U.S. agencies trying to ensure the financial system is strong enough to withstand another crisis have settled on one of the last pieces of their regulatory apparatus to limit the size of bank debt, according to two people briefed on the discussions.
The decision on how to count bank assets used in an institution’s so-called leverage ratio will be in line with an international standard, the people said. That would be welcomed by the eight largest U.S. banks since they could more easily meet new capital rules than they could under an earlier plan.
Banking overseers have made it clear since the 2008 credit crunch that they would require firms including JPMorgan Chase (JPM:US) & Co. and Bank of America (BAC:US) Corp. to hold more capital relative to what they borrow to make investments. U.S. agencies have already proposed a leverage ratio of 5 percent for bank holding companies and 6 percent for their banking units -- higher than the 3 percent set by an international group of regulators.
What has been less clear is how to count certain complex transactions as assets in calculating that ratio. U.S. regulators have now agreed to take the approach adopted in January by the Basel Committee on Banking Supervision, according to the people briefed, who spoke on condition of anonymity because the talks aren’t public.
In dialing back parts of an earlier plan, the 27-nation group in effect reduced a bank’s required capital cushion by allowing some financial obligations to cancel each other out and disregarding certain credit commitments.
The Federal Reserve, Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. have decided to adopt this approach in a separate proposal that will be put out for public comment, the people briefed said. That could happen at the April 8 meeting that regulators announced today.
“If they use the Basel asset calculation, it should reduce the cost of maintaining liquid assets under the leverage rule,” said William Sweet, a former Fed lawyer who is a partner at Skadden, Arps, Slate, Meagher & Flom LLP in Washington.
Spokesmen for the three agencies -- Barbara Hagenbaugh at the Fed, Bryan Hubbard at the OCC and David Barr at the FDIC -- declined to comment on plans for the rule.
The role of the Basel group -- with U.S. regulators actively involved -- has been to create a consistent capital approach around the world. Basel sets standards that each member country uses as a template for re-writing its own rules.
In the U.S., the leverage limits are aimed at eight of the biggest banks: JPMorgan, Bank of America, Citigroup Inc. (C:US), Wells Fargo (WFC:US) & Co., Goldman Sachs Group (GS:US) Inc., Morgan Stanley (MS:US), BNY Mellon and State Street (STT:US) Corp.
The U.S. agencies drew ire from the banks last year for suggesting higher leverage ratios than the Basel standard. The original U.S. plan also would have counted off-balance-sheet assets such as derivatives when adding up total assets. The higher the sum total of assets, the more capital a bank would have to hold, potentially reducing profits.
While the industry awaited the final U.S. version, the Basel group was loosening its standards on how assets should be tallied. Like the U.S., for example, the group originally planned to count as assets repurchase contracts, or repos. In January, the Basel committee said it was revising the rules so that banks could consider a repo designed to hedge another contract as an offset that could yield a net value of zero, an approach backed by financial firms.
If U.S. regulators borrow Basel’s most recent easing, the big banks are “going to be very happy,” said Mayra Rodriguez Valladares, managing principal at New York-based MRV Associates, which trains bank examiners and finance executives.
Rodriguez Valladares said she would prefer that the U.S. not go the Basel route on counting assets. That approach lets banks shrink their apparent assets to be “much smaller than the real extent of risk,” she said.
Even so, overall U.S. leverage rules would remain more stringent than the Basel plan. FDIC Vice Chairman Thomas Hoenig said last month that he expected his fellow regulators to stick to the proposal to hold at least 5 percent capital. The people briefed on the discussions also said the final U.S. proposal would remain at the previously released levels.
Though global banks were stretched so thin during the 2008 crisis that the U.S. government intervened with a cash rescue, the regulators estimated last year the industry was on track to make up the tens of billions in capital still needed to meet the new leverage proposal well before a 2018 deadline. Banks failing to toe the line could have bonuses and dividends blocked.
The lenders would still like to see Basel’s more gentle 3 percent requirement migrate into the U.S. version.
“We’re hopeful that U.S. regulators will adopt an approach that follows the Basel agreement,” said Robert Hatch, a regulatory attorney for the Financial Services Roundtable. Even beyond the 3 percent question, Hatch said some of the Basel group’s recent changes on assets were helpful.
The leverage rule is meant as a backstop to an earlier set of capital demands the regulators already placed on U.S. banks: a more complex standard known as Basel III that requires certain levels of capital be held against assets depending on how risky they are. Banks argued that the Basel-topping ratio of the U.S. leverage proposal could instead make it the dominant capital demand, shoving risk-weighting to the background, according to a comment letter last year from Citigroup.
They’ve also argued it could encourage banks to chase riskier assets.
“We want to make sure the leverage ratio isn’t something that causes the bank holding companies to take on more risk as a way of maintaining their return on equity,” Hatch said.
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