The amount of cash banks are required to hold in case of an emergency is increasing, thanks to a rule that U.S. regulatory agencies finalized Tuesday.
The Federal Reserve and other agencies voted to increase the supplementary leverage ratio for the eight largest U.S. banks, requiring that they hold a certain percentage of their total assets as reserves, regardless of the composition or riskiness of those assets.
The vote finalized a draft proposed last summer that raised the required leverage ratio from 3 percent to 5 percent for big bank-holding companies, and to 6 percent for their subsidiaries that receive deposit insurance.
The leverage-ratio rule, intended to prevent panics and runs on banks, is part of the regulatory agencies' efforts to implement the 2010 Dodd-Frank financial reform law, as well as the Basel III international capital standards.
Fed Chairwoman Janet Yellen called the rule an “important part” of a package “designed to materially reduce the probability of failure of these firms and to materially reduce the damage that would be done to our financial system if one of these firms were to fail.”
The higher leverage ratio would take effect on Jan. 1, 2018, giving banks time to prepare. It applies to U.S. banks that have been designated as “systemically important” by the Financial Stability Board, an international body that monitors finance. That designation can vary from year to year. For the current year, those are J.P. Morgan, Citigroup, Bank of America, Goldman Sachs, Morgan Stanley, Bank of New York Mellon, State Street and Wells Fargo.
If the rule was currently in place, those banks would have been $68 billion short of the required capital, according to a memo prepared by the staff of the Federal Reserve’s Board of Governors for the vote.
At the time the draft was proposed in 2013, Fitch Ratings called the requirement “tough but manageable,” noting that it could prompt some bank-holding companies to move certain activities out of their banking subsidiaries.
The leverage ratio is just one part of a complex system of capital standards that regulators are imposing on banks. In particular, it complements the Basel III risk-based capital requirements, which require banks to have more cash on hand for assets that regulators view as more likely to go bad. In her confirmation hearing for Fed chairwoman in November, Yellen described requiring a minimum leverage ratio as a “belt-and-suspenders kind of approach.”
The leverage ratio would be binding for only some banks today, said Michael Gibson, director of the Fed's Division of Banking Supervision and Regulation. For most banks, the risk-weighted capital requirements would effectively set the minimum capital requirements. Gibson added that in general, and especially as banks reorganize to adjust to the rule over time, the leverage ratio would be a “tight backstop” rather than the main capital rule for banks.
Federal Deposit Insurance Corp. Chairman Martin Gruenberg said the leverage ratio “may be the most significant step we have taken to reduce the systemic risk posed by” big banks.
Nevertheless, it's well short of what some Wall Street critics in Congress have proposed. In particular, Sens. David Vitter, R-La., and Sherrod Brown, D-Ohio, have introduced legislation that would require banks to have capital reserves of 15 percent.