U.S. regulators might double minimum capital requirements for the largest banks to 6 percent of total assets, according to Bloomberg Businessweek.
Yalman Onaran of Bloomberg Businessweek reports that the Federal Reserve and Federal Deposit Insurance Corp are weighing the idea of doubling the capital requirement to 6 percent of total assets for the biggest banks in the U.S., regardless of their risk.
More Pressure on European Banks
According to Yalman Onaran, the U.S. regulators’ stricter capital requirement would put pressure on their counterparts in the U.K. and Switzerland. Yesterday, both regulators asked their banks to enhance their ratios of capital to total assets.
For nearly two decades, U.S. banks have been mandated with a simple leverage requirement of 4 percent. However, the new version proposed last June expanded the list of assets that would be counted for computing the ratio besides items considered for off-balance-sheet computations. The recent draft is intended to align U.S. accounting standards with international standards.
Interestingly, banks are not required to report what their ratios would be under the new Basel method of calculating assets or the off-balance-sheet items that would go into the calculation.
Basel’s Risk Based Capital Requirements
Banks across 100 countries, including the U.S., are already complying with Basel’s risk-based capital rules. These rules assign weighting to assets based on their riskiness. For instance, corporate debt carries a higher risk weight as compared to government bonds. This would necessitate banks to shell out more capital for their corporate debt exposure.
The Basel committee also increased the minimum capital requirements based on risk-weighted assets. The world’s two dozen largest financial institutions need to have common equity equal to 8 percent to 9.5 percent of those assets by 2019. The six biggest U.S. lenders either already meet that requirement or are close, with their risk-weighted capital ratios ranging from 8.4 percent to 9.7 percent at the end of March.
Some analysts, however, feel the leverage ratio is a good safety tool, as risk-weighting can be maneuvered by banks to their advantage.
Recently, FDIC Vice Chairman Thomas Hoening said Basel III accord facilitates lenders to appear well-capitalized, though they are not so well-capitalized. He feels the capital rules permit banks to adopt complicated processes to determine the capital required to support their risky loans. Instead, Hoening suggests a tougher leverage ratio to measure banks’ ability to absorb sudden losses. The leverage ratio compares a bank’s shareholder equity to its total assets without using risk-weightings.
Yalman Onaran of Bloomberg Businessweek reports that sources indicated while the final version of the proposal to implement Basel rules could be issued in the next few weeks, the increased leverage requirement might not be included.
Interestingly the capital rules promulgated by the Basel committee, which brings together regulators and central bankers from 27 countries, aren’t binding on members. Individual country’s regulators must still translate the standards into its own laws and rules. The committee asked that governments put the new leverage ratio into effect by 2018.
Wells Fargo Fulfills 6 Percent Threshold
According to an estimate by KBW, among the biggest U.S. banks, only Wells Fargo & Co (NYSE:WFC) would exceed the proposed 6 percent threshold requirement, as it boasts of a healthy 7.3 percent capital requirement. JP Morgan Chase & Co. (NYSE:JPM) and Citigroup Inc (NYSE:C) each have 4.5 percent, Goldman Sachs Group Inc (NYSE:GS) has 4.6 percent, while Bank of America Corp (NYSE:BAC) has 5.1 percent.
Technically, a bank with a leverage ratio of 4 percent would see its equity wiped out if the value of its assets drops 4 percent.
The banking industry is pushing regulators to revise the calculation of leverage to include fewer off-balance-sheet assets and even exclude some balance-sheet items. Some feel the proposed requirement would limit banks’ ability to lend to business, hampering economic growth and job creation.
Interestingly, the draft law to implement the new Basel rules, approved by EU governments yesterday, doesn’t include a binding leverage ratio. The EU has indicated it would need more time to study its impact on the economy.