Big banks in the U.S. are facing the prospects of tighter capital requirements as regulators move forward with regulations intended to prevent another financial crisis.
Three regulatory agencies on Tuesday proposed raising the required leverage ratio, a stringent measure of banks’ reserves, by two percentage points to 5 percent. Regulators also approved final rules for implementing the Basel III international agreements for capital requirements in the U.S.
The leverage ratio rule would require the largest Wall Street bank to maintain at least 5 percent of assets, broadly defined, as capital. Regulators said that requiring big banks to hold extra reserves on hand protects them from becoming insolvent in case of a sudden downturn, and lowers the chances that the any bank will require a government bailout.
The leverage ratio rule is meant to be a tougher capital requirement than the risk-weighted capital requirements included in other final rules issued by the Federal Reserve last week and approved by the Federal Deposit Insurance Corporation on Tuesday. Those rules were designed to meet the agreements regarding banking regulations made between advanced nations in Basel, Switzerland in 2010. They would require banks to hold 7 percent of risk-weighted capital as capital.
Banks can manipulate their holdings to minimize their holdings of securities defined by regulators as risky, and in doing so drive down the amount of reserves they are required to keep. The leverage ratio would prevent such gaming of risk weights.
FDIC officials said the leverage ratio rule would apply to bank holding companies with 700 billion in assets. Currently, according to the FDIC’s estimates, eight banks would meet that threshold and would have had to raise $63 billion in capital to meet the requirement if it had been in effect in the third quarter of 2012.
Jeremiah Norton, director of the FDIC, complained that “it should not have been as difficult as it has been” to propose raising the leverage ratio, which he said “hardly seems like a seismic shift in capital requirements and represents an attempt to address one of the core causes of the financial crisis.”
FDIC vice chairman Thomas Hoenig expressed support for raising the leverage ratio, while also raising concerns about moving ahead with the Basel III capital requirements without the leverage ration requirement in place. In the past, Hoenig has stated support for setting the ratio at 10 percent.
Last week, officials at the Federal Reserve indicated support for more stringent capital requirements and hinted that a raised leverage ratio was in private consideration among regulators. Daniel Tarullo, the member of the Fed’s Board of Governors overseeing financial regulation, said at the Fed’s meeting to consider the Basel III rules last week that the 3 percent leverage ratio called for in the Basel III rules “seems to have been set too low.”
Some critics of too-big-to-fail banks had also supported a legislative push to raise the leverage ratio. Sens. Sherrod Brown (D-Ohio) and David Vitter (R-La.) introduced a bill earlier in the year that would have set the ratio at 15 percent. Tennessee Republican Bob Corker said in a statement that he was “happy to see that the regulators are moving forward on a new rule to constrain excessive leverage through the use of a more simple and effective ratio.”
The Financial Services Roundtable, a banking industry group, immediately criticized the rules with a statement from its president, former Minnesota governor Tim Pawlenty. “This new proposal, combined with existing capital and leverage requirements, will make it harder for banks to lend and keep the economic recovery going,” Pawlenty said, adding that the result would be “American banks being put at a global competitive disadvantage.”