The crisis of 2008 spawned countless rules and regulations that are designed to reduce risk in the financial system. One of the most important new rules requires the Federal Reserve to classify banks based on their systemic importance. This is what Form FR Y-15 is for.
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Form FR Y-15 lists five broad categories that are correlated with a bank's systemic importance -- size, interconnectedness, substitutability, complexity, and cross-jurisdictional activity. It then breaks these down into 12 systemic indicators, and assigns each a relative weighting.
*Available for sale. Source: Federal Reserve.
The purpose of Form FR Y-15 is to collect data related to each of these indicators from banks with more than $250 billion worth of assets. The data is then weighted and combined to score banks based on their systemic importance.
The first time the Fed did this -- last year -- JPMorgan Chase got the highest score. Not only is it the nation's biggest bank by assets, which factors into the "total exposure" indicator, but it also placed first in eight out of the 11 remaining categories. For example, it led the way with $461 billion worth of intra-financial system assets, $323 trillion worth of payments activity, and $65 trillion worth of exposure to over-the-counter derivatives.
Data source: Federal Reserve. Chart by author.
The score that comes from a bank's Form FR Y-15 matters not only because it determines if a bank is a global systemically important bank, or G-SIB, but even more critically because it dictates how much capital the biggest and most complex banks have to hold. This is why JPMorgan Chase was originally assessed a G-SIB surcharge equal to 4.5% of its highest quality capital whereas Wells Fargo faced a comparatively reasonable 2% surcharge.
To be clear, these surcharges phase in over the next three years, being fully applicable in 2019. But even though the banks have largely built up their capital bases in anticipation of this, it remains to be seen how the fully phased-in rule will impact investing patterns in the big banks. This is because the higher capital requirements facing the nation's biggest banks seem to give their smaller and simpler counterparts in the regional banking space an advantage.
That said, big banks with the ability to counteract the more stringent capital requirements will do so through scale, efficiency, and dominance of their market niches -- be it investment banking in JPMorgan Chase's case or mortgage/commercial banking in Wells Fargo's case. The new rules underlying Form FR Y-15 thereby underscore the enhanced role that durable competitive advantages like these will play in the future when it comes to distinguishing between the best bank stocks and the rest.
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John Maxfield owns shares of Wells Fargo. The Motley Fool owns shares of and recommends Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.