This is the second of a three-part series rebutting the three most popular approaches toward lowering the systemic risk of large U.S. banks. Make sure to read Part 1, on breaking up the big banks and Part 3, on the folly of bringing back Glass-Steagall.
NEW YORK ( TheStreet) -- The Federal Reserve's annual stress test process has done a lot of good, but the tests need to be broadened to include stresses to liquidity as part of the regulator's "severely adverse scenarios."
This is the second of our three-part series rebutting the three major ideas for ending the perception that the nation's largest banks are "too big to fail," focusing on the emphasis of regulators on making sure large banks have enough capital to avoid another government bailout.
In part one we discussed the prospects of simply breaking up the six largest U.S. banks. The easiest way for politicians to achieve that goal, rather than passing legislation directly to break them up, would be to increase the capital ratio requirements for the big six banks so high, that their shareholders would conclude that breaking up would be the only choice.In part three, we consider the cries to bring back the Glass-Steagall amendment to the Banking Act of 1933, which, for the most part, separated investment banking from commercial banking.
Dodd-Frank, Stress Tests and CapitalAs required under the Dodd-Frank Wall Street Reform and Consumer Protection Action of 2010, the Federal Reserve has been conducting annual stress tests to gauge the nation's largest banks' ability to withstand a severe and immediate recession, while continuing to lend and remaining "well-capitalized," with Tier 1 common equity ratios of at least 5.0%.
Here's a quick look at the capital ratio improvement for the six big banks known as "megabanks," under the misguided plan to "walk away" from the Basel III capital standards, not to mention Dodd-Frank's capital directives, that was proposed by senators Sherrod Brown (D., Ohio) and David Vitter (R., La.) last month:
- Bank of America's (BAC - Get Report) ratio of tangible common equity to tangible assets increased to 6.78% as of March 31 from 3.35% at the end of 2007, according to Thomson Reuters Bank Insight. The company reported a March 31 estimated Basel III Tier 1 common equity ratio of 9.42%, putting it in compliance with the Federal Reserve's proposed enhanced capital requirements years ahead of the full implementation in January 2019. The Basel III Tier 1 common equity ratio applies risk-weighting to the assets in the denominator, unlike the tangible common equity ratio. For global systemically important banks (GSIFIs), an additional capital buffer over the 7.0% minimum Basel III Tier 1 common equity ratio is required. Bank of America's buffer is 1.5%, making for a full Basel III Tier 1 common equity ratio minimum requirement of 8.5%.
- JPMorgan Chase's (JPM - Get Report) March 31 tangible common equity ratio as of March 31 was 6.28%, increasing from 4.76% at the end of 2007. The company's estimated Basel III Tier 1 common equity ratio was 8.9% as of March 31. JPMorgan's fully phased-in Basel III Tier 1 common equity ratio requirement will be 9.5%, including a GSIFI buffer of 2.5%.
- For Citigroup (C - Get Report), the tangible common equity ratio was 8.71% as of March 31, increasing from 2.72% at the end of 2007. The company's estimated Basel III Tier 1 common equity ratio was 9.3% as of March 31. Citi's fully phased-in Basel III Tier 1 common equity ratio requirement will be 9.5%, including a GSIFI buffer of 2.5%.
- Wells Fargo's (WFC - Get Report) tangible common equity ratio was 8.29% as of March 31, increasing from 5.99% at the end of 2007. The company's estimated Basel III Tier 1 common equity ratio was 8.39% as of March 31. Wells Fargo's fully phased-in Basel III Tier 1 common equity ratio requirement will be 8.0%, including a GSIFI buffer of 1.0%.
- For Goldman Sachs (GS), the March 31 tangible common equity ratio was 6.95%. A comparable figure for year-end 2007 is not available since the company was not required to publicly disclose its capital ratios until it was registered as a bank holding company in 2008, making it eligible for access to the Federal Reserve's discount window. But based on the reported numbers, Goldman's ratio of tangible equity capital to total assets was 3.82% at the end of 2007. The company's estimated Basel III Tier 1 common equity ratio was 9.0% as of March 31. Goldman's fully phased-in Basel III Tier 1 common equity ratio requirement will be 8.5%, including a GSIFI buffer of 1.5%.
- Morgan Stanley's (MS - Get Report) tangible common equity ratio was 6.43% as of March 31. Like Goldman, the investment bank became a bank holding company during 2008, so a comparable tangible common equity ratio isn't available for the end of 2007. However, based on the reported numbers, Morgan's ratio of total shareholders' equity to total assets was just 2.99% as of Dec. 31, 2007. The company's estimated Basel III Tier 1 common ratio was 9.8% as of March 31. Morgan Stanley's fully phased-in Basel III Tier 1 common equity ratio requirement will be 8.5%, including a GSIFI buffer of 1.5%.
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