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Banks' Dividend Gravy Train Charges Past Regulators

Updated from 9:50 ET with morning market action and comment from Goldman Sachs's equity research team.

NEW YORK ( TheStreet) -- Most bank stocks were up on Tuesday, showing investors' relief that the regulators didn't follow the lead of Senators Brown and Vitter, who in May proposed a radical 15% Tier 1 leverage requirement for the largest U.S. banks.

Bank stocks were weaker on Wednesday morning, with the KBW Bank Index (I:BKX) down 1%, although that may be reaction to China's report that its exports during June declined 3.1% from a year earlier.

Despite federal regulators' move on Tuesday to greatly increase leverage capital ratios for large U.S. banks, the key factor in banks' capital deployment decisions will be the Federal Reserve's annual stress tests.

Just one week after the Federal Reserve, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. issued their final rules to implement the Basel III capital standards for U.S. banks, the three regulators on Tuesday doubled the minimum Basel III supplementary Tier 1 leverage capital requirement for the nation's largest financial institutions.

Under Basel III, banks are required to have minimum Tier 1 leverage ratios of 4%, but large, systemically important banks are required to perform a separate supplementary Tier 1 leverage ratio calculation that incorporates off-balance-sheet items. The minimum requirement for this supplementary Tier 1 leverage ratio is 3%.

Except for U.S. banks. The federal regulators have proposed requiring U.S. banks with total assets in excess of $700 billion to maintain supplementary Basel III Tier 1 leverage ratios of 6%. For large U.S. bank holding companies, the minimum ratio is 5%.

The Basel III capital standards and the Fed's annual stress tests for large banks focus on Tier 1 common equity ratios, which are risk-based ratios. This means that assets are weighted by perceived risk, with cash, for example, having a zero risk rating. So a bank's Tier 1 common equity ratio is always higher than its Tier 1 leverage ratio, or its supplementary Tier 1 leverage ratio.

The new rules proposed Tuesday are subject to a 60-day comment period. The rules are to be phased in beginning in 2015, with full compliance required by January 2018.

At this point in the long phase-in of Basel III, investors may be frustrated at another regulatory monkey wrench one week after the final rules were issued. After all, the large banks were all in full compliance, or close to compliance with the Basel III Tier 1 common equity ratio requirements years ahead of the deadline.

Guggenheim Securities analyst Marty Mosby on Tuesday said "the regulators want to make sure that the large-cap banks don't get too comfortable with where their capital requirements are... This leaves some uncertainty out there to encourage them to be more conservative in their deployment of capital."
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