WASHINGTON — The Federal Reserve Board has no plans to force big banks to meet Basel III capital requirements early — unless, of course, those institutions want to issue dividends next year.
That, at least, was how observers interpreted comments by Fed Gov. Daniel Tarullo, in which he said the central bank would not "pull forward" several deadlines under the new rules.
Before any banks could take comfort in such assurances, however, he added that institutions would have to show they could meet the revised capital targets if they want to issue dividends next year.
"We will be comfortable with proposed capital distributions only when we are convinced they are consistent with a bank holding company readily and without difficulty meeting the new capital requirements as they come into effect," Tarullo said in a speech Wednesday to The Clearing House.
Observers said Tarullo's message, which was also conveyed last week to the American Bar Association, was unequivocal.
"It was meant to be a warning to the industry," said Greg Lyons, a partner at Debevoise & Plimpton LLP. "We're not going to force anybody to accelerate their capital timing — but keep in mind when you're thinking about paying dividends or redemptions, we're going to expect you pursuant to your capital plans not only to keep pace with the proposals, but frankly demonstrate you're well ahead of where the pace is supposed to be."
Part of the reason the Fed is keeping such a close eye on the situation is the difficulty institutions have in raising capital in such a volatile environment. Bank stocks are under pressure and asset sales can only benefit a bank so much. As a result, the Fed is clearly eyeing retained earnings as the primary means for banks to reach the Basel III capital thresholds.
"These institutions are required to do their plan in a forward looking way," said Karen Shaw Petrou, a managing partner at Federal Financial Analytics Inc. "This is an incredibly difficult exercise under current market volatility conditions. It's not the relatively ordinary scenario building."
In his speech last week, Tarullo emphasized that the Fed expects holding companies to improve their capital ratios through retained earnings, including firms that have already reached their intermediate targets.
That also includes complying with all the Basel III deadlines under the six-year transition period as well as the surcharge institutions may pay because they are considered globally systemically important.
On Friday, regulators released the names of 29 banks considered globally systemically important banks, or G-SIBs, including eight U.S. institutions: Bank of America Corp., Bank of New York Mellon, Citigroup Inc., Goldman Sachs, JPMorgan Chase & Co., Morgan Stanley, State Street, and Wells Fargo.
Tarullo shed more light on the issue when he spoke in New York Wednesday before The Clearing House, a trade group that represents the largest U.S. commercial banks.
"We will be implementing the specific stress testing requirements of Dodd-Frank over the next year," Tarullo said in prepared remarks. "However, in the interim we are using a modified form of stress testing as part of the annual capital planning process we have established for large bank holding companies. This goes well beyond a stress testing exercise."
Tarullo also reiterated comments that the Fed would only allow firms to engage in capital distributions when they can easily meet the Basel III requirements.
"He seems to be the Fed's designee for presaging what proposals are going to be coming," said Lyons. "I can't imagine for these largest banks at The Clearing House there's any more significant issue."
Banks have wrestled with not being able to issue dividends, share repurchases, and redemptions at will without approval by regulators.
JPMorgan received approval last March by the Fed to buyback $8 million in shares in 2011, but was told to wait until next year when it pressed the Fed to allow it to buy more, according to media reports.
It hasn't been the only one.
"The Fed is taking a cautious approach in light of increasing capital requirements under Basel III and the need for continuing wariness about maintaining high levels of capital and depleting those with dividends or stock buybacks," said Chip MacDonald, a partner at Jones Day in Atlanta.
On Wednesday, Tarullo again emphasized the importance of the capital planning process.
"During the financial crisis, we used our safety-and-soundness authority to require banks to hold sufficient capital to weather the impact of the crisis and the serious recession that followed," Tarullo said. "Similarly, our annual capital plan review is a forward-looking exercise that, in estimating losses and reduced revenues that would follow an adverse economic scenario, may result in requiring banks to maintain more capital than would a static, backward-looking snapshot of minimum capital levels."
Starting last year, the Fed has taken steps in slowly allowing banks to reinstate their capital distribution plans since the fallout of the financial crisis. However, not all holding companies have asked to be allowed to do so nor have all been allowed by the Fed to proceed.
As part of that effort, the central bank issued a proposal in June requiring all holding companies with assets of $50 billion or more to issue capital review plans each year as part of its stress test in January.
Final details on how institutions will have to go about convincing regulators they have enough capital to safely reward shareholders with dividends has yet to be released; but is expected in the coming weeks as the Fed begins its 2012 review.
In a comment letter, The Clearing House, along with other trade groups, raised a number of concerns on the Fed's June proposal, including providing institutions more time — at least 12 weeks — to process any of the Fed's stress scenarios and related data requests.
Tarullo said the final rule would respond to a number of concerns raised by some firms and clarify other issues that arose in the 2011 capital review. Those issues, he said, would be addressed in the 2012 exercise such as describing exactly what "constitutes the kind of material change in the risks faced by a firm" that would require a bank to supply an additional capital plan later in the year.
Analysts said the Fed is resolved to ensure institutions remain on track to meet each of the phase-in requirements under Basel III.
"The Federal Reserve was never going to let banks fall behind in meeting the Basel III schedule," Jaret Seiberg, an analyst with MF Global Inc.'s Washington Research Group wrote in a recent research note. "That is why capital distributions are always going to be dependent on being on the Basel III compliance path."
"If you can't make a capital distribution, you're obviously retaining earnings," said Petrou. "That's why it had been clear to me if you weren't meeting Basel, you couldn't distribute capital and therefore you were recapitalizing through retained earnings."