The U.S. banking regulators’ proposal to double the minimum Basel III leverage ratio, referred to as the supplementary leverage ratio, is likely to be manageable for affected banks, Fitch Ratings said. But the 6% standard is onerous for bank subsidiaries covered by the proposal and may encourage banking groups to conduct certain activities, such as derivatives, from their broker-dealer subsidiaries.
Fitch said it believes three of the eight U.S. global systemically important banks (G-SIBs) already have supplementary leverage ratios close to or above the 5% threshold set for bank holding companies (BHC). This threshold is made up of the 3% minimum requirement under Basel III and an additional 2% buffer. Based on its preliminary estimates, Fitch sees Wells Fargo as the leader in the group of eight and Morgan Stanley as below average in terms of the leverage ratio.
Regulators identified $89 billion of capital required to meet the 6% leverage ratio at the bank level and $63 billion of capital to meet the 5% leverage ratio including the buffer at the holding company level as at end-Q3/12. Fitch said it anticipates the institutions should be able to build capital and be in compliance by the proposed 2018 effective date, so it is unlikely that any would be subject to limitations on distributions and discretionary bonus payments that apply when the leverage buffer is breached.
The higher 6% minimum required for subsidiary banks of covered BHCs to be considered “well capitalized” and avoid prompt corrective action is tough. It may lead to balance sheet changes at bank subsidiaries as some assets and businesses are shifted to non-bank subsidiaries within the same group. However, the extent to which non-bank subsidiaries can grow their balance sheets is limited by the leverage buffer requirement for BHCs.
It is possible that banks may reduce some of their excess liquidity given the higher leverage ratio requirements because the negative carry is likely to increase for more liquid investments that are unlikely to exceed their capital cost. The supplementary leverage ratio is more onerous than the generally applicable leverage ratio for U.S. banks. It is calculated using a tighter definition of Tier 1 capital in the numerator and the denominator includes off-balance sheet exposures such as the grossing-up of derivatives to include collateral and cash.
On July 9, the Federal Reserve Board (FRB), Office of the Comptroller of the Currency (OCC) and Federal Deposit Insurance Corporation (FDIC) released a Notice of Proposed Rulemaking (NPR) on the supplemental leverage ratios for the largest banks that will be open for comment for 60 days. Given past changes to NPRs and how dynamic regulators have proved to be in final rule making, it is possible that this rule will change. There are also numerous issues that have been flagged but are yet to be addressed, such as additional capital charges on banks’ long-term unsecured debt. Fitch said it expects these issues to be addressed in 2013 and the debate on appropriate capital levels to continue.