Fed Proposes New Rule, and Wall St. Banks Feel the Pressure
By NATHANIEL POPPER September 9, 2014 9:09 pmSeptember 9, 2014 9:28 pm
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Daniel K. Tarullo, left, a Federal Reserve Board member, testified on Tuesday before the Senate Banking Committee.Credit Jonathan Ernst/Reuters
Wall Street banks scrambled on Tuesday to determine how they might have to adjust their business models to comply with newly proposed rules that could push the banks to downsize.
In testimony before the Senate Banking Committee on Tuesday, a Federal Reserve official, Daniel K. Tarullo, said that the central bank was hoping to tip the regulations against banks that are still thought to be too big to fail, and in favor of smaller, less-complex banks.
While Mr. Tarullo gave few specifics on how the rules would be carried out, his comments suggested that financial firms that rely the most on Wall Street trading, like Goldman Sachs and Morgan Stanley, would probably face the stiffest requirements.
The rules could increase the pressure on the big banks to reduce, or even sell, some traditionally profitable operations, like lending to hedge funds and other investors.
Most of the nation’s largest banks have actually grown bigger since the financial crisis, but the Fed’s new rules would be among several recent measures that could reverse that tide.
“The big story we’re going to be talking about in 2015 is whether any of these banks do decide to materially shrink,” said Jaret Seiberg, an analyst at Guggenheim Partners. The requirements discussed by Mr. Tarullo govern the extent to which banks finance themselves by issuing stock or retaining profits — what is referred to as capital — rather than borrowing money.
Debt, particularly short-term debt, is viewed as risky for banks because it can be easily pulled in times of crisis, leaving banks with no way to finance themselves.
A group of international regulators had already been planning to impose higher capital requirements on so-called globally significant banks. The capital ratio for the biggest banks in the world, including JPMorgan Chase, was expected to be a minimum of 9.5 percent, compared with the 7 percent minimum for most banks.
But the Fed’s new rules could raise the minimum for some banks to 11.5 percent, according to a Federal Reserve official briefed on the matter.
The banks that would be forced to adhere to the highest standard of 11.5 percent might not just be the biggest ones. Mr. Tarullo said that the Fed would look particularly carefully at the degree to which banks rely on short-term debt — a market that froze up in the last financial crisis.
That could put a heavier burden on Goldman Sachs and Morgan Stanley, firms that get more of their money from short-term funding. For both banks, a jump to a capital ratio of 11.5 percent would be a 3 percent increase from the levels that had been previously discussed.
In Goldman’s case, that would mean increasing its capital by about $17 billion over previous expectations — through selling stock, holding on to profits or cutting its business proportionately.
“There’s no question that the regulations are trying to incent the banks to simplify and shrink,” said Mike Mayo, a bank analyst at CLSA.
In addition to the increased requirements for big banks, Mr. Tarullo said that the Fed was looking at rolling back some of the rules it was planning to impose on smaller banks.
Regulators have focused on a handful of banks that are large enough to destabilize the economy if they fail, necessitating government bailouts. Only eight banks have been categorized as global systemically important: Bank of America, Bank of New York Mellon, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street and Wells Fargo.
Shares of all eight of those banks fell more sharply than the broader market on Tuesday. Wells Fargo, which has little reliance on short-term debt, declined the least: 0.8 percent. Shares of Morgan Stanley fell the most: 2.7 percent.
As of Tuesday, the banks had been given little specific guidance on what the new rules might look like and expressed uncertainty about how they would be affected.
“The devil will be in the details,” Marianne Lake, the chief financial officer at JPMorgan, said at a conference on Tuesday.
All of the banks have already given themselves a buffer of capital beyond what international regulators had called for. But only Morgan Stanley and State Street are above the 11.5 percent maximum, according to Barclays research.
The banks would have years to come into compliance with the new rules, and the rules could be softened before they went into effect.
But Mr. Tarullo indicated in his testimony that the Fed was eager to discourage banks from using too much short-term funding. He said that the capital ratios could rise “noticeably” for some firms. The Fed’s chairwoman, Janet L. Yellen, had previously expressed support for tighter rules on the biggest banks.
“We’re all trying to come to grips to what we really need to provide more assurance that these institutions don’t threaten the global financial system,” Mr. Tarullo said.
Steps being taken by the Fed are only the latest measures that have encouraged the banks to cut back on what was once one of the most profitable parts of Wall Street: bond trading and other related activities.
Most of the banks have already reduced their bond holdings significantly. The new rules could push them to cut even more from the business of buying and selling bonds for short periods — what is known as the repurchase market.
Peter Eavis contributed reporting.
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