Some of the largest U.S. banks said a proposed rule to increase the capital they hold against potential losses is arbitrary and would put them at a disadvantage against non-U.S. banks facing easier requirements.

The leverage ratio — proposed by banking regulators at 5 percent for holding companies and 6 percent for their banking units, targets banks with the most assets. In comment letters yesterday, New York-based Citigroup Inc. (C), the third-biggest U.S. bank, said the idea could worsen an uneven global playing field for U.S. banks, and State Street Corp. (STT) said the regulators' proposal showed "no evidence" that they studied the potential impact on banks.

"The minimum ratios are highly arbitrary," said Stefan Gavell, Boston-based State Street's head of regulatory affairs, in a comment letter. The rule could squeeze global custody banks' ability to provide client access to "core payment, clearing and settlement functions," he wrote.

The Federal Reserve, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. proposed a tougher limit on U.S. firms than those agreed to in Basel III international accords. The leverage cap — also affecting JPMorgan Chase & Co. (JPM), Goldman Sachs Group Inc. (GS), Morgan Stanley (MS), Bank of America Corp., Wells Fargo & Co. (WFC) and Bank of New York Mellon Corp. — is meant to limit vulnerabilities in the financial system seen in the 2008 credit crisis.

Basel Backstop

The July proposal is intended to be a backstop to the Basel III risk-based capital rules already set by the U.S. regulators. This week, the agencies will also propose a rule setting a higher standard for the minimum amount of easy-to-sell assets banks have to hold to tide them over during a credit drought.

"A forceful application of the 6 percent requirement contemplated here to the full range of gross bank exposures will clearly create significant benefits for financial stability," nonprofit group Americans for Financial Reform wrote in a comment letter.

Citigroup Chief Financial Officer John Gerspach and Brian Leach, its head of franchise risk and strategy, said that the leverage standards — if the final rule tracks Basel Committee on Banking Supervision ideas for derivatives and securities financing transactions — could put U.S. banks "at a competitive disadvantage, exacerbating an already uneven playing field for U.S. financial institutions."

Capital Demands

While Gerspach said last week Citigroup already meets the proposed capital demands, analysts at Goldman Sachs said in a July report that the capital shortfall at all the banks could approach $98 billion — a gap the report said banks are capable of bridging within three years. Among holding companies, Morgan Stanley and Bank of New York Mellon have the most ground to make up, according to the report.

"Portions of the proposal could operate at cross-purposes with other recent macroprudential, capital, and liquidity reforms," BNY Mellon Chairman and Chief Executive Officer Gerald Hassell said in a letter yesterday. As proposed, it could "totally change the fundamental balance present in the existing U.S. regulatory capital framework."

Because the proposed leverage demands are well above the 3 percent agreed to in Basel, financial industry groups said the simple capital equation could displace risk-based capital as the main buffer instead of acting as a backstop.

'Fundamental' Flaw

"There is a fundamental conceptual flaw in a leverage ratio in that it ignores risk, notwithstanding that capital is specifically intended to act as a buffer to risk," Brett Waxman, associate general counsel at New York-based trade group the Clearing House Association LLC, wrote in a letter. The ratio discourages the holding of low-yield, low-risk assets such as mortgages and government securities, he said.

"The prospect of an excessive, overriding leverage ratio would effectively require much more capital to be held for banks' least risky assets, such as cash," according to a comment letter signed by the Securities Industry and Financial Markets Association, American Bankers Association and Financial Services Roundtable. The groups asked regulators to exempt cash and Treasuries from asset calculations.

Some have advocated even higher leverage minimums, such as former FDIC Chairman Sheila Bair, who favors an 8 percent minimum.

'Improves' Transparency

"A leverage ratio is easy to understand, comparable across firms, and difficult to 'game'," Bair, chairman of the Washington-based Systemic Risk Council, wrote in an Oct. 15 comment letter. "This dramatically improves market transparency about a firm's risk."

Two Democratic lawmakers urged more stringent ratios.

"Every financial crisis has one critical ingredient: excess leverage," wrote Representatives John Conyers of Michigan, and Alan Grayson of Florida. "Whether these liabilities are in the form of derivatives and off-balance-sheet assets or overvalued tulips pledged as collateral, too much debt without loss-absorbing equity to match it is simply too dangerous to exist."

Tod Burwell, president and chief executive officer of BAFT-IFSA, an international financial-services trade group, said in a comment letter that the rule should be postponed until there's further agreement at the Basel committee and a comprehensive impact study is done. He said the proposal could hamper "global trade flows" needed for economic recovery.

Other Banks

The comment letters also included concerns that the rule sends ripples beyond the eight banks directly affected.

"It would potentially create incentives for organizations to hold higher-yielding, higher-risk assets, which likely would lead to a distortion of how the market prices these higher-risk assets," said a letter from banks including Capital One Financial Corp. (COF), PNC Financial Services Group Inc. (PNC) and SunTrust Banks Inc. (STI) "Even institutions that are not subject to the enhanced leverage ratio requirement would feel the impact of changes to asset pricing."

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