The U.S. banking industry is continuing to fight new and more robust capital standards that were devised in the wake of the recent financial crisis. These higher capital standards would impact banks that are classified as global, systemically important financial institutions. (For more, read Assessing Bank Assets: Are Your Savings Safe?)
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The Basel Committee on Banking Supervision has responded to the recent financial crisis with a series of measures that have attempted to improve the ability of the banking sector to deal with financial shocks on an individual and systemic basis.
The latest regulations are known as Basel III, and they impact capital levels, leverage, disclosure and risk management practices of the industry. Banks that are considered global systemically important financial institutions are required to have extra capital to absorb losses.
Basel III established a Tier 1 common ratio minimum of 3.5% starting in 2013, with the minimum ramping up to 9.5% by 2019. This minimum includes the extra capital required for the systemically important banks.
One argument made by the managements of many banks is that the new capital requirements will reduce economic growth as more capital means that less will be available for lending. The new rules will also result in wider interest rate spreads, as banks need to charge more to borrowers.
The Bank of International Settlements recently studied this issue and released a report on the economic impact of the new rules. The study found that a full implementation of the Basel III regulations would reduce GDP growth relative to the baseline by only 0.34%. (To see what impact past Basel regulations brought, read How Basel 1 Affected Banks.)
The issue of additional capital has plagued the stock performance of some of the largest U.S. banks. Bank of America (NYSE:BAC) has dropped more than 50% in 2011 as investors speculate on whether the company will have to raise equity to meet the upcoming capital requirements. The bank is also divesting some of its business units to lower the amount of risk-weighted assets under the new rules.
Jamie Dimon, the CEO of JPMorgan (NYSE:JPM), has taken a leading role in opposing the new capital requirements and even called them "anti-American" during a recent public appearance.
Vikram Pandit, the CEO of Citigroup (NYSE:C) argues that if banks are required to hold more capital, then systemic risk may shift to less regulated sectors. Citigroup reported a Tier 1 common ratio of 11.7% at July 30, 2011.
Despite the opposition and strong words, there is no sign that the regulators are throttling back on efforts to prevent another financial crisis. The Financial Stability Oversight Council (FSOC) has proposed rules that would classify non-bank financial institutions as systemically important and subject these organizations to stricter regulations. The FSOC was created under the Dodd-Frank Act and is responsible for monitoring the stability of the U.S. financial system.
These proposed FSOC rules are targeted mostly towards insurance companies and may be motivated by the impact that American International Group (NYSE:AIG) had on markets in late 2008.
The Bottom Line
Although there may be some validity to the arguments raised against higher capital requirements under Basel III, the public is in no mood to give anything to an industry that is blamed for helping to cause the financial crisis and vilified by politicians, the media and ordinary Americans. The banking industry may have to accept these rules as purgatory until that perception changes. (For more on Basel III, check out Understanding The Basel III International Regulations.)
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