The Federal Reserve Board on Tuesday unanimously proposed to set tough capital rules for the eight biggest U.S. banks. The measure would be tougher than an international agreement already in place for large institutions and seeks to press big banks to reduce their 'systemic footprint.'
The new measure is harsher than standards of the Basel Committee on Banking Supervision, which is the primary global rule setter for prudential regulation of big banks. The Fed measure requires the U.S. banks to evaluate how much they rely on short-term wholesale funding as part of their calculation, a consideration that is not included directly in the broader Basel agreement. Other characteristics, which are included in the Basel framework, include size, interconnectedness, cross-jurisdictional activity and complexity.
Nevertheless, the wholesale short-term funding provision in the rule is not surprising. Daniel Tarullo, the top Fed bank supervisor, has suggested in a number of speeches and testimony that the biggest U.S. banks may soon need to hold more capital in the form of common equity to offset concerns about their short-term wholesale funding, a key source of liquidity that dried up during the 2008 financial crisis.
On Tuesday, Tarullo said the tougher restrictions including a short-term wholesale funding provision were put in place because the Fed believes that this kind of funding can leave a firm vulnerable to creditor runs that force a rapid liquidation of positions. That, he suggested, can "lead to fire sales that create a vicious cycle of mark-to-market losses, margin calls, forced deleveraging, and further losses."
Overall, the new restrictions were put in place to limit the impact to the U.S. and global markets of a failing systemically important bank. Tarullo noted that some other countries, including Switzerland, Sweden and the Netherlands, are applying capital standards above what was set in the global agreement.
Fed chairwoman Janet Yellen and other top central bank regulators, including Tarullo, have suggested that the biggest U.S. banks may need to hold more capital to offset risks associated with their short-term wholesale funding of operations. Yellen raised the concern in a July speech at the International Monetary Fund, noting that short-term funding markets are a substantial source of funding for the biggest banks.
A senior Fed official said that the top eight banks have mostly met the new requirements already, even though the requirements are being phased in between Jan. 1, 2016 and Jan. 1, 2019. He added that, in aggregate, the biggest banks have a shortfall of $21 billion based on their capital levels, not a significant amount for the largest institutions.
The eight banks impacted are: Bank of America Corp. (BAC) , Bank of New York Mellon (BK) , JPMorgan Chase & Co. (JPM) , Morgan Stanley (MS) , Goldman, Sachs & Co. (GS) State Street Corp. (STT) , Wells Fargo & Co. (WFC) and Citigroup Inc. (C) . A Fed official declined to comment on how the rules will impact each of the biggest banks except to note that it will likely vary by bank, adding that the investment banking model is more reliant on short-term wholesale funding than the commercial bank approach. However, he acknowledged that the details of how these banks stack up will not be clear until the Fed approves a final rule. The rules will probably require capital buffer hikes that range from 1% to 4.5% of their risk-weighted assets.
Nevertheless, he added that the goal of the new restrictions is to give the largest banks another incentive to reduce their "systemic footprint" – essentially get smaller on their own either organically or through divestitures. It also seeks to drive a big bank to rely less on short-term funding.
The provision is one of a number of new restrictions on big banks that have been imposed in the wake of the 2008 crisis. The new restrictions are implemented also, in part, to comply with a provision in the post-crisis Dodd-Frank Act. Another provision in the statute, the Volcker Rule, is having a complementary impact of requiring big banks to divest hedge fund and buyout shop assets. Bank of America on Monday announced that its Merrill Lynch Alternative Investments LLC unit had agreed to sell its fund of hedge funds portfolio, with $1.2 billion in assets under management, to London-based Man Group plc, in what many see as a move to help the financial institution keep up with new requirements under the Volcker Rule.
Analysts argue that among the eight biggest banks, JPMorgan has the most short-term funding, followed by Citigroup and then Bank of America.
Karen Petrou, analyst at Federal Financial Analytics, said in a note leading up to the proposal that the U.S. will "go its own way" with its capital rules, adding that the rules show that countries can't agree on common bank capital limits. "The more it tries, the farther nations retreat into their separate corners, convinced that no one understands them and crafting rules meant for their own statutory regimes and policy objectives," she said.