. banks compared with firms in other parts of the world, according to analysts. The extra capital requirement could be heavier for firms such as Goldman Sachs Group Inc. and Morgan Stanley that rely more on markets for short-term funding, instead of looking to depositors.

“The U.S. once again chooses to go its own way and exceed international minimums,” said Karen Shaw Petrou, managing partner of Washington-based research firm Federal Financial Analytics Inc. “We don’t know yet how it’s going to be structured, but if they squeeze the big banks too much, they’ll force some out of some businesses.”

In the wave of rules meant to prevent a repeat of the 2008 financial crisis, the Fed has made global agreements tougher when applying them to U.S. lenders. This rule will see the same treatment, according to Tarullo, the Fed governor in charge of bank supervision.

Banks should consider whether it makes sense to reduce their “systemic footprint” to minimize the extra capital requirement, Tarullo said in September. He said the Fed was putting emphasis on banks that rely the most on short-term funding because they are vulnerable to runs in a crisis.

Risk Weighted

The extra core-capital requirement could be as high as 4.5 percent of risk-weighted assets on top of the baseline 7 percent defined under rules known as Basel III, according to analysts including Citigroup’s Keith Horowitz.

That’s higher than the 2.5 percent maximum to be levied on banks deemed globally significant in an annual list issued by the Financial Stability Board, which advises the Group of 20 nations on bank regulation. Less complex firms would be held to the baseline capital ratio of 7 percent set by the 27-nation Basel Committee on Banking Supervision.

Wholesale Funding

A rule that targets firms that are more dependent on short-term funding from the markets could hurt New York-based Morgan Stanley and Goldman Sachs most. Such funding is about 35 percent of their liabilities, compared with about 20 percent for the others, according to data compiled by Keefe, Bruyette & Woods Inc.

Morgan Stanley (MS:US), which has the highest proportion of short-term wholesale funding, probably faces an extra charge of 3.5 percent, according to estimates yesterday from Citigroup analysts led by Horowitz.

Goldman Sachs will probably receive a 3 percentage-point surcharge. The central bank would bring JPMorgan’s surcharge to 3.5 percent, Bank of America Corp. (BAC:US)’s to 2.5 percent and State Street Corp.’s to 2 percent, according to Horowitz. He didn’t estimate a surcharge for Citigroup.

A Fed rule that instead emphasizes the absolute dollar amount of short-term funding, rather than the proportion of short-term funds to liabilities, could place a heavier burden on New York-based JPMorgan.

Bank of America

Among the eight U.S. banks on the FSB’s list of globally significant firms, JPMorgan ranks as the most systemically important. It had the most short-term wholesale funding at the end of September, according to data compiled by KBW. Its $483 billion of short-term funds was followed by Citigroup’s $432 billion and Bank of America (BAC:US)’s $407 billion.

A 1 percentage-point increase in JPMorgan’s capital requirement would lower the firm’s return on equity by about 1.1 points, KBW calculated in a report this week. Most banks could meet the requirement by holding onto a larger proportion of their earnings, KBW said.

KBW analysts led by Fred Cannon said that under Basel III rules, Morgan Stanley’s capital level is already at 11.8 percent, more than the maximum of 11.5 percent that could be imposed by the Fed. Goldman Sachs is at 10 percent, JPMorgan at 10.1 percent, Bank of America at 9.5 percent and Citigroup at 10.7 percent, according to KBW.

U.S. banks have complained that domestic regulators going beyond international standards put them at a disadvantage against overseas rivals. The Fed, together with other bank supervisors, already set tougher U.S. standards for liquidity and leverage.

With so many countries taking different approaches, international comparisons are difficult. For example, Switzerland has asked its two largest banks to have twice the capital level set by Basel, while defining capital more loosely.

To contact the reporters on this story: Jesse Hamilton in Washington at jhamilton33@bloomberg.net; Ian Katz in Washington at ikatz2@bloomberg.net; Yalman Onaran in New York at yonaran@bloomberg.net

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