WASHINGTON International regulators' decision to ease a final global leverage ratio will force the U.S. agencies to decide if they will follow suit and could cause them to make the domestic version of the ratio even tougher.
The Basel Committee on Banking Supervision on Sunday made several concessions to the world's biggest banks by changing how financial institutions treat derivatives and repurchase agreements. Such modifications impact a key part of the leverage ratio calculation: the denominator of certain bank exposures.
U.S. regulators' decision is two-fold. First they must decide whether they will incorporate changes on how banks will calculate their exposure to repos and derivatives. Secondly, they must decide whether they should modify the actual leverage ratio from their July proposal to account for the difference in how they calculate the denominator.
It's unclear how regulators will proceed, but some lawmakers were already urging regulators not to ease up.
"Heavy lobbying from the Wall Street megabanks led international banking regulators to water down leverage ratio standards," said Sen. David Vitter, R-La., a member of the Senate Banking Committee and co-author with Sen. Sherrod Brown, D-Ohio, of a bill to raise capital requirements on the largest institutions. "Quite frankly, it's dangerous and understates the risks in the system. We need to be bold and set an example in the U.S. and show that a strong increased leverage ratio is better for the safety of our system."
But observers said the global changes, while offering the industry some victories, made sense.
"The Basel leverage framework is an appropriate rule, not a 'watered down' one as many will allege," said Karen Shaw Petrou, a managing partner at Federal Financial Analytics Inc. "Netting reduces risks when done right and rules should recognize risk reduction incentives."
Among the changes global regulators made to the initial proposal included several technical adjustments on how banks will calculate their exposure to repos, cleared transactions and derivatives.
The adjustments by the Basel Committee appeared to accommodate concerns aired by the industry in ensuring exposure requirements adequately reflected the economic realities tied to certain transactions that banks regularly engage in, such as the clearing of derivatives a bank does on behalf of a customer.
"In terms of making the Basel III leverage ratio a more credible and meaningful backstop measure that better reflects economic reality rather than overstate certain exposures, some of the Basel Committee's final revisions to the denominator may be characterized as a step in the right direction," said Andrew Fei, an associate at Davis Polk & Wardwell.
Still, it is an open question of how U.S. regulators will look to amend their own rule.
"It will be interesting to see when the U.S. ratio comes out if it is stricter once again than the international standard," said Greg Lyons, a partner at Debevoise & Plimpton.
In July, U.S. regulators issued a plan that would require the eight largest financial institutions, including JPMorgan Chase (JPM), Bank of America (BAC), Citigroup (NYSE: C) and Wells Fargo (WFC) to comply with a so-called supplementary leverage ratio in order to add an extra safeguard in the event of a financial crisis.
Under the plan, which has yet to be finalized, the biggest bank holding companies would have to meet a 5% leverage ratio, while their insured subsidiaries face a 6% ratio. That would come on top of a 4% leverage ratio already applied to all banks under the Basel III package finalized this summer.
"U.S. banks face a major challenge the enhanced supplemental leverage rule which I think will follow the Basel structure, but tack on additional capital requirements," said Petrou.
U.S. regulators have previously signaled they had been awaiting the Basel Committee to complete its work on the leverage rule and would be open to making changes as a result.
Observers anticipate that the U.S. will adopt the Basel leverage framework, but like past regulations tied to capital and liquidity, make it tougher than the international standard.
There is some early consensus that regulators are will not lower the 6% proposed ratio, especially given the heightened focus by board members on the Federal Deposit Insurance Corp. and political pressure not to weaken standards.
"It's unlikely they'll move below the 6%," said Lyons. "The leverage ratio is for a lot of the FDIC board a particularly sensitive issue. It will be interesting to see if they try to push to have the U.S. standard be somewhat stricter."
But that is unlikely to stop industry from lobbying on the issue, hoping regulators will lower the overall leverage ratio to keep a balance between leverage and risk-based capital rules.
"If the denominator of the Basel III leverage ratio has become more expansive compared with the original December 2010 version because of the Basel's final revisions, then re-evaluating the proposed 5% and 6% levels seems appropriate, but whether U.S. regulators will do so remains to be seen," said Fei.
A telling sign of which direction regulators may be going in is how quickly they move to finalize the U.S. leverage rule.
"If the U.S. rules comes out reasonably quick, I think it's indicative that they are more or less adopting the Basel III approach," said Lyons.
In order to ensure consistency, U.S. regulators would also have to issue a separate proposal that would modify the final Basel III rules agreed upon in July to reflect all changes in the global leverage rule.
One other issue global regulators left open was the existing tension between liquidity and leverage rules in the Basel framework. U.S. banks have argued that the proposal to raise the leverage ratio would be at "cross-purposes" with new liquidity requirements.
Under the liquidity proposal, banks must hold a buffer of high quality liquid assets like Treasuries and cash against expected stress outflows over a 30-day period. A higher leverage ratio, they argue, would only wind up creating pressure on banks to shed liquid assets above the minimum required under the liquidity rule.