The first big dream of every bank is to become too-big-to-fail. The second big dream is to avoid capital constraints that now go along with that designation.
Global regulators said banks deemed too big to fail must hold as much as 2.5 percentage points in additional capital as part of efforts to prevent another financial crisis.
The additional capital buffers will range from 1 percentage point to 2.5 percentage points, the Basel Committee on Banking Supervision said in a statement today. From 28 to 30 banks, including as many as eight in the U.S., may face surcharges, according to a person familiar with the discussions, who declined to be identified because the negotiations are private.
Many banks are “vigorously lobbying” against being branded as systemically important, Sheila Bair, chairman of the U.S. Federal Deposit Insurance Corp. told U.S. lawmakers on June 22.
The Basel committee has said internationally active banks should hold core Tier 1 Capital of 7 percent of their risk- weighted assets, and the additional requirements are for banks it considers systemically important financial institutions, or those whose collapse would harm the global economy.
The extra fee must be met by banks building up their core reserves, and not by issuing so-called contingent capital instruments such as CoCo bonds, the committee said today.
“You are looking at a situation here where the capital requirements for the biggest banks have gone from as low as 2 percent before the crisis now to well north of 10 percent,” said Karen Shaw Petrou, managing partner of Washington-based Federal Financial Analytics Inc., a bank consulting firm. “It means the banks are going to have to constrain activities both by reducing risk and denying credit.”
The Basel group said banks should have to meet the extra requirement using common equity, a measure of their core reserves which is made up mainly of ordinary shares and retained earnings. So-called contingent convertible bonds, or CoCos, which convert into ordinary shares when a bank’s reserves fall below a certain level, won’t be eligible, the committee said, adding that national regulators are free to include them in any separate requirements they impose.
The Basel committee will release more details on the capital buffers “around the end of July,” the group said in its statement. That document won’t name banks that could face a surcharge, said a person familiar with the discussions.
While the largest surcharge that banks will initially face will be 2.5 percentage points, this number would rise to 3.5 percentage points if lenders facing the highest buffers increase in size, the Basel committee said. The 3.5 percentage point fee would act as a “disincentive for banks facing the highest charge to increase materially their global systemic importance,” it said.
Banks’ systemic importance will be assessed by measuring their size, interconnectedness with other financial institutions, the difficulty for another institution to take over the role they play in the market, complexity and global activity, the Basel group said.
The new requirements will be introduced with other measures from Jan. 1, 2016, through Jan. 1, 2019.
Banks Already Capital Constrained
Banks are already capital constrained. That is the primary reason they are not lending. Nonetheless, this is a small but important step in the right direction, assuming it sticks.
Too-big-to-fail is the same thing as too-big. Moreover, banks should be banks, not trading vehicles.
Bank of America has billions of dollars worth of exposure writing credit default swaps on Greek debt. That trade was a big winner in 2010, but seems to be blowing up in Bank of America’s face right now.
Writing credit default swaps may or may not be lucrative, but banks have no business doing it.
Bank of America and Citigroup should be busted apart. Goldman Sachs should not be a bank or a bank holding company at all. So why is Goldman a bank holding company? Because it suits the Fed’s manipulative purposes, that’s why.
Of course, the proper thing to do is kill fractional reserve banking totally, but any steps in that direction are welcome.
Mike “Mish” Shedlock
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