WASHINGTON A draft plan by U.S. regulators to significantly increase a leverage requirement for top U.S. financial institutions is at odds with a separate proposal to force banks to hold highly liquid assets to buffer against market crises, according to senior bank executives.
In more than a dozen letters to U.S. banking agencies, firms like Bank of New York Mellon and Citigroup along with trade groups that represent the largest U.S. banks repeatedly expressed concerns that the proposal to raise the leverage ratio was at "cross-purposes" with other pending rules.
U.S. banks argue that the proposal would subvert the purpose of Basel III by discouraging firms from holding reserves of liquid assets.
"A leverage ratio that functions as the binding constraint could actually undermine rather than promote financial stability and actually contribute to, rather than mitigate, systemic risk," wrote Brett Waxman, senior vice president and associate general counsel for The Clearing House in a letter.
Under the plan, the eight largest financial institutions, including JPMorgan Chase, Bank of America, Citigroup and Wells Fargo, will have to comply with a so-called supplementary leverage ratio in order to add an extra safeguard in the event of a financial crisis.
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.
But affected firms say they will wind up being penalized for complying with a separate requirement called the Liquidity Coverage Ratio, or LCR, which requires banks to hold a buffer of high quality liquid assets against expected stress outflows over a 30-day period.
A higher leverage ratio, they say, would create pressure on banks to shed liquid assets above the minimum required under the liquidity rule and encourage banks to curtail activities that put liquid assets on their balance sheets.
"In many respects the supplementary leverage ratio is fundamentally at odds with the important liquidity reform work the agencies are undertaking," wrote Gerald Hassell, chairman and CEO of Bank of New York Mellon, in a letter. "The agencies are not simply proposing super-equivalent leverage standards, which would be their prerogative, but are proposing to totally change the fundamental balance present in the existing U.S. regulatory capital framework."
A Fed official disputed such critiques last week, arguing that the liquidity coverage ratio would set up a floor that effectively establishes a minimum of high-quality liquid assets that banks would have to hold. That would negate any incentive for a firm to reduce the amount of high-quality liquid assets it would hold as a result of the leverage ratio, the official said.
But John Gerspach, Citigroup's chief financial officer, urged U.S. regulators to take a "comprehensive and holistic approach" in crafting such new requirements so as not to distort incentives.
"The interaction of different leverage, capital, liquidity, debt and wholesale funding-related requirements is not well-understood, but in fact may lead to incentives that increase risk in the system, as banks seek to 'optimize' their balance sheet structure across these different requirements," Gerspach wrote.
Firms also expressed worry over the impact a binding constraint would have on U.S. banks by altering certain types of financing or potentially causing international pricing dislocations.
"A binding leverage ratio undercuts attempts to make financial institution liquidity more robust," the American Bankers Association, Securities Industry and Financial Markets Association, and Financial Services Roundtable wrote in a joint letter.
The three trade groups outlined several drawbacks in regulators' plan to set a binding constraint. For example, it would incentivize banks to hold higher yielding, yet far more risky assets and also wind up hurting those firms that held risk-free or very low risk assets like cash and government securities.
"This goes against the intent of the improvements to liquidity risk management put forth by the Basel Committee and endorsed by the G20 and by the U.S. regulators," the trade groups wrote.
Industry critics strongly encouraged regulators to postpone finalizing the rule until global policymakers concluded their work in determining what exposures would be captured in a separate, but related part of the calculation. The Basel Committee plans to replace the Current Exposure Method from the current risk-based capital rules with an alternate, simplified method for capturing derivatives exposure.
"Citi remains concerned that such measures should not be finalized without full consideration and understanding of the impact of any subsequent alterations in the exposure method," said Gerspach.
The Clearing House went even further, suggesting that regulators should hold off finalizing a rule until U.S. regulators proposed an additional regulation to impose a capital surcharge on those 8 U.S. financial institutions. Fed officials have signaled they would submit a proposal to implement the additional capital buffer later this year.
"Until the international process through the Basel Committee of considering revisions to the exposure measure is completed, and until the agencies address the G-SIB surcharge for affected U.S. banks, it simply is not possible to accurately evaluate the impact of the recalibration included in the U.S. leverage proposal," wrote Waxman of The Clearing House.
While the scope of the leverage rule is limited to the largest eight firms, more than half a dozen banks, including Capital One, PNC Financial, SunTrust and Regions Financial, argued the impact of the new requirement on firms could be much broader, if implemented as proposed.
"Even institutions that are not subject to the enhanced leverage ratio requirement would feel the impact of changes to asset pricing," seven U.S. firms wrote in a joint letter. "A binding leverage ratio also would penalize banking organizations for holding risk-free or very low risk assets, such as cash and government securities."