(Updates with additional details on Federal Reserve rules starting in seventh paragraph.)
Dec. 19 (Bloomberg) -- The Federal Reserve will issue capital and liquidity rules this week reshaping supervision of the riskiest, largest banks and those with more than $50 billion in assets, a government official familiar with the matter said.
The Dodd-Frank Act requires the Fed to impose heightened standards including stricter capital levels for banks with over $50 billion in assets whose failure would threaten the financial system and similar non-bank institutions. The stricter standards also target liquidity, risk management structure, credit reporting, concentration limits, stress tests, contingent capital and short-term debt limits.
“The Fed is raising requirements as firms get bigger in part to reduce their systemic footprint,” said John Dugan, a partner at Covington & Burling LLP and a former comptroller of the currency. “They are creating disincentives to growth and complexity. It definitely creates more cost the bigger you get.”
The Fed’s rules will not be more stringent than international capital standards agreed to in Basel, Switzerland. Fed Governor Daniel Tarullo cited a “goal of congruence” between the Basel standards and the Fed’s work on rules under Dodd-Frank, which overhauls banking regulation, in a June 3 speech.
The Basel Committee on Bank Supervision agreed earlier this year that global banks such as Goldman Sachs Inc. and Deutsche Bank AG whose failure could send shock waves throughout the financial system should apply a risk surcharge of 1 percentage point to 2.5 percentage points.
Tarullo has said he would have preferred a higher capital surcharge than the 2.5 percentage points agreed upon by international regulators in Basel, Switzerland, this year.
The Basel Committee listed eight U.S. institutions as being systemically important globally. These U.S. standards go further by applying heightened rules to all banks over the $50 billion in assets. Tarullo has indicated that institutions over $50 billion that don’t represent a global risk won’t have as high a surcharge and the capital instead would be based on a sliding scale.
“No decision has yet been made as to whether the more stringent capital requirement to be applied to firms other than those on the eventual list of g-sifis (global systemic institutions) will be in the form of a surcharge,” Tarullo said in a Nov. 9 speech, referring to the global institutions that represent the greatest risk. He said even if surcharges were to apply to those firms it would be ”quite modest.”
Joe Engelhard, senior vice president of Capital Alpha Partners LLC, called the heightened standards “the single most important” parts of Dodd-Frank.
It’s unclear what capital requirements will be for regional banks like Ohio’s Huntington Bancshares Inc. or Pennsylvania’s PNC Financial Services Group, said Engelhard, compared to larger banks like JPMorgan Chase & Co. and Citigroup Inc.
Large banks have argued that the heightened standards would be too burdensome and would restrict lending. JPMorgan Chairman and CEO Jamie Dimon said at the capital surcharge is ”contrived.”
“There are unintended consequences to” the global capital rules for systemically important financial institutions like JPMorgan, he said. Since JPMorgan will have to carry extra capital compared with competitors against its consumer loan holdings, ”we’re not going to want to own” them, he said, indicating that large banks would curb consumer lending.
The Basel committee has said it’s going to revise its short-term liquidity rule in the first quarter of next year. This would set in stone how much cash and easily cashable securities a bank needs to hold to meet one month of liabilities coming due. The Dodd-Frank act requires the Fed to issue its own liquidity standards for institutions over $50 billion in assets.
The Dodd-Frank act also requires the Fed to issue proposals requiring leverage requirements, concentration limits, and risk- management standards. Dodd-Frank asks systemic firms to maintain a debt-to-equity ratio of at least 15-to-1 if the Financial Stability Oversight Council determines that a company poses a ”grave threat” to the U.S. financial stability.
”Regulators’ primary focus should be constraining absolute leverage through an international leverage ratio that is significantly higher” than the Basel Committee’s proposed 3 percent standard, former Federal Deposit Insurance Corp. Chairman Sheila Bair said in Dec. 7 testimony.
To address the relationships between systemic institutions, Dodd-Frank directs the Fed to issue rules limiting the credit exposure one company has to another significant institution and curb such exposure to unaffiliated companies to 25 percent of total capital, impacting banks’ derivatives and securities trading.
”It’s a huge, big change on the interconnectedness on systemic risk,” said Karen Shaw Petrou, managing director of Federal Financial Analytics Inc. ”These credit exposure limits will be the first global effort to contain those risks and it’s another franchise redefining for the biggest, most complex, banks.”
--Editors: Carlos Torres, Gail DeGeorge
To contact the reporters on this story: Cheyenne Hopkins at Chopkins19@bloomberg.net;
To contact the editor responsible for this story: Christopher Wellisz at email@example.com