Coverage: Banks face new capital rules

Many are saying the Federal Reserve Board is pushing banks to shrink after issuing new rules for how much they have to reserve to cover bad loans. Some firms are OK, but others have some money to raise.

The New York Times story by Peter Eavis reported that most of the banks are close to having enough capital:

The Federal Reserve, fearing complacency six years after the financial crisis, moved on Tuesday to preserve the efforts that have strengthened large banks.

The Fed proposed a rule that would increase capital requirements for the nation’s eight largest banks, including JPMorgan Chase and Goldman Sachs. By increasing the requirements, the Fed aims to make large banks more resilient to shocks. A bank with higher capital depends less on borrowed money, which may cease to be available in times of stress.

The Fed’s push to increase capital may also reduce the chances that a large bank’s problems may weigh on the wider economy. Some economists have said that the size of some banks has made them “too big to fail.”

Janet L. Yellen, the Fed’s chairwoman, said on Tuesday that the proposed rule might persuade banks to shrink. The rule, she said in a statement, “would encourage such firms to reduce their systemic footprint and lessen the threat that their failure could pose to overall financial stability.”

Most of the affected banks have raised billions of dollars of new capital since the crisis, so they will most likely not find the proposed rule onerous to comply with.

Tom Braithwaite and Gina Chon wrote for The Financial Times that JPMorgan Chase might be the exception with a $22 billion shortfall:

JPMorgan Chase has a $22bn capital hole under new rules proposed by the Federal Reserve on Tuesday, a blow to a bank which has long boasted of a “fortress balance sheet”.

The Fed is introducing new capital requirements for systemically important banks, which go beyond the minimum international standards in an effort to protect the US financial system from the collapse of a large institution.

Officials had not intended to release the fact that JPMorgan had a large capital hole under the new framework. They said only that there was an aggregate shortfall of $21bn from eight banks: Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, Wells Fargo, Bank of New York Mellon and State Street.

But at a Fed meeting, during an exchange with Stanley Fischer, the vice-chairman of the Fed, and Fed staff, it emerged that JPMorgan accounted for the entire shortfall and every other bank already met the estimated requirement with room to spare.

“[It is] the firm that is actually going to have to come up with more capital,” said Mr Fischer. He said “that seemed a pretty impressive shortfall”.

JPMorgan has until 2019 to reach the new buffer and it should be able to avoid the embarrassment of raising equity in the market. The bank makes about $20bn in net income every year and could retain earnings to meet the new requirements. Shares in JPMorgan fell a modest 0.35 per cent on Tuesday and a further 0.6 per cent after hours to $62.10.

Bloomberg’s Yalman Onaran, Jesse Hamilton and Ian Katz pointed out that the rules were more stringent than those in other countries, putting some of the firms at a competitive disadvantage:

“The U.S. once again chooses to go its own way and exceed international minimums,” Karen Shaw Petrou, managing partner of Washington-based research firm Federal Financial Analytics Inc., said before today’s announcement. “If they squeeze the big banks too much, they’ll force some out of some businesses.”

A rule that targets firms that are more dependent on short-term funding from the markets could hurt New York-based Goldman Sachs and Morgan Stanley most. Such funding is about 35 percent of their liabilities, compared with about 20 percent for the others, according to data compiled by Keefe, Bruyette & Woods Inc.

Analysts including Citigroup’s Keith Horowitz had predicted that the extra core-capital requirement could be as high as 4.5 percent of risk-weighted assets on top of the baseline 7 percent defined under rules known as Basel III.

That’s higher than the 2.5 percent maximum to be levied on banks deemed globally significant in an annual list issued by the Financial Stability Board, which advises the Group of 20 nations on bank regulation. Less complex firms would be held to the baseline capital ratio of 7 percent set by the 27-nation Basel Committee on Banking Supervision.

Writing for The Wall Street Journal, Victoria McGrane said that banks could either raise more money or shrink to comply:

To meet the new capital charge, banks can either fund themselves with significantly more equity—which tends to be more expensive than deposits or borrowed money—than their smaller peers. Or they can get smaller and make other changes that would reduce the size of their extra capital levy.

Fed Chairwoman Janet Yellen said the rule “would encourage such firms to reduce their systemic footprint and lessen the threat that their failure could pose to overall financial stability.”

Most of the big, systemically important firms are already at the required levels but are likely to build larger capital cushions to keep them well above the requirement, analysts said, which could mean retaining a portion of their earnings every year. J.P. Morgan also is expected to meet the higher amount by retaining earnings. That could squeeze the ability of the big banks to return capital to their shareholders through higher stock dividends and stock buybacks, increasing market pressure on the banks to shrink or even break up.

Analysts, pundits, politicians and many others have been calling for regulators to break up banks that are “too big to fail” since the 2008 financial crisis. If you look at the numbers, it seems that most large firms won’t have anything to worry about. And banks that can weather crises should give investors and others confidence in the system. For those who have to raise money, the rules are likely unwelcome news.