WASHINGTON -- Top policymakers and lawmakers have increasingly acknowledged over the past year that despite a new law and numerous regulations enacted in the wake of the financial crisis, some banks remain "too big to fail" -- and a threat to the economy.
On Tuesday, the three federal agencies that regulate the nation's banks responded to those worries, and concerns over subsidies that could be provided -- and funded by taxpayers -- to shore up these critical institutions. The Federal Deposit Insurance Corporation, Federal Reserve and Office of the Comptroller of the Currency answered with a proposal for a much stricter cap on big banks' leverage than had been set as part of an international agreement on bank regulation known as the Basel III accords.
In turn, regulators estimate eight of the largest U.S. banks -- JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs, Morgan Stanley, Bank of New York Mellon and State Street -- may be forced to stump up some $89 billion in capital to back up their loans and securities, in order to guard against unforeseen losses.
The proposed limits on the targeted banks could affect their ability over the next few years to make dividend payments to shareholders, buy back stock or reward their executives with bonuses in the name of preserving financial stability.
Borrowing by the eight financial groups would be capped at 20 times their total assets, which includes some off-balance sheet commitments like unused credit card lines and derivatives contracts. Their subsidiary banks would have their leverage capped at roughly 17 times their assets.
The new limits are particularly more stringent because they expand the definition of assets used to calculate a bank's leverage, compelling banks to further reduce their borrowing or sell off assets in order to meet the requirements. Under this new formula, regulators estimate that total assets at the banks, on average, would swell by 43 percent. The banks would have to comply by the start of 2018.
All eight banks either have more than $700 billion in assets or more than $10 trillion in assets under custody, or held for customers. A global committee of national regulators known as the Financial Stability Board has tagged the eight financial groups as "systemically important."
The federal agencies' proposal represents the culmination of a year-long effort by some U.S. policymakers to shift the domestic debate away from a focus on a regulatory system in which lenders are given broad borrowing discretion and adherence to international agreements is put above all. Instead, they are moving toward hard yet simple rules that force leading U.S. banks to conform to a higher standard than their peers in countries such as Germany and France.
“Too much effort has been placed on achieving a global agreement at a cost of a more suitable framework for the U.S. economy,” said Jeremiah Norton, FDIC director.
Compared to last year, “the debate has shifted and a great deal of progress has been made,” Norton said.
The move by the three U.S. agencies comes as an increasing number of regulators overseas question the adequacy of Basel III, or the third version of the bank capital accords named after Basel, Switzerland.
Basel III forces banks to increase the amount of equity capital they use to fund assets such as loans and securities, reducing their ability to borrow. But the rules rely on banks determining the amount of capital by judging the relative riskiness of their assets, a practice known as risk-weighting. Riskier assets, such as securitized private student loans, carry higher risk-weights than safer assets, such as U.S. Treasuries. Assets deemed to have higher risk-weights demand more equity capital.
Regulators including Norton and Tom Hoenig, FDIC vice chairman, have criticized the reliance on risk-weighting and argued the Basel III rules are easy to game, as have former regulators such as Sheila Bair, who used to lead the FDIC. Surveys by analysts at Barclays, the U.K. bank, suggest that investors harbor similar doubts.
“The result has been confusion instead of clarity among the public and among bank directors who have a responsibility to oversee these firms,” Hoenig said.
The Basel committee in recent months has given critics added ammunition in the form of two recent studies that found significant variation in how large banks calculated the relative riskiness of the same assets. Some banks were found to use models that allowed them to get away with putting up one-eighth of the capital compared to their peers for the same trading assets, while a separate review revealed similar practices when it comes to plain-vanilla banking assets.
This week, the Basel committee itself signaled through a discussion paper that it is open to simplifying its complex rules in the wake of significant public criticism by policymakers such as Hoenig, Norton and Andrew Haldane, Bank of England executive director for financial stability.
Stefan Walter, former secretary general of the Basel committee, said the paper was “extremely important” because it signified the “beginning of the committee crystallizing a longer-term philosophy on the longer-term direction of the capital framework.”
The Basel committee is “revisiting a number of assumptions that had driven the approach to capital to date,” said Walter, who now serves as global bank supervisory and regulatory policy leader at EY, the accounting consultancy formerly known as Ernst & Young.
The move to a simplified regime in which the biggest banks also are forced to limit their borrowing is a result of U.S. regulators agreeing that the concept of too big to fail may be distorting the banking system, and thus needs to be stamped out.
Creditors that think big banks would be bailed out by the government tend to demand less interest on the money they loan those banks, because there is virtually no risk they wouldn’t be paid back in full. Smaller banks that presumably would be allowed to fail are charged higher amounts.
"A perception continues to persist in the markets that some companies remain 'too big to fail,' posing an ongoing threat to the financial system," regulators said in a memo accompanying the rule. “This distortion is unfair to smaller companies, damaging to fair competition, and tends to artificially encourage further consolidation and concentration in the financial system.”
Big banks have been trying to convince skeptical policymakers, lawmakers and the public that too big to fail is either dead or soon will be. The Obama administration has done the same. Both groups have argued that the funding advantage commanded by banks considered too big to fail either does not exist, or is due to other factors.
The joint statement by the regulators could serve as a public rebuke to those arguments. It’s also likely to be used by members of Congress who are agitating for more aggressive action.
“Today’s announcement is a major step forward, but it should only be the first step,” said Sen. Sherrod Brown (D-Ohio). “We must do more, and this proposal will be insufficient if it is weakened by Wall Street lobbying.”
Brown, Sen. David Vitter (R-La.) and a small group of senators have been trying to ratchet up requirements for the past several months. Analysts have said their proposed law would effectively force the biggest banks to break up.