Regulators Increase Leverage Ratio of Largest Banks

Banking regulators took another step to raise leverage ratios for the largest banks in a bid to prevent serious issues from another 2008-like market crash.

Regulators Increase Leverage Ratio of Largest Banks

Leverage ratio: $68 billion required as margin on over $400 trillion in OTC risks

The largest banks, which will be required to keep in reserve $68 billion under the new plan, are said to have a significant combined exposure to OTC derivatives in excess of $400 trillion, according to the Comptroller of the Currency Administrator of National Banks quarterly report on derivatives activities.  The leverage ratio is also designed to cover other potential bank losses, such as bad loans.

The special banks designated with a government failure guarantee backstop that will be impacted by the new rules are: Bank of America Corp (NYSE:BAC), The Bank of New York Mellon Corporation (NYSE:BK), Citigroup Inc (NYSE:C), Goldman Sachs Group Inc (NYSE:GS), JPMorgan Chase & Co. (NYSE:JPM), Morgan Stanley (NYSE:MS), State Street Corporation (NYSE:STT) and Wells Fargo & Co (NYSE:WFC).

Leverage ratio of 6%

Under the proposed rules the biggest banks will be required to maintain loss reserves equal to 5% of assets, and FDIC-insured banks will have to keep a minimum leverage ratio of 6%. The higher capital requirements stand in contrast to international standards, which require a 3% ratio.

Yellen uses carrot and stick

In prepared remarks announcing the new rules, Fed Chair Janet Yellen noted the leverage with discretionary bonus to encourage compliance: “Under this framework, these banking organizations would have to hold substantially increased levels of high-quality capital as a percentage of their total on- and off-balance sheet exposures to avoid restrictions on capital distributions and discretionary bonus payments. Thus, the framework provides incentives to such firms to maintain capital well above regulatory minimums,” she said.

Leverage ratio: New rules don’t take effect until 2018

The new rules came as banks fought the changes, leaning on a common refrain that it would hurt lending and place them at a competitive disadvantage with foreign banks. However, not to worry, as compliance with the new rules is not required until several bonus seasons have passed – the rules will go into effect on January 1, 2018.

Noting the potential for the banks to underestimate their risk, Fed board member Daniel Tarullo, who oversees regulation for the central bank, was coy, saying the increased leverage requirements “helps compensate for the possibility that risk-weighted measures understate the risk that large holdings of assets that are very safe in normal times may, as we observed during the financial crisis, become considerably less so in periods of serious financial market stress,” he said.