The proposed supplementary leverage ratio requirement goes beyond those approved by the Basel Committee on Banking Supervision in 2010 and has drawn criticism because it provides no incentive for U.S. banks to hold less risky assets. The Basel rules require a leverage ratio with a 3% minimum of equity to assets, allowing banks to decide whether certain loans or securities are risky and require more equity to cover a potential default.
By contrast, the U.S. supplementary leverage ratio has higher absolute capital requirements and weighs a government bond for capital purposes in the same manner as a risky commercial loan. It also counts off-balance sheet exposures such as the grossing-up of derivatives toward a bank's capital requirements. Despite this -- and cries of foul play from U.S.-based SIFIs -- ratings agencies such as Fitch have characterized the leverage ratio as "tough but manageable" by the proposed 2018 effective date.
Some observers believe that additional capital levies might prompt some U.S. SIFIs to push into riskier areas as they seek higher returns. Killian argues that banks may also focus on business areas that do not require much capital support such as operations and payment processing.
Skeptics note that reorienting a business model toward processing may be challenging given it is a capital-intensive, commoditized business that has already consolidated. Among those that dominate the financial processing business are Bank of New York Mellon (BK), JPMorgan Chase and State Street.More broadly, Spencer notes that new regulatory and capital requirements have already slashed returns on equity for large banks -- risking their appeal to investors if returns fall much further. "For [global] SIFIs, returns on equity are about half what they were pre-crisis: ROEs were about 12% to 13% between 2004-2006 and today they are 8% or 9 %, so there's tremendous downward pressure on returns caused by the new rules," he says, adding that banks need both stronger loan growth and rate increases for sustainable earnings improvement. "Large banks' book-to-value ratios were at 2.5 to 3 times pre-crisis and are currently 1.5 times, so investors have concern about industry growth prospects." Advocates of higher capital requirements argue that while ROEs are falling, the longer-term pay-off is far greater: a capital cushion to absorb losses and reduce the fragility of the banking system, slashing the risk of taxpayer bailouts in times of crisis. The intense focus on ROE is relatively recent. Banks in the 1950s and '60s were heavily regulated and had low ROEs while still providing ample lending for a booming, if very different, economy. Fierce competition in finance, public ownership and the ascendancy of shareholders put increasing focus on ROE in the 1970s and '80s, driving bank mergers, both geographically and by product line, and boosting leverage.
Select the service that is right for you!COMPARE ALL SERVICES
- $2.5+ million portfolio
- Large-cap and dividend focus
- Intraday trade alerts from Cramer
- Weekly roundups
Access the tool that DOMINATES the Russell 2000 and the S&P 500.
- Buy, hold, or sell recommendations for over 4,300 stocks
- Unlimited research reports on your favorite stocks
- A custom stock screener
- Upgrade/downgrade alerts
- Diversified model portfolio of dividend stocks
- Alerts when market news affect the portfolio
- Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
- Real Money + Doug Kass Plus 15 more Wall Street Pros
- Intraday commentary & news
- Ultra-actionable trading ideas
- 100+ monthly options trading ideas
- Actionable options commentary & news
- Real-time trading community
- Options TV