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Feds Move Forward With Tougher Bank Debt Limit

The Basel III framework, approved in January, added tougher rules about how big banks must calculate their ratio. Kevin Petrasic, partner at Paul Hastings in Washington, said the calculation proposal if adopted in its current form as expected, will increase the amount of capital big banks must hold on their balance sheets. He said a provision would require banks to consider off-balance-sheet assets towards the calculation, a move that would hike the amount of capital they must hold. He added that the proposal also toughens how some derivatives exposures are calculated, another move that will increase the amount of capital they must hold.

"What the Basel folks did in January and what the U.S has done with this complementary proposal, is to essentially develop a much more expansive view of what counts towards the denominator, which will limit debt more so," he said.

The rule maintains tough requirements to have banks count Treasury Securities, excess reserves held at the Fed and cash for the purpose of the limit. Banks may want to shed some of these liquid assets to allow them to hold less capital on hand and still meet the leverage ratio. However, regulators are also working on a so-called liquidity coverage ratio that would require them to hold more liquid assets that they could sell easily in the event of a crisis.

"These two rules appear to be in conflict with each other," said one lawyer following the Fed's efforts.

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The new proposal is expected by regulators to modestly increase restrictions in aggregate but some observers believe it could end up easing capital buffer restrictions for some institutions. Greg Lyons, co-chairman of Debevoise & Plimpton's financial institutions group in New York, said he believed that for some banks the proposal might be less restrictive as to the denominator calculation than the previous standard.

The leverage ratio is considered tougher than other bank capital buffer rules because it is calculated as a percentage of a bank's total assets and doesn't rely on risk-based capital modeling requirements that are easier to manipulate through banks' internal modeling. However, Fed officials argued that the risk-based rules and the leverage ratio are intended to complement each other.

The new rules come after Sen. Sherrod Brown, D-Ohio and other lawmakers on Capitol Hill have been calling on federal bank regulators to break up the biggest banks, arguing that they are too large and complex to exist at their current size. Regulatory observers argue that the decision by the Fed, OCC and FDIC to move towards tougher leverage limits was driven, partly, by an effort to appease disgruntled lawmakers like Brown. However, the rules also were driven by certain regulators who have been pushing the Fed and FDIC from the inside to limit bank riskiness through leverage caps. At the FDIC, two Republican commissioners, Tom Hoenig and Jeremiah Norton, were key drivers of the tougher leverage restriction.

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