Where Banks Win Big Under the Mnuchin Plan

The Treasury Department's proposals to overhaul financial regulation offer banks, especially the biggest, potentially significant relief when it comes to how much capital they must hold.

That would answer banks' biggest complaints in the post-financial crisis era -- that excessive capital requirements are holding them, as well as lending, back. J.P. Morgan Chase & Co. Chief James Dimon, for example, has described his bank's balance sheet as a "fortress" that could absorb crisis-style losses not just for itself, but many other banks as well.

If the Treasury's changes were adopted, they could allow banks to return more capital to shareholders, which in turn would boost returns on equity and possibly further bolster stock-market valuations. The downside, say critics, is that this could weaken banks' loss-absorbing buffers and threaten confidence in the financial system.

Here are some areas where banks stand to gain from the Treasury proposals:

Leverage Ratio -- Current rules say the biggest banks must hold capital equal to at least 5% of their total leverage exposure, a broad-brush measure of their total assets and exposures. Treasury is proposing that banks be allowed to exclude some holdings from that measure, namely cash deposited at central banks, U.S. Treasury debt, and some of the money held at clearinghouses related to derivatives.

That small change would give a big boost to leverage ratios. J.P. Morgan's could possibly increase by more than 1 percentage point or more. The higher that ratio goes, the more likely the bank is able to return more capital to shareholders.

Goldman Sachs analysts estimated that such rules changes could leave the four biggest U.S. banks with nearly $90 billion in excess common equity.

There is another potential benefit. The House recently passed the so-called Choice Act, which would allow banks to opt out of stringent regulation if they maintained a leverage ratio of at least 10%.

While that legislation isn't expected to be taken up by the Senate, the Treasury proposals support the 10% choice. Changing the calculation of leverage exposure it would make it easier for banks to get to that level.

The big six banks would need to raise nearly $400 billion, combined, to get to that level, based on March 31 figures and Wall Street Journal calculations. At J.P. Morgan alone, the shortfall to 10%, which currently would be about $105 billion, would fall to about $60 billion or less.

Operational Risk -- Bankers say that among the most onerous requirements they face is one that forces them to effectively hold capital against possible "operational" losses. These are losses that could come not from things like market moves or loan defaults, but from the banks' own actions. Those could include fines or big legal settlements.

Such costs soared after the financial crisis, amid a series of billion-dollar settlements over mortgage practices, faulty money-laundering monitoring and currency-market manipulation. Those have created so-called operational risk assets that are equal in some cases to about 30% of bank assets weighted for risk, which are key to determining other capital measures.

Treasury says that a "more transparent, rules-based approach should be used in the calculation of operational risk capital." This means capital required for such risks would be more in line with recent actions and could be reduced if banks take measures to reduce that risk.

Analysts estimate the big banks have more than $200 billion in capital tied up due to operational risk. Changes wouldn't eliminate the need for all of this capital, but would likely allow banks to return a big slug of it over time.

G-SIB Surcharge -- The largest "global systemically important banks," known as G-SIBs, are required by U.S. regulators to hold an additional capital buffer, or surcharge, on top of their other requirements. This is to reflect their complexity and the disastrous spillover effects their failure would have on the global financial system.

This charge varies, but will average 2.8 percentage points across the biggest banks when it is fully phased-in, according to analysts at Nomura Instinet.

The Treasury proposes that this standard be "recalibrated," in part to reflect the fact that these banks don't rely as much on short-term funding, such as repurchase agreements, or "repos," to fund themselves, reducing their risk of sudden insolvency.

Again, that could free up capital that could be returned to shareholders.

TLAC -- Big banks subject to annual stress tests have to prove that they hold enough capital and debt to cover major losses, a measure known as "total loss-absorbing capacity."

The idea is that in a failure or stressed situation, some debt, along with equity, could be used to absorb losses. As part of this, banks have had to hold more long-term debt than they may otherwise have done.

That pushes up banks' overall interest costs, which reduces net interest income. This weighs on profits and dampens returns.

Treasury is proposing that regulators revisit rules on this regarding the mandatory minimum debt ratio included in calculating this requirement.

Write to Telis Demos at telis.demos@wsj.com

(END) Dow Jones Newswires

June 13, 2017 13:15 ET (17:15 GMT)