U.S. bank indices fell 2% yesterday after fears that capital requirements would increase as much as 7%. Bank of America (NYSE: BAC), fell below $11.00, the lowest since last year. The discussion came about after the Basel Committee on Banking revealed how levered large financial institutions still were, and tried to reconcile levels with future recession risks. A 7% equity capital raise for most banks would be catastrophic and dilute equity by 50%+, but a 3% raise seems manageable in a functioning economy. The problem is that the U.S. economy is on life support, and that life support is called Quantitative Easing 2. Once this support fades on June 30th, how will U.S. banks (at their already low valuations due to real estate risk and put backs) raise new equity capital? A replay of 2009? You be the judge.
According to Bloomberg, “The Fed supports a proposal at the Basel Committee on Banking Supervision that calls for a maximum capital surcharge of three percentage points on the largest global banks, according to a person familiar with the discussions.
International central bankers and supervisors meeting in Basel, Switzerland, have decided that banks need to hold more capital to avoid future taxpayer-funded bailouts. Financial stock indexes fell in Europe and the U.S. yesterday as traders interpreted June 3 remarks by Fed Governor Daniel Tarullo as leaving the door open to surcharges of as much as seven percentage points.
“A seven percentage-point surcharge for the largest banks would be a disaster,” said a senior analyst at Barclays Capital Inc. in NY. “It will certainly restrict lending and curb economic growth if true.”
Basel regulators agreed last year to raise the minimum common equity requirement for banks to 4.5 percent from 2 percent, with an added buffer of 2.5 percent for a total of 7 percent of assets weighted for risk.
Basel members are also proposing that so-called global systemically important financial institutions, or global SIFIs, hold an additional capital buffer equivalent to as much as three percentage points, a stance Fed officials haven’t opposed, the person said.
Bank Indexes Fall
The Bloomberg Europe Banks and Financial Services Index fell 1.45 percent yesterday, while the Standard & Poor’s 500 Index declined 1.1 percent. The KBW Bank Index, which tracks shares of Citigroup Inc., Bank of America Corp., Wells Fargo. and 21 other companies, fell 2.1 percent.
In a June 3 speech, Tarullo presented a theoretical calculation with the global SIFI buffer as high as seven percentage points.
“The enhanced capital requirement implied by this methodology can range between about 20% to more than 100% over the Basel III requirements, depending on choices made among plausible assumptions,” he said in the text of his remarks at the Peter G. Peterson Institute for International Economics in Washington.
In a question-and-answer period with C. Fred Bergsten, the Peterson Institute’s director, Tarullo agreed that the capital requirement, with the global SIFI buffer, could be 8.5 percent to 14 percent under this scenario. A common equity requirement of 10 percent is closer to what investors are assuming.
‘Across the Board’
“I think 3 percent is where everyone expected it to come out,” Simon Gleeson a financial services lawyer at Clifford Chance LLP, said in a telephone interview. “If it is 3 percent across the board then it will be interesting to see what happens to the smallest SIFI and the largest non-SIFI” on a competitive basis, he said.
U.S. Treasury Secretary Geithner, in remarks yesterday before the International Monetary Conference in Atlanta, said there is a “strong case” for a surcharge on the largest banks. Fed Chairman Bernanke is scheduled to discuss the U.S. economic outlook at the conference today.
“In the US, we will require the largest U.S. firms to hold an additional surcharge of common equity,” Geithner said. “We believe that a simple common equity surcharge should be applied internationally.”
Financial industry executives are concerned that rising capital requirements will hurt the economy, which is already struggling with an unemployment rate stuck at around 9 percent.
Higher capital charges “will have ramifications on what people pay for credit, what banks hold on balance sheets,” JPMorgan Chase & Co. chairman and chief executive officer Jamie Dimon told investors at a June 2 Sanford C. Bernstein & Co. conference in New York.
The Global Financial Markets Association, a trade group whose board includes executives from GS and Morgan Stanley, said the surcharge may apply to 15 to 26 global banks, according to a May 25 memo sent to board members by chief executive officer Tim Ryan.
Dino Kos, managing director at New York research firm Hamiltonian Associates, said the discussion about new capital requirements comes at a time when banks face stiff headwinds. Credit demand is weak, and non-interest income from fees and trading is also under pressure.
U.S. banks reported net income of $29 billion in the first quarter, the best result since the second quarter of 2007, before subprime mortgage defaults began to spread through the global financial system, according to the Federal Deposit Insurance Corp.’s Quarterly Banking Profile.
Still, the higher profits resulted from lower loan-loss provisions, the FDIC said. Net operating revenue fell 3.2 percent from a year earlier, only the second time in 27 years of data the industry reported a year-over-year decline in quarterly net operating revenue, the FDIC said.
“You can see why banks are howling,” said Kos, former executive vice president at the New York Fed. Higher capital charges come on top of proposals to tighten liquidity rules and limit interchange fees, while the “Volcker Rule” restricts trading activities. Taken together these imply lower returns on equity, he said.
“How can you justify current compensation levels if returns on equity are much lower than in the past?” Kos said.