Banking regulators on Tuesday took another step in their efforts to ensure that the largest U.S. banks have enough capital to withstand a financial crisis similar to the 2008 crisis that led to a massive tax-payer backed bailout.
The Federal Deposit Insurance Corp., the Federal Reserve and the Office of the Comptroller of the Currency were set to approve new final rules that will require the eight largest U.S. banks – those with assets greater than $700 billion – to hold about double the amount of capital previously required.
The so-called too-big-to-fail banks impacted by the new rules are: Bank of America (BAC), Bank of New York Mellon (BNY), Citigroup (C), Goldman Sachs (GS), JPMorgan Chase (JPM), Morgan Stanley (MS) State Street Corporation (STT) and Wells Fargo (WFC).
In total, the banks would have to raise a total of $68 billion to meet the new regulations, according to a memo prepared by the Fed.
Known as “leverage ratio,” the enhanced capital requirements are intended to ensure that the banks have more than enough cash on hand to back loans made to borrowers and to pay off their own debts should capital markets dry up like they did in 2008.
Under the new rules, the biggest banks will be required to hold loss-absorbing capital equal to at least 5% of their assets, and FDIC-insured banks will have to keep a minimum leverage ratio of 6%. International standards require a 3% ratio.
“Under this framework, these banking organizations would have to hold substantially increased levels of high-quality capital as a percentage of their total on- and off-balance sheet exposures to avoid restrictions on capital distributions and discretionary bonus payments. Thus, the framework provides incentives to such firms to maintain capital well above regulatory minimums,” Fed Chair Janet Yellen said in prepared remarks announcing the new rules.
Several large banks teetered on the brink of bankruptcy over five years ago – and Lehman Brothers collapsed – because their leverage ratios were insufficient to meet their needs when the crisis struck. In other words, they lent more money than they should have and borrowed more than they could afford to pay back, and when they couldn’t borrow more money to keep their cash flow moving they required a government-backed bailout to stay afloat.
By ensuring that banks are holding large new amounts of capital to cover bad loans and pay down in-house debts, the new leverage ratio requirements would help prevent another scenario like that one.
The rules were approved despite opposition from the banks, some of which will have to raise billions in additional capital to meet the new ratios. Others have resigned themselves to the new regulations and have already started raising the money.
The banks have argued that the rule will impede their ability lending, raise their costs and put them at a competitive disadvantage with foreign competitors that aren’t held to the same regulatory standards.
Compliance is required by Jan. 1, 2018.
The stricter leverage ratios “helps compensate for the possibility that risk-weighted measures understate the risk that large holdings of assets that are very safe in normal times may, as we observed during the financial crisis, become considerably less so in periods of serious financial market stress,” said Fed board member Daniel Tarullo, who oversees regulation for the central bank.