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Morgan Stanley, Goldman Brutalized by Proposed Capital Rules: Citi

Stocks in this article: MSGSBACJPMWFCBKSTT

NEW YORK ( TheStreet) -- Proposed leverage capital rules for large banks may hit Goldman Sachs (GS) and Morgan Stanley (MS) the hardest, according to Citigroup analyst Keith Horowitz.

Federal regulators on July 9 proposed new leverage capital requirements for the nation's banks, just one week after the Federal Reserve finalized its rules to implement the Basel III capital requirements.

The large banks have for several years been on a path to full compliance with Basel III, with most reporting estimated June 30 Basel III Tier 1 common equity ratios at or near the levels that will be required when the rules are fully implemented in January 2019.

But things are not so simple for the big banks, because of federal regulators' new requirements and the added complication of the Basel Committee's proposed changes for ratio calculations.

The U.S. regulators have proposed U.S. bank holding companies with total assets of at least $700 billion or at least $10 trillion in assets under custody, be required to maintain supplementary Basel III Tier 1 leverage ratios of 5%, with their bank subsidiaries being required to maintain minimum supplementary Basel III Tier 1 leverage ratios of 6% in order to be considered well-capitalized.

The proposed rules affect the following U.S. holding companies and their bank subsidiaries:

  • JPMorgan Chase (JPM)
  • 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 Basel III Tier 1 common equity ratio is a risk-based ratio, meaning a bank's assets are weighted, as defined by regulators. Cash or U.S. Treasury bonds, for example, have zero risk-weightings. A one-to-four family residential mortgage loan that was properly underwritten, with the borrower keeping current on payments, is assigned a 50% risk-weighting. Any other one-to-four family mortgage loan has a 100% risk weighting.

But the leverage ratio isn't risk based, meaning that the banks must hold the same amount of capital for a non-risky asset, such as cash, as they do for a risky asset, such as a junk bond or a loan that lacks collateral.

Under Basel III, banks are required to maintain leverage ratios of 4%, while the global systemically important financial institutions (GSIFIs) are also required to maintain supplementary leverage ratios of 3%. The supplementary leverage ratio requirement is lower, because it incorporates off-balance-sheet assets in the denominator.

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