WASHINGTON The eight largest financial institutions will have to raise roughly $68 billion over the next several years to meet a tough new leverage ratio finalized by regulators on Tuesday.
The Federal Deposit Insurance Corp., the Federal Reserve Board, and the Office of the Comptroller of the Currency unanimously endorsed the ratio, which is designed to prevent the largest banks from becoming as highly leveraged as they were in the lead up to the 2008 financial crisis.
"This is a rule of significant consequence," said FDIC Chairman Martin Gruenberg at the agency's board meeting. "In my view, this final rule may be the most significant step we have taken to reduce the systemic risk posed by these large, complex banking organizations."
Under pressure from top FDIC officials, regulators agreed last summer to go beyond the Basel Committee on Banking Supervision's suggested 3% minimum leverage ratio for the top eight U.S. institutions, which are considered the most systemically important, and tack on an additional buffer for those companies and their insured subsidiaries.
Regulators have repeatedly argued the necessity of raising the leverage ratio to serve as a backstop in order to adequately complement robust risk-based capital rules that have been put into place in recent years.
"It 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," said Fed Gov. Daniel Tarullo, at the agency's board meeting.
As a result, all three agencies agreed to lift how much the biggest banks and their insured subsidiaries are allowed to borrow against their total balance sheets to a total of 5% and 6%, respectively.
Banks such as JPMorgan Chase, Wells Fargo, Citigroup, and Bank of America must begin meeting the tougher requirement starting in January 2018. Despite opposition, they will also have to begin disclosing their leverage ratio starting next year.
The final leverage ratio approved by the agencies, however, can change in the future. All three banking regulators separately agreed to weigh an additional proposal that would make critical changes to how the leverage ratio is calculated.
The adjustments incorporated revisions made by the Basel Committee in January 2014, which included ensuring exposure requirements adequately reflected the economic realities tied to certain transactions that banks regulatory engage in, such as the clearing of derivatives a bank does on behalf of a customer.
Industry representatives said they are looking closely at the new plan. David Wagner, executive managing director and head of finance affairs for The Clearing House, said it was vital that any final leverage rule supplement the risk-based capital regime, but not serve as a binding constraint.
"We will be carefully reviewing and commenting on the U.S. agencies' new proposal to ensure it achieves the right balance on this point and accurately reflects banks' real economic exposure for different types of assets," said Wagner.
Already, all eight firms meet the 3% minimum enhanced leverage, a fact that Jeremiah Norton, a director of the FDIC Board suggested meant that a "more robust leverage ratio" for the biggest banks had been "warranted."
In total, bank holding companies would be required to shore up additional capital of $68 billion, a figure that reflects the final rule and the proposed changes made to the denominator. Their insured depositories would have to raise even more, closer to $97 billion, given the higher threshold they must meet.
Banks have dramatically improved their Tier 1 capital over the last five quarters since the initial estimates were taken based on data from the third quarter of 2012. While banks have made significant improvements, the total aggregate amount they will need to raise is still higher than initial estimates.
Regulators made the case that a tougher rule would incentivize firms to hold capital well above the regulatory minimums.
"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," said Fed Chair Janet Yellen at the board meeting.
Any changes to the denominator would impact the heft of the overall ratio, potentially making a 5% leverage requirement for holding companies much more stringent. As more assets are brought into the definition of the denominator, the tougher the requirement.
Separately, the Fed's staff memo also made clear that the new proposal would not have an impact on the Federal Open Market Committee's ability to pursue its monetary policy objectives.
"The Federal Reserve has a flexible and diverse policy toolkit that can offset most, if not, all unwanted pressures that may develop as a result of the supplementary leverage ratio, and so any effect likely would be limited," according to the Fed's memo.