WASHINGTON – Regulators are acting to require U.S. banks to build a sturdier financial base to lessen the risk that they could collapse and cause a global meltdown.
The eight biggest banks will have to meet stricter measures for holding capital — money that provides a cushion against unexpected losses — under a rule that regulators adopted Tuesday.
The Federal Reserve, the Federal Deposit Insurance Corp. and the Treasury’s Office of the Comptroller of the Currency voted separately to require those banks to raise their minimum ratio of capital to loans to 5 per cent from the current 3 per cent.
The banks’ deposit-holding subsidiaries will have to achieve a ratio of 6 per cent. The subsidiaries are subject to a stricter ratio requirement because the deposits are insured by the government.
The rule won’t take effect until 2018. It applies to eight U.S. banks deemed so big and interconnected that each could threaten the global financial system: Goldman Sachs, Citigroup, Bank of America, JPMorgan Chase, Wells Fargo, Morgan Stanley, Bank of New York Mellon and State Street Bank.
The eight banks will have to add about $68 billion in capital to their reserves to meet the 5 per cent minimum requirement, government officials estimate.
The new requirements “will definitely make the biggest banks far stronger, but they will also make the financial system weaker,” said Karen Shaw Petrou, an analyst who heads Federal Financial Analytics in Washington. She said that’s because more lightly regulated financial firms outside the traditional banking industry hold an increasing proportion of assets, and the new rule means “still more risk will flow their way.”
The financial companies that collapsed or nearly fell in the 2008 meltdown, such as Lehman Brothers, American International Group and Fannie Mae and Freddie Mac, showed that threats to the global system can come from any big interconnected firm, not just banks, Petrou noted.
The regulators also are proposing to change how banks’ potential losses on investments are calculated in accordance with new international standards. Among other things, banks would have to calculate their investment holdings using daily averages. The proposal could lead to stricter accounting for some derivatives held by banks, the regulators said.
Derivatives are complex investments whose value is based on a commodity or security, such as oil, interest rates or currencies. Their use helped ignite the 2008 financial crisis.
Fed governors discussed at their meeting the possibility that the proposal could cause banks to end some higher-risk activities. The proposal will be open to public comment through June 13.
“The financial crisis showed that some financial companies had grown so large, (heavily indebted) and interconnected that their failure could pose a threat to overall financial stability,” Fed Chair Janet Yellen said at the Fed meeting. She said the action by regulators was a step “to address those risks.”
“This may be the most significant step we have taken to reduce the systemic risk” posed by the biggest banks, FDIC Chairman Martin Gruenberg said at the agency’s meeting.
Officials said banks have been building up their capital reserves and appear on the way to meeting the standards. All eight mega-banks are expected to meet the 5 per cent minimum requirement by January 2018, they said.
Banks’ capital includes money that isn’t at risk, such as shareholders’ stakes. Equity includes the money banks receive when they issue stock, as well as profits they have retained.
The stricter capital requirements were mandated by Congress after the financial crisis, which struck in 2008 and ignited the worst economic downturn since the Great Depression. The rules also are in accordance with international standards agreed to after the crisis, and the new requirements for the eight mega-banks exceed the global standards.
The head of the Financial Services Roundtable, whose members include the largest banks, complained that the new requirements for the eight big banks put “American financial institutions at a clear disadvantage against overseas competitors.”
The rule “will likely result in tighter access to loans for businesses across the country, the group’s CEO Tim Pawlenty said in a statement.
Hundreds of U.S. banks received federal bailouts during the financial crisis. The list included the nation’s largest financial firms, including all eight banks that will be subject to the rule adopted Tuesday.
Regulators say the goal is for banks to build buffers strong enough to withstand financial stress and avoid another crisis in which taxpayers would have to bail them out. Critics worry that the largest banks still represent a danger to the financial system.
The U.S. banking industry has been steadily recovering since the crisis. Overall profits have been rising, and banks have begun lending more freely.
The results of the Fed’s annual bank “stress tests,” announced last month, showed that the industry is better able to withstand a major economic downturn than at any time since the financial crisis. The Fed said only one of the 30 biggest banks in the country needed to take more steps to shore up its capital base.
Banks have lobbied to ease the requirements for higher capital, which they say could hamper their ability to lend.