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Tougher Leverage Ratio Will Force $200B Capital Raise

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Bankers have been warning for months about the grim consequences of jacking up the leverage ratio and now one of their trade groups put some hard numbers behind the complaints.

The Clearing House Association concluded that 12 large banking companies would have to raise $202 billion in Tier 1 capital or reduce their assets by $3.7 trillion to comply with both the US and Basel capital rules.

Putting that in percentage terms, the association figured the extra capital amounted to nearly 25% of these banks' current Tier 1 capital and 20% of their total assets.

Raising the leverage ratio to 6% of bank assets and 5% of the parent company's assets also would transform what has long been considered the backup capital rule into the binding constraint for 67% of the largest banks' assets, the association said.

(To see more posts from Barb Rehm's Blog, click here.)

The leverage ratio is often called a crude measure because it's a relatively straight calculation of equity to assets. The Basel rules are considered more sophisticated because they attempt to take into account the riskiness of an asset when determining how much capital must be held behind it.

But because these "risk-weighted assets" have so often underestimated risk, the leverage ratio has gained a lot of clout among regulators.

The Clearing House is hoping that putting some hard numbers to the proposal will help regulators improve the rule before finalizing it.

"We felt it was important to study the aggregated data across the institutions that are affected…and see what the industry impact will be," Sridhar Iyer, The Clearing House's director of research, said in an interview.

"We want to translate the effect to the broader economy effect on lending rates and macroeconomic behavior in the form of employment and GDP."

Iyer said the Clearing House is working with Oxford Economics to quantify those broader effects and will share those findings with the regulators soon.

U.S. regulators proposed the new leverage ratio on July 9 and said it would take effect on Jan. 1, 2018. Comments on the plan are due Oct. 21.

The tougher leverage ratio will apply to JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs, Morgan Stanley, Bank of New York Mellon and State Street, which all have assets exceeding $700 billion or more than $10 trillion under custody. The Clearing House study included four more large banking companies that it declined to identify but may include the next tier down in size like U.S. Bancorp, HSBC, PNC and Capital One.

Some policymakers who want the largest banks to shrink may be heartened by the Clearing House's conclusions. But Iyer said regulators are concerned banks may abandon certain products. "They are now aware of the likely impact," he said. "And we believe the regulators are concerned about the disproportionate impact and the market dislocation with regard to certain asset classes."

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Comments (8)
If these banks are required to hold more capital, there seems a simple solution. Raise their prime lending rate to generate an appropriate return on the needed capital. If that isn't the desired impact on the economy, then the Fed and regulators will need to find another way to offset this impact, but if banks, whatever size, have higher capital requirements, they have to price to earn more money. And if they can't do it on investments because of Fed Open Market activity, they can at least control their own lending rates and spreads they will accept. Make the impact of these requirements obvious and attributable to the ones pushing for them. Capital cost money and has to generate a reasonable return.
Posted by pdf70101862 | Monday, September 23 2013 at 11:21AM ET
Here is a case where I hope, but cannot say, that the author is wrong. I sincerely hope that the regulators are not intentionally trying to contract the economy. More capital to do the same amount of activity will not only shrink banks but it will shrink the economy. Remember, there are largely two components to the money supply, government money created by the Fed and Treasury, and bank money (created by deposits and loans). And still in our economy, bank money is the larger component. Raising bank capital requirements means reducing deposits and/or loans, hence shrinking the economy.
Posted by WayneAbernathy | Monday, September 23 2013 at 11:27AM ET
So banks can earn 3% on government securities, pay half of that back in taxes and pay 1.5% to their shareholders. Who could refuse that deal?
Posted by kvillani | Monday, September 23 2013 at 11:32AM ET
"Wrong" is such a harsh word, Wayne. I wasn't takes sides, just suggesting that the impact TCH estimates may be exactly what the regulators want to occur. And I get that higher capital and a smaller industry have other repercussions but at least some of the regulators aren't too worried about those just yet. Will be interesting when TCH/Oxford report comes out, showing macroeconomic effects on GDP and jobs.
Barb Rehm, editor at large, American Banker
Posted by brehm | Monday, September 23 2013 at 11:39AM ET
Well, maybe "mistaken." I don't differ with your analysis, because I fear that you may be right. Some regulators perhaps don't care about the impact on the overall economy, or have been able to convince themselves that the rules of monetary economics don't hold. I just hope that is not true.
Posted by WayneAbernathy | Monday, September 23 2013 at 11:45AM ET
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