The Federal Reserve said it will expand a capital-planning program to the 35 largest US banks to ensure they have an adequate buffer in an economic crisis.
Bank holding companies with at least $50 billion in assets will be required to adopt “robust, forward-looking capital planning processes that account for their unique risks,” the Fed said on Saturday in a statement in Washington.
Banks would be required to submit plans to raise dividends or repurchase stock as part of the reviews, to begin early next year, the Fed said. Firms whose plans are rejected would have to get approval before distributing capital.
The reviews are part of a broader effort, which includes the Dodd-Frank Act overhauling financial regulation, to tighten supervision of financial firms and reduce the risk of another crisis. In March, the 19 largest banks, such as Wells Fargo & Co (WFC) and JPMorgan Chase & Co (JPM), completed capital reviews that allowed many of them to boost dividends or buy back shares.
“During the years leading up to the recent financial crisis, many bank holding companies made significant distributions of capital, in the form of stock repurchases and dividends, without due consideration of the effects that a prolonged economic downturn could have on their capital adequacy,” the Fed said in its proposed rule.
Bankers such as JPMorgan Chase Chief Executive Officer Jamie Dimon have criticised stricter federal oversight of the biggest firms, saying new regulations may impair lending and economic growth.
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THREAT TO PROFITS
The initiative may force banks to hold additional capital and reduce profitability measured by return on equity, said Bert Ely, an industry consultant based in Alexandria, Virginia.
“In wanting higher capital standards, they really want the bigger banks to be bulletproof,” he said. “There will be tremendous pressure to downsize” or have “financial engineers to come up with new forms of shadow banking” by moving activities outside commercial banks.
Some investors welcomed the tougher supervision, saying it’s long overdue.
“This amount of oversight is something that has been lacking in the corporate board room in most banks,” said Joel Conn, president of Lakeshore Capital LLC in Birmingham, Alabama. “For smaller banks, it is pretty clear that their capital ratios were not adequate for a major economic downturn.”
BANK SHARES
The KBW Bank Index, which tracks 24 US financial institutions, extended losses after the Fed announcement, then rallied after CNBC reported that the biggest banks are likely to face a capital surcharge of 2 to 2.5 per centage points rather than 3 points. The index fell 0.4 per cent at 4 pm in New York after declining as much as 2.3 per cent.
International central bankers and supervisors have decided banks need to hold more capital to avoid future taxpayer-funded bailouts. A proposed surcharge, previously reported to be 3 per cent, may be lowered amid pushback from European nations, especially France, CNBC said without saying where it got the information. The amount may be set at a meeting in two weeks.
The Dodd-Frank Act, passed last July, gives the Fed new authority to control lending and risk-taking at the largest, most ‘systemically important’ banks, following the government’s $700 billion financial-market rescue package in October 2008.
While the capital plans aren’t required under Dodd-Frank, “the Board believes it is appropriate to hold large bank holding companies to an elevated capital planning standard because of the elevated risk posed to the financial system,” the Fed said.
FOCUS ON CAPITAL
The expansion of the reviews shows how the Fed and other regulators are focusing on capital as the most important buffer against risk. Financial stability isn’t the only objective, said Dino Kos, managing director at Hamiltonian Associates Ltd, New York. Regulators don’t want to ask Congress for another bailout, he said.
“Nobody in the regulatory apparatus ever wants to do that again,” said Kos, a former executive vice president at the New York Fed. The reviews should be extended to more banks because many need the discipline of looking at capital needs over longer time horizons, he said.
“For the past 20 years, bankers have said, ‘We understand derivatives, we understand risk management, we understand risk controls,’” Kos said. “What regulators learned was, no, they don’t.”
Under the $50 billion asset threshold regional lenders including M&T Bank Corp (MTB), Comerica Inc (CMA) and Huntington Bancshares Inc would be among banks asked to conduct reviews.