There has been increasing speculation that under Basel III regulators, i.e., The Federal Reserve, are considering raising the  minimum supplementary ratio from the current proposal of 3 percent according to reports from Bloomberg, Reuters and other major new outlets on June 21, 2013.

Current  reporting  according  to  “people  with  knowledge  of  the  talks,”  suggests  a potential doubling of the minimum supplementary ratio from 3 percent to 6 percent. Banks in the US have yet to provide any disclosure on what their supplementary leverage ratio would look like.

Advanced Approaches and Non-Advanced Approaches Under Basel III

Under Basel III, regulators are proposing to separate banks into two camps: Non-Advanced Approaches  Banking  Organizations  and  Advanced  Approaches  Banking  Organizations.  The Advanced  Approaches  rules  are  generally  mandatory  for  banks  that  have  $250  billion  or more in total assets or more than $10 billion in on-balance sheet foreign exposure. All other banks would fall under the Non-Advanced Approaches rules.

RBC  in the recent report highlighted that the  selected  bank regulators think that the “Too Big to Fail” banks do not carry sufficient capital and they will “game” system when it comes to calculating risk weighted capital ratios. These regulators believe a higher supplementary leverage ratio will offer greater protection during a financial crisis. The two most outspoken regulators are Federal Reserve Board of Director Tarullo and FDIC Board of Director Hoenig.

RBC Estimated : Leverage Ratio for the Top 4 Banks and GS and MS for 1Q13

RBC estimate the supplementary leverage ratio for the four largest banks, as well as Goldman Sachs Group, Inc. (NYSE:GS) and Morgan Stanley (NYSE:MS), using publicly available data along with their interpretation of the Basel III NPR framework and certain assumptions.

Basel III

Based on RBC estimates the six banks in the table are all significantly above the current 3 percent minimum  supplementary  ratio  proposed  in  the  NPR.  However,  on  RBC  estimates,  if  the minimum supplementary leverage ratio is increased to 6 percent from 3 percent, only Wells Fargo & Company (NYSE:WFC) would meet the minimum requirement. They believe it is unlikely that it will be raised to 6.0 percent.

RBC measures  the  estimated  shortfall  in  capital  as  a  percentage  of  Tier 1 Capital  at  various minimum supplementary leverage ratio levels. One can see  (below chart) that aside from Morgan Stanley (NYSE:MS), all banks in the analysis would meet 4 percent while shortfalls in capital start appearing at 5 percent and above with the exception of Wells Fargo & Company (NYSE:WFC), which passed even at the 6 percent level.

a2

RBC most likely scenario

Currently, in RBC view if the supplementary leverage ratio were to be increased, the most likely scenario is that it would be boosted to 4 percent from the contemplated 6 percent level, although 5 percent is also a possibility. At 4 percent, all of the banks in RBC analysis pass the minimum requirement, with the exception of Morgan Stanley (NYSE:MS). They point out that these are their best estimates based on the data available and their interpretation of the Basel III NPR.

There is scope for RBC estimate to be too low and this could be some 30–50bp, which would mean that Morgan Stanley (NYSE:MS) could meet the minimum requirement  if  it  were  raised  to 4 percent.  In  addition,  banks  could  make  business  decisions  to boost  their  supplementary  leverage  ratio,  such  as  eliminating  unused  non-cancellable commitments (this would add ~40 basis points to MS’s supplementary leverage ratio).