NEW YORK (The Deal) -- Federal bank regulators on Tuesday moved forward with tough leverage restrictions on the largest eight U.S. banks as part of an effort to ensure they rely less on debt and have enough capital to withstand a financial crisis like the one that shook the economy in 2008.
The Federal Deposit Insurance Corp., Office of the Comptroller of the Currency and the Federal Reserve voted unanimously at two separate meetings to adopt both a tough leverage limit rule and to introduce a proposal that officials say would "modestly" strengthen how the debt cap is calculated. Ultimately, observers will need to wait until the calculation proposal is adopted before the combined regulation is completed.
Regulators have some time to review and adopt the proposal because the debt restrictions don't take effect until Jan. 1, 2018.
"This final rule may be the most significant step we have taken to reduce the systemic risk posed by these large, complex banking organizations," said FDIC Chairman Martin Gruenberg. He added that the rules will reduce the likelihood that regulators will need to employ a special system being set up as an alternative to bankruptcy to dismantle a large failing bank so that its collapse does not cause Lehman-like collateral damage to the markets.
The move to impose tougher leverage caps comes, partly in response to pressure applied by some lawmakers on Capitol Hill, who are urging policymakers to break up the largest banks in response to the 2008 financial crisis.
Specifically, regulators adopted a rule, which was proposed in July, that require the biggest federally insured commercial banks to hold 6% of their total assets in capital as part of a leverage ratio, twice that agreed to in a 2010 global agreement on bank capital known as Basel III. Bank holding companies would need to hold 5% of their total assets in capital as part of the measure. The move is a significant improvement over the period 2006 to 2008, when there was no binding leverage ratio at all on the largest U.S. institutions.
However, regulators also voted to introduce a proposal that would add new details for how the leverage cap is calculated. Proponents say the proposal would make the leverage cap modestly tougher in aggregate if adopted however some observers contend it could ease restrictions for some banks. Regulators said they introduced it so they can incorporate a new methodology approved by the Basel Committee on Banking Supervision in January for calculating the leverage cap. The proposal is an attempt to harmonize U.S. and international rules for calculating the debt cap, even though the U.S. banks would ultimately need to hold much more capital than what the international framework requires.
FDIC and Federal Reserve officials say that the top eight banks must raise an estimated $95 billion to meet the 6% leverage ratio for insured commercial banks. That includes $38 billion to comply with the rule approved Tuesday and an estimated additional $57 billion to meet the requirements in the tougher leverage cap proposal. They said that this estimate is based on a variety of assumptions and that the banks appear to be well on their way to meeting the restrictions by 2018. In 2015 Banks must start disclosing how they calculate their leverage ratios.
The rules impact banks with more than $700 billion in assets. Regulatory observers predict that Bank of America (BAC) and Wells Fargo (WFC) would have the least difficulty meeting the new restrictions of the eight financial institutions that are impacted. The other institutions that must comply include Citigroup (C), Goldman Sachs (GS), JPMorgan Chase (JPM), Bank of New York Mellon (BK), State Street (STT) and Morgan Stanley (MS). Federal Reserve Governor Dan Tarullo noted that the proposal would modestly increase capital requirements though with "potentially different impacts on different firms." However, regulators did not disclose which banks will have the most trouble.
Proponents of a stronger U.S. cap argue that a tough leverage limit is another way to ensure big banks have sufficient capital cushions so that any future financial problems they might experience won't spread havoc throughout the global economy as many over-leveraged banks did during the 2008 financial crisis. Opponents, including lobby groups for the large banks, contend that the cap proposal under consideration in the U.S. would hamper bank lending, hurt the economy and put U.S. institutions at a global competitive disadvantage.
"This rule puts American financial institutions at a clear disadvantage against overseas competitors," said Tim Pawlenty, CEO of the Financial Services Roundtable, a lobby group for big banks. "It is disappointing this proposal wasn't further examined by economic experts and will likely result in tighter access to loans for businesses across the country."
However, Sheila Bair, former FDIC chairman and a big proponent of a tougher leverage cap, said the rule will help ensure that these institutions have a more robust cushion against losses and stand ready to lend even when markets change. "This in turn will protect markets, shareholders, and taxpayers," she added.
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.
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.