Don’t Bank on Relief for These Lenders

Investors shouldn’t count on lighter capital requirements for biggest U.S. banks

By Aaron Back



Banks have rallied since the election, in part because investors think they might benefit from a lighter regulatory touch. A look at two of the people who could shape that policy shows that investors might be a bit too optimistic.

Given President-elect Donald Trump’s lack of experience and ever-changing positions, the people he puts in place are likely to exert significant influence on policy. One is Jeb Hensarling, chairman of the House Financial Services Committee and a potential candidate for Treasury secretary. Even if he stays in Congress, he will be instrumental in shaping any new bank legislation.

Another person to watch is Thomas Hoenig, who is vice chairman of the Federal Deposit Insurance Corp. Mr. Hoenig’s name has been making the rounds as a possible pick for Federal Reserve vice chairman for supervision. This regulatory role was never filled by President Barack Obama, but its duties have been de facto filled by Fed governor Daniel Tarullo.

Both men have argued publicly that holding more loss-absorbing equity capital is the best way to make systemically important banks more resilient. Mr. Hensarling has proposed legislation that would exempt banks from a broad range of regulations in exchange for holding higher levels of capital.

Specifically, he focuses on the “leverage ratio” of tangible equity to total assets plus off-balance-sheet exposures. This would be more stringent than the current regulatory standards, which measure capital against risk-weighted assets. To qualify for relief, Mr. Hensarling wants banks to maintain “tangible equity,” defined in the proposal as Tier 1 common equity plus preferred shares, equivalent to 10% of total assets and exposures.

Calculations by The Wall Street Journal show that none of the six biggest banks in the U.S. would qualify for regulatory relief under this standard. Collectively, they would fall short by about $115 billion of equity capital. This estimate could undercount the amount of needed capital because it is based on total assets and doesn’t take into account off-balance-sheet exposures.

 J.P. Morgan Chase is short by the most, about $44 billion. But  Morgan Stanley’s shortfall is biggest relative to its size, at 18% of its market capitalization. The need to issue shares or cut dividends and buybacks to get to the standard suggests they would hesitate to make the trade, even in exchange for substantial regulatory relief.

Mr. Hoenig hasn’t proposed anything so specific, but in speeches he has argued against lowering capital requirements for systemically important banks. He has also favored use of the more stringent leverage ratio and tangible equity capital. Mr. Hensarling’s proposals cite Mr. Hoenig’s arguments for inspiration.

There are other reasons why big banks are rallying, including higher interest rates and trading volumes. But investors hoping for increased capital returns should temper expectations.

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