WASHINGTON — Two Federal Deposit Insurance Corp. board members are urging policymakers to strengthen a leverage ratio that would be applied to banks of all sizes before regulators finalize the U.S. version of Basel III rules.
FDIC Vice Chairman Thomas Hoenig and Jeremiah Norton, a director on the agency's board, are both calling for a significantly higher leverage ratio beyond the 4% that was proposed by regulators in June. They argue that the ratio is insufficient to protect the banking system, noting that banks held just 3% in tangible equity to total assets prior to the financial crisis. (The largest banks also face an additional 3% supplemental leverage.)
"If we're picking a number that wouldn't have been as effective as we wanted it to be going into the crisis, then the answer coming out of the crisis is: more can be achieved," said Norton in an interview with American Banker.
Fellow board member Hoenig has also repeatedly called on officials to scrap Basel III for a more straightforward minimum requirement that banks maintain a tangible capital ratio.
"Tangible leverage needs to be the primary measure of capital adequacy and it needs to be much higher for the largest banks," said Hoenig in a separate interview where he endorsed Norton's effort to further dissect problems with the proposed leverage ratio.
Norton raised the issue in February when he suggested that U.S. regulators should consider tangible common equity and Tier 1 common equity when establishing a leverage ratio requirement. He said that the current Basel III proposal relies too heavily on risk-weightings that do not adequately capture risk.
"Evidence suggests that globally active and complex banks often run at a lower level of capital with higher leverage," said Norton in the interview. "Reducing leverage will help the safety of the banking system and make it stronger."
Doing so could potentially make the leverage ratio stricter than the current Basel III plan that U.S. regulators proposed this summer and also might delay U.S. policymakers from finalizing the package of rules. Norton has not suggested how high the ratio should be.
"There is a case to be made we would benefit from a higher leverage ratio," said Norton. "Directionally, I think, it should be significantly higher than 3%. We should have a process that everybody can weigh in. I think that's a reasonable way to go about it."
He proposed that policymakers review it while they are weighing industry comments, and said it wouldn't take too much time for regulators to revamp the ratio if desired.
"The debate on the leverage ratio has been in place for a long time," said Norton. "I'm not sure we would need a whole lot of time to do it, but what I think is important is that we get the right framework in place as opposed to going forward with something that would be incomplete at the end of the day."
Regulators indefinitely postponed final Basel III rules in December, saying they needed more time to review thousands of comment letters submitted by industry members. They have hinted that a final package could be delivered in the spring.
Norton has previously argued that a leverage ratio based on total assets is a far better indicator of bank distress than a risk-based capital ratio. Additionally, methodology used to calculate risk weights is often too complex and provides banks with an opportunity to manage those assets in order to reduce their capital requirements.
He and Hoenig are uneasy with the current approach because of the reliance on risk-weighted assets, like residential mortgages and sovereign debt, which fail to account properly for risk.
Hoenig's solution to the problem, however, is markedly different. He said that regulators should set a tangible capital ratio of 10% with items like tax-deferred and goodwill excluded from the calculation. He argues that regulators would be better off with a measure that is easily calculated, understood and enforced. Risk weights can then serve as a backup system for regulators.
Because of the complexity of Basel III, Hoenig said it opens an opportunity for firms to game the system and manipulate their risk weights to look like they have higher capital ratios even though they are no more resilient. (Hoenig is scheduled to give a speech on the topic of leverage ratios and the latest agreement in Basel, Switzerland, on Tuesday.)
"Don't you feel better with 20% capital? But are you safer? Have you allocated anything better? Do you expect a better outcome?" said Hoenig.
He said he also believes that regulators must strengthen their ability to assess the risks of banks' portfolios and therefore the quality of their capital.
But even with a potential delay, both make the case it's about getting the requirements right. They agree that changes to the leverage ratio should be undertaken within the current process, not as a separate proposal.
"I don't think the driving force should be a deal," said Hoenig. "I think the driving force should be the right package for the industry. It's better to say 'Let's have a debate. Let's think about it. Let's do it right. So we don't have to do it over later.' "