Compromise on Leverage Ratio Angers Both Sides of Capital Debate

WASHINGTON — A proposal by U.S. regulators to raise the leverage ratio at the biggest bank holding companies and their subsidiaries is already drawing fire from both sides of a raging debate about how high capital requirements must be to ensure no institution poses a systemic risk.

On one side are some top regulators, including Federal Deposit Insurance Corp. Vice Chairman Thomas Hoenig, who worry the agencies may not ultimately go through with the plan, as well as some lawmakers who say it does not go far enough.

On the other are bankers and their representatives who contend the proposal is excessive, forcing the largest institutions to raise billions of dollars in capital and potentially hurting the economy in the process.

"It's a very loud opening salvo," said Karen Shaw Petrou, a managing partner at Federal Financial Analytics. "It will be making a big dent, but it's part of a broader campaign for a still more stringent leverage ratio requirement for the biggest banks."

At issue is a plan approved Tuesday by regulators that would require the biggest bank holding companies to comply with a 5% leverage ratio while their insured subsidiaries face a 6% ratio.

The new requirements would only apply to the eight bank holding companies already identified by the Basel Committee on Banking Supervision as globally systemically important. Under the proposal, banks with at least $700 billion of assets or $10 trillion of assets under custody — a threshold that includes Citigroup, Bank of America and JPMorgan Chase — would have to comply with a minimum supplemental 3% leverage ratio plus an additional 2% buffer to be considered "well capitalized."

Those requirements would be in addition to a 4% leverage ratio for all banks that is already part of a finalized Basel III package, which was approved by the Federal Reserve Board last week and the FDIC and the Office of the Comptroller of the Currency on Tuesday.

If bank holding companies failed to meet the 5% supplemental ratio, regulators would impose restrictions on a firm's ability to make discretionary bonus payments and capital distributions. If the proposal is finalized, it would be stricter than what most other countries will have to adhere to under the international framework.

FDIC officials argued that the originally proposed supplemental minimum threshold of 3% would not have been enough to protect the banking system prior to the financial crisis, and therefore should be significantly higher.

"Analysis by the agencies suggests that a three percent minimum supplementary leverage ratio would not have appreciably mitigated the growth in leverage among these organizations in the years preceding the recent crisis," said FDIC Chairman Martin Gruenberg, at a board meeting to discuss the issue. "Higher capital standards for these institutions would place additional private capital at risk before calling upon the Deposit Insurance Fund and the federal government's resolution mechanism."

All eight U.S. bank holding companies, collectively, will have to shore up an additional $89 billion in capital to meet the higher leverage requirement, while their insured subsidiaries will have to fill a shortfall of $63 billion to meet the proposed 6% leverage requirement.

Still, that did not satisfy some regulators, who said higher leverage requirements should have been part of the final Basel III rule. Hoenig broke with the five-member board of directors and voted against the interim final Basel III rule, saying it had not sufficiently addressed flaws with the proposed leverage ratio, which would be applied to all U.S. banks.

"I cannot support the interim final rule because without a binding leverage ratio, it is incomplete and inadequate," said Hoeing, who advocated for a leverage ratio as high as 10%. "You cannot have a strong capital standard without an adequate leverage ratio, and it should be part of any rule we adopt, even on an interim basis."

Hoenig supported the separate proposal to raise the supplemental leverage ratio on the biggest banks, but argued that waiting 60 days for comment on the plan was a disservice to a complete Basel III package. He said it raised the risk of a stronger leverage ratio being "delayed, or worse, not being adopted." Banks will have to meet the requirement starting in 2018, according to the proposal.

His grievance was also echoed by Jeremiah Norton, a director on the FDIC's board, who has also been very vocal about the necessity of U.S. regulators raising the leverage ratio. Norton hailed the draft plan as a "step in the right direction," and supported the final Basel III rule, but said the agencies took too long to come to an accord.

"It should not have been as difficult as it has been for the agencies to come together on today's leverage ratio proposal, which hardly seems like a seismic shift in capital requirements and represents an attempt to address one of the core causes of the financial crisis," Norton said.

And the draft interagency plan did little to end threats by Congress to raise capital requirements, with some lawmakers saying the suggested hikes were just the beginning.

Sen. Sherrod Brown, D-Ohio, a co-author of a "too big to fail" bill with Sen. David Vitter, R-La., which calls for scrapping Basel III and imposing a 15% leverage ratio on U.S. banks, said the proposal by regulators was a "major step forward, but it should only be the first step."

"We must do more, and this proposal will be insufficient if it is weakened by Wall Street lobbying. That's why we must pass Brown-Vitter and end 'too big to fail' once and for all,"  Brown said in a joint statement with Vitter.

Sen. Bob Corker, R-Tenn., a member of the Senate Banking Committee, said he was "happy" to see the regulators move ahead with a rule "to constrain excessive leverage through the use of a more simple and effective ratio that will help curb a lot of the gaming that goes on with risk weights."

But large banks and their representatives saw the situation differently, with some warning the new requirements are too high.

"This new proposal, combined with existing capital and leverage requirements, will make it harder for banks to lend and keep the economic recovery going," said Tim Pawlenty, president of the Financial Services Roundtable. "To increase the safety and soundness of the industry, the vast majority of banks have already made important strides to increase capital levels. This new heightened requirement would only impact U.S. institutions, resulting in American banks being put at a global competitive disadvantage."

Rob Nichols, the head of the Financial Services Forum, urged "regulators to be mindful of the fact that ever-higher capital requirements, while a critically important element of safety and soundness, can become prohibitive and actually lead to reduced capability to lend to our nation's families and businesses at a time when the economic recovery remains fragile."

Outside analysts said the proposal was serious and that the banks would need time to digest its full impact.

"It's expensive and sure to get more so as it takes further shape," said Petrou. "It's a very significant systemic leverage ratio."

What's of top concern to the largest banks will be how regulators ultimately change part of the supplemental ratio, which includes items like off-balance-sheet assets such as derivatives exposures that are not part of the basic 4% leverage ratio included in the final Basel III rule.

At the FDIC's board meeting, FDIC officials suggested that the size of the denominator for the supplemental ratio for the eight largest bank holding companies would be 43% larger than the current formula. It could potentially be even higher based on further changes the Basel Committee is now considering, which U.S. regulators have said they will incorporate at a later date into a revised ratio.

"They would be very interested in how the Basel Committee will finalize its recent proposed changes to the denominator of the Basel III leverage ratio and whether the U.S. bank regulators will eventually implement those changes in the U.S.," said Andrew Fei, an associate at Davis Polk & Wardwell and a Basel expert.

Wayne Abernathy, executive vice president for financial institutions policy for the American Bankers Association, said "there's certainly going to be a response" by the largest institutions as they discern in the coming days how it will affect their business and capital decisions.

One of the biggest drivers of the debate, he says, will be figuring out what qualifies as capital and assets, which in many ways will have a larger impact than what the actual ratio will be.