By Victoria McGrane
WASHINGTON--The Federal Reserve is set to finalize the amount of
additional capital the nation's eight biggest banks must maintain,
with J.P. Morgan Chase & Co. facing the highest capital
increase of the group, a policy designed to encourage firms to
reduce their size or risk profile.
J.P. Morgan would face a capital "surcharge" of 4.5% of its
risk-weighted assets under the final rule. The other seven firms
must maintain an additional capital buffer of between 1% and
3.5%.
J.P. Morgan has made some strides in raising the equity needed
to meet the new requirement, Fed officials indicated, saying the
bank is about $12.5 billion shy of the surcharge, which takes full
effect in 2019. In December, Fed governor Stanley Fischer, in an
apparent slip, disclosed that J.P. Morgan was about $21 billion
short.
The other banks currently have enough capital to meet the
requirement, the officials said.
The size of each bank's additional capital requirement is
tailored to the firm's relative riskiness, as measured by a formula
created by international regulators and the Fed. A bank's surcharge
can grow or shrink depending on changes such as size, complexity
and entanglements with other big firms.
The Fed Board of Governors is slated to formally adopt the final
rule at an open meeting this afternoon.
The Fed unveiled the details of the final rule, first introduced
last December, nearly five years to the day since President Barack
Obama signed the Dodd-Frank financial overhaul into law. In keeping
with the spirit of that legislation, Fed officials say the capital
requirement is designed to encourage the biggest banks to shrink
and take other steps to reduce the threat their potential failure
poses to the financial system.
"A key purpose of the capital surcharge is to require the firms
themselves to bear the costs that their failure would impose on
others," Fed Chairwoman Janet Yellen said in a written statement
prepared for this afternoon's open meeting. "They must either hold
substantially more capital, reducing the likelihood that they will
fail, or else they must shrink their systemic footprint, reducing
the harm that their failure would do to our financial system."
Banks would have to meet this additional capital requirement
with common equity, considered the highest form of regulatory
capital because it can directly absorb losses. The new surcharge
requirement comes on top of a base 7% common-equity capital
requirement that most banks face.
The surcharge gives big banks a choice. They can fund their
operations with less borrowed money and hold more common equity,
which can crimp returns. Or, they can reduce the size of this new
surcharge by shrinking or making other changes such as cutting
their reliance on short-term funding sources that can be
volatile.
Among the other banks, Citigroup Inc. faces a 3.5% surcharge;
Bank of America Corp., Goldman Sachs Group Inc. and Morgan Stanley
face 3%; Wells Fargo & Co. 2%; State Street Corp. 1.5%; and
Bank of New York Mellon Corp. 1%.
As with its other major rules, the Fed capital measure goes
beyond what international regulators in Basel, Switzerland,
negotiated for "systemically important" banks. The biggest
difference is how much more the Fed's rule penalizes banks for
relying on volatile forms of short-term funding such as overnight
loans. The Fed's formula roughly doubles the surcharge amount for
each U.S. bank compared with the international version of the rule,
Fed officials said.
The final surcharge requirement, when it takes full effect, will
result in the eight U.S. banks maintaining an equity cushion
against losses that is more than $200 billion larger than it would
otherwise have been, Fed officials said.
While the broad contours of the surcharge remained unchanged
from the December draft, the Fed did adjust pieces of the rule in
response to industry concerns.
Most significantly, the Fed gave banks more credit for reducing
their "systemic footprint," as Fed officials call it. Big banks had
complained that under the proposed rule, each bank's riskiness was
determined relative to 75 other large global banks. That meant that
even if one bank shed assets, it might not see a lower capital
requirement if the broader industry shrunk as well.
Under the final rule, the Fed will determine each bank's
riskiness by comparing it to a fixed baseline: Global statistics on
the banking sector from 2012 and 2013.
The Fed's final rule also reduced how heavily banks would be
penalized for relying on certain of types of short-term funding,
including wholesale deposits.
In addition, the Fed sought to address a concern raised publicly
by several big bank executives that a quirk in the formula could
force them to maintain billions of dollars more capital than their
foreign peers when the dollar is strong against the euro. The Fed
tweaked its formula to use an average euro-dollar exchange rate
over a three-year period, as opposed to a spot rate.
Comments from Fed governor Lael Brainard earlier this month
raised anxiety among banks that the Fed is preparing to incorporate
the new surcharge requirement into its annual "stress test" exam.
While the rule itself is silent on whether that will happen, Fed
governor Daniel Tarullo in prepared remarks said Fed officials are
considering "whether and, if so, how to incorporate the surcharges"
into the capital minimums banks must meet.
The Fed is undertaking a broader review of possible changes to
the stress test, and Mr. Tarullo said expected Fed staff to develop
recommendations--including on the issue of the new surcharge--by
the end of the year.
Adding all or part of the surcharge to the minimum capital
levels banks must meet in the stress test, designed to ensure a
bank could survive a sharp crisis, would likely require the banks
to boost their capital levels even higher.
The Wall Street Journal reported in late February that J.P.
Morgan would begin charging large institutional customers fees for
certain deposits, known as nonoperational, citing new rules that
make holding money for clients too costly, including the pending
capital surcharge. That move helped drive some of that business
away from the bank, and J.P. Morgan Chief Financial Officer
Marianne Lake said last week on an earnings call with analysts that
the largest U.S. bank by assets had surpassed its goal of reducing
$100 billion in so-called operational deposits by the end of
2015.
Ms. Lake as well as Chairman and Chief Executive James Dimon
have said they are in the early stages of a long-term plan to
reshape the balance sheet. The bank has also been exiting
businesses that are too risky or don't bring in enough money. In
2014 it exited about a dozen businesses, including the
physical-commodities business, student-lending origination and some
correspondent-banking relationships.
"The effort to optimize the balance sheet...is not going to
stop," Mr. Dimon said last week. "That is what we're going to
continue to do."
Still, Mr. Dimon has been a staunch defender of the bank's
scale, citing market-share gains across its businesses, good
returns and high customer satisfaction levels. Mr. Dimon said in a
January earnings call that a full-fledged breakup of the bank
doesn't make sense, saying he believes the bank can "manage
through" higher capital levels.
Write to Victoria McGrane at victoria.mcgrane@wsj.com
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