Fed to Hit Biggest US Banks With Tougher Capital Surcharge
WASHINGTON—The Federal Reserve plans to hit the biggest U.S. banks with a costly new requirement aimed at reducing the risk that some financial firms remain "too big to fail" nearly six years after the financial crisis erupted.
In testimony prepared for a Senate Banking Committee hearing Tuesday, Fed Governor Daniel Tarullo said the regulator intends to impose a capital surcharge that will require the biggest U.S. banks to maintain fatter cushions to protect against potential losses. The Fed's version of the capital surcharge will be tougher than one agreed to by international regulators.
The Fed also will penalize U.S. banks that rely heavily on volatile forms of short-term funding, such as overnight loans, in determining the size of a new capital surcharge.
The move would mean at least some big U.S. banks would be forced to increase their capital cushions beyond their global rivals, deepening a debate about whether Washington is better-protecting its banks or putting them at a competitive disadvantage. How much additional capital the big banks will need to add has yet to be determined.
Since the financial crisis, banks have added substantial capital—and are subject to a number of new rules. A July analysis of six U.S. banks by policy Federal Financial Analytics calculated that those firms increased their capital by $29.07 billion between 2007 and 2013.
Fed officials haven't yet settled on an exact range for their capital surcharge but are considering a range that stretches as much as a couple of percentage points higher than the top range of 2.5% of risk-weighted assets agreed to by international regulators, a senior Fed official said. That could mean some U.S. banks might face a surcharge as high as 4.5%, the official said.
Mr. Tarullo said surcharge levels for a small group of "systemically important financial institutions," or SIFIs, would increase "noticeably" for some U.S. banks. Surcharge levels wouldn't necessarily increase for every bank.
"By further increasing the amount of the most loss-absorbing form of capital that is required to be held by firms that potentially pose the greatest risk to financial stability, we intend to improve the resiliency of these firms," he said.
At issue is a requirement for the world's largest banks to hold an extra layer of financial padding in case of another crisis. The move was agreed to in 2011 by international regulators in Basel, Switzerland. This so-called capital surcharge would require giant, complex banks to increase their high-quality capital by between 1 and 2.5 percentage points, calibrated to the relative riskiness of the bank as measured by a series of factors. A total of 29 global banks, including the eight U.S. firms, are required to pay the surcharge.
While the impact of the Fed's stricter proposal on specific banks isn't clear, firms with large broker-dealer operations such as Goldman Sachs Group Inc. and Morgan Stanley have the potential to face higher capital charges under the Fed's plan since they often rely on large short-term loans to help finance activities on behalf of clients.
Goldman and Morgan Stanley both count such short-term liabilities as more than one-third of their total liabilities, the highest levels among the eight U.S. banks likely to be affected by the rule, according to data from SNL Financial. Both firms have said in regulatory filings that they are maintaining enough capital to meet the Basel surcharge level. They declined to comment Monday.
The U.S. plan to impose a higher surcharge marks the latest move by Washington to bolster the banking system by requiring large Wall Street firms to better protect themselves against losses. Last week, the Fed and other regulators adopted another set of rules that require banks to hold very safe assets they can sell for cash in a pinch. That rule, too, was stricter for U.S. banks than the requirement agreed to internationally.
It isn't clear how many firms would need to raise capital to meet the tougher U.S. surcharge. Bank of America Corp., Citigroup Inc., Bank of New York Mellon Corp., J.P. Morgan Chase, Wells Fargo & Co. and State Street declined to comment.
Banks around the world fought the original surcharge proposal, arguing it was unnecessary and could restrict their ability to lend. U.S. banks now are likely to argue the Fed is putting them at a competitive disadvantage.
Fed officials always thought the surcharge range should be higher than the level Basel negotiators ultimately settled on, a point Mr. Tarullo and other Fed officials have voiced for years.
Janet Yellen, now the Fed's chairwoman, last year signaled that she was eyeing a tougher surcharge. Ms. Yellen said in a June 2013 speech that "it may be appropriate to go beyond" the Basel surcharge levels.
One new wrinkle in the Fed's plan is to tie the size of the surcharge to a bank's reliance on short-term financing, essentially penalizing banks that readily turn to the wholesale funding markets. The Fed has been eager to reduce reliance on short-term financing, such as overnight loans, which were a source of instability during the 2008 financial crisis when such financing dried up. Heavy dependence on short-term funding helped sink Lehman Brothers Holdings Inc.
Fed officials thought the original Basel methodology didn't give enough weight to a firm's reliance on such short-term loans in determining how much extra capital a specific firm must maintain. The new approach could either force banks to further boost their capital cushions if they rely heavily on short-term loans or make less frequent use of short-term financing.
As part of that effort, Mr. Tarullo said Fed officials are working on a separate rule that would require all financial firms—not just banks—to hold a minimum amount of securities or other collateral in short-term financing transactions, such as repurchase agreements.
The Fed is planning to use its authority under the 1934 Securities Exchange Act to adopt the margin rule but is first trying to negotiate an agreement ensuring other countries will take similar steps, the senior Fed official said. The Fed's authority extends to many transactions, except those where U.S. Treasurys are used as collateral, the official said.
An agreement with international regulators is crucial, since firms could simply move trading activity to another country to avoid the U.S. margin rule if a deal isn't reached.
The capital surcharge for banks could change each year, depending on a calculation that takes into account its size, exposures, international activity, and other data.
Excluding the changes in the works at the Fed, the Basel capital accords could require banks to have a capital ratio of as much as 12.5% of risk-weighted assets by 2019.