Brown-Vitter Bill May Have Negative Ratings Impact For Banks: S&P

NEW YORK ( TheStreet) -- The new Brown-Vitter bill that proposes a new, higher capital standard for banks may have a negative impact on bank ratings if enacted, Standard and Poor's Rating Services said in a report Thursday.

The draft of the legislation introduced earlier this week proposed that banks with assets greater than $500 billion raise capital levels to at least 15% of total assets (including off-balance sheet items), with regional banks with assets in the $50 billion to $500 billion range required to have a minimum of 8%.

The bill attempts to offer a simpler, yet harsher alternative to the Basel III capital rules for banks, which is now the internationally agreed standard.

Basel III requires the large banks to hold a minimum of 7% in common equity capital, while the too-big-to-fail banks are required to hold an additional buffer of up to 2.5%, depending upon their size and complexity. JPMorgan Chase ( JPM) and Citigroup ( C) will need to hold 9.5% under Basel III for instance, while Bank of America ( BAC) will need to hold 8.5% and Wells Fargo ( WFC) will have to hold 8%. Those capital requirements are considerably lower than what the new bill proposes.

Moreover, Basel III follows a risk-weighted capital approach, requiring banks to hold more capital against risky assets, such as junk bonds. The Brown-Vitter bill does away with risk weights, arguably in response to critics of the Basel rules who believe the risk weights are arbitrary.

While the higher capital adequacy would, in theory, reduce bank riskiness, "rating implications would likely be neutral to negative for those banks the bill affects," S&P said. "A possible economic downturn is likely to more than counteract the positive impact from higher capitalization. In addition, banks' franchises could weaken as a result of fewer sources of revenue, and they could engage in more risk-taking because of less focus on risk-weighted capital charges."

The analysts are worried that the transition period of 5 years to adapt to the new requirements is too short under the proposed bill. Banks would have to raise $1.5 trillion in capital under the new standards, according to the report.

Banks are unlikely to be able to raise that much capital from the markets, given the tremendous dilution and lower return on equity, and will be forced to break up or deleverage. This could spark a credit crunch, the analysts fear, which could cause an economic downturn that would further hurt banks.

The rejection of the Basel III Capital rules is also of concern to the analysts because it might leave the U.S. banks on an "uneven playing field vis-à-vis their global peers."

TheStreet's Philip van Doorn has a more detailed critique of the proposed legislation.

The bill will however succeed at one level. It might help to eliminate the perception that some banks are too big to fail, which allows those banks to get an implicit subsidy from the market.

"Whether the largest banks become smaller because of breaking up or deleveraging, we will assess the ongoing interconnectedness of these entities and determine whether they would still be classified as highly systemically important under our criteria. Should we conclude that these banks are no longer highly systemically important we would likely not factor support into our ratings," the report said."However, higher capital could, in some instances, offset the loss of uplift of support on the issuer credit rating."

-- Written by Shanthi Bharatwaj in New York.

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