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Too Big to Fail Banks Prepared for Basel III: Fitch Ratings

NEW YORK ( TheStreet) - The nation's largest 'too big to fail' banks and their undersized competitors are able to meet tougher capital standards soon to be adopted by the Federal Reserve, according to a Friday report from Fitch Ratings

Most U.S. banks already have the capital in place to meet tougher Basel III capital standards, Fitch said, while noting megabanks such as JPMorgan (JPM - Get Report), Citigroup (C - Get Report) and Bank of America (BAC - Get Report) that are deemed global systemically important financial institutions (G-SIFI's) also are also able to meet higher requirements

"Fitch considers that most of its rated banks would be likely to achieve a full 7% [tier one common equity] ratio ahead of full implementation," Christopher Wolfe, a Fitch Managing Director, wrote in a Friday ratings note. "The largest banks, those designated as global systemically important financial institutions (G-SIFIs) already exceed the required minimum, and with few exceptions, would also meet G-SIFI buffers."

Regulators are asking that the world's largest and most interconnected banks hold an extra capital cushion above ordinary banks, given the havoc such institutions can wreak on global markets in the event of a credit crunch or panic.

On July 2, the Federal Reserve approved a final rule that will implement Basel III, however, the Office of the Comptroller of the Currency (OCC) and Federal Deposit Insurance Corporation (FDIC) have yet to do so. Basel III is expected to phase in in 2014 and 2015 for large and small banks.

The Fed has made "meaningful progress" in repairing the U.S. financial system, Federal Reserve Governor Jeremy C. Stein said on June 28. Stein highlighted the finalization of Basel III capital rules, the central bank's stress testing and progress made on a so-called 'resolution authority' to wind down failing large banks.

The Fed governor, however, indicated further work may need to be done to end a perception of 'too big to fail.'

"I would not characterize this as job done," Stein said. "I think there is potentially a further road to go on large institutions."

Even if the nation's most systemically important banks and their smaller regional banking brethren have the capital in place to meet new global regulations, the industry and its investors are poised to see big change.

Notably, Basel III rules may change the accounting for some crucial components of bank earnings such as gains and losses firms record on the assets they hold out as available for sale (AFS). Under new rules, gains and losses on AFS portfolios will flow into their balance sheet as other comprehensive income (OCI) and be reflected in regulatory capital ratios.

"Banks subject to this requirement will need to manage their balance sheets carefully to minimize OCI fluctuations, and thus will need to operate with an adequate cushion above minimum requirements," Wolfe, the Fitch Managing Director, wrote.

Large commercial banks such as JPMorgan, Bank of America, Citigroup and even Wells Fargo (WFC - Get Report) hold considerable AFS portfolios, all of which face a slowing or reversal in gains as interest rates rise from historic lows.

Wells Fargo, for instance, calculated in its most recent quarterly earnings filing with the Securities and Exchange Commission its AFS portfolio would fall $4.8 billion in the event of a 200 basis point rise in interest rates. Across the banking industry, some calculations indicate losses would reach just under $20 billion, if interest rates continue a torrid rise.
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