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Big Bank Bashers See First Unintended Consequences

NEW YORK (TheStreet) -- The exit from student lending by JPMorgan Chase (JPM) is not simply an effort by the largest U.S. bank to "simplify" its business.

It's an unintended consequence of new capital rules proposed in July to "reduce the likelihood of economic disruptions caused by problems" at the nation's largest banks. Ironically, the new capital rules are forcing the biggest banks to shy away from less risky and lower-margin businesses like student loans. That will make the big bank more risky overall, while also enhancing returns to investors, as the banks focus on higher-margin areas of business.

The Wall Street Journal on Friday reported that JPMorgan in October would stop making student loans to its customers; the bank had already stopped making student loans to noncustomers last year. According to the report, the bank is seeking to "simplify its operations amid heightened scrutiny from regulators," in the wake of the "London Whale" hedge trading losses, which in 2012 amounted to at least $6.2 billion before taxes.

But there is another major reason for JPMorgan to exit student lending and other low-risk, low-margin businesses the company was historically happy to participate in: Under regulators' proposed leverage capital rules, the largest banks will have the same capital requirement for a safe asset, like cash for example, as they will for junk bonds or risky noncollateralized loans, such as credit card loans.

Federal Regulators' proposal of new leverage capital requirements for the nation's banks on July 9 -- which came only one week after the Federal Reserve finalized its rules to implement the Basel III capital requirements -- raised required leverage capital ratios for bank subsidiaries of U.S. bank holding companies with total assets of at least $700 billion, as well as those with at least $10 trillion in assets under custody.

In addition to JPMorgan, the new rules affect the following bank holding companies:

  • Bank of America (BAC)
  • Citigroup (C)
  • Wells Fargo (WFC)
  • Goldman Sachs (GS)
  • Morgan Stanley (MS)
  • State Street (STT)
  • Bank of New York Mellon (BK)

The nation's biggest bank holding companies have shown their ability to fully comply with minimum Basel III capital requirements, many years ahead of the full Basel III implementation in January 2019. The big banks for many years have been "managing to" the Basel III requirements, which center on the Tier 1 common equity ratio -- a risk-based ratio.

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