Tougher Leverage Ratio Will Force $200B Capital Raise

Bankers have been warning for months about the grim consequences of jacking up the leverage ratio and now one of their trade groups put some hard numbers behind the complaints.

The Clearing House Association concluded that 12 large banking companies would have to raise $202 billion in Tier 1 capital or reduce their assets by $3.7 trillion to comply with both the US and Basel capital rules.

Putting that in percentage terms, the association figured the extra capital amounted to nearly 25% of these banks' current Tier 1 capital and 20% of their total assets.

Raising the leverage ratio to 6% of bank assets and 5% of the parent company's assets also would transform what has long been considered the backup capital rule into the binding constraint for 67% of the largest banks' assets, the association said.

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The leverage ratio is often called a crude measure because it's a relatively straight calculation of equity to assets. The Basel rules are considered more sophisticated because they attempt to take into account the riskiness of an asset when determining how much capital must be held behind it.

But because these "risk-weighted assets" have so often underestimated risk, the leverage ratio has gained a lot of clout among regulators.

The Clearing House is hoping that putting some hard numbers to the proposal will help regulators improve the rule before finalizing it.

"We felt it was important to study the aggregated data across the institutions that are affected…and see what the industry impact will be," Sridhar Iyer, The Clearing House's director of research, said in an interview.

"We want to translate the effect to the broader economy effect on lending rates and macroeconomic behavior in the form of employment and GDP."

Iyer said the Clearing House is working with Oxford Economics to quantify those broader effects and will share those findings with the regulators soon.

U.S. regulators proposed the new leverage ratio on July 9 and said it would take effect on Jan. 1, 2018. Comments on the plan are due Oct. 21.

The tougher leverage ratio will apply to JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs, Morgan Stanley, Bank of New York Mellon and State Street, which all have assets exceeding $700 billion or more than $10 trillion under custody. The Clearing House study included four more large banking companies that it declined to identify but may include the next tier down in size like U.S. Bancorp, HSBC, PNC and Capital One.

Some policymakers who want the largest banks to shrink may be heartened by the Clearing House's conclusions. But Iyer said regulators are concerned banks may abandon certain products. "They are now aware of the likely impact," he said. "And we believe the regulators are concerned about the disproportionate impact and the market dislocation with regard to certain asset classes."