Bank regulators modified debt rules – How will it change things?

U.S. bank regulators have come up with some modified rules for the least possible holding company debt requirements. By the first week of July this year, the U.S. regulators disclosed the new set of rules which are supposed to limit the leverage that banks can engage in business. As per the economists, these new rules may have significant impact on the business decisions of eight of the most important financial institutions in U.S. This will also have an impact on consumers as well as on investors.

So what are the bank regulations and possible debt rules?

BankBefore you know about the impacts, it’s important to know what exactly is the proposal. The three chief bank regulators – the Federal Deposit Insurance Corp., Office of the Comptroller of the Currency, and the Federal Reserve have jointly proposed that all eight of the most influential bank holding companies should consider maintaining the leverage ratios to as low as 5%. On the other hand, the FDIC-insured bank subsidiaries will have to maintain minimum 6% leverage ratio. Apart from this, all the other financial institutions are supposed to follow the standard leverage limit of 3%. Now, if you’re wondering what leverage ratio is, here is the answer for you: it’s basically the ratio of assets and capital of bank’s balance sheet. The capital is mainly termed as the Tier 1 capital and it includes non-redeemable preferred shares, money from the general stock and retained earnings. Bank regulators come up with these rules to reduce the risk factor for the largest banks in U.S. However, it’s too early to decide whether the things actually going to work positively for the banks or not.

Which are the most affected banks?

It’s may not that easy to assess the actual level of the threshold and mix. So, it’s difficult to say accurately which banks are going to be affected in the long run. However, as the financial experts believe, JPMorgan Chase, Wells Fargo and State Street Corp. are the three banks which will be impacted the most. However, Morgan Stanley and Goldman Sachs are performing better to deal with the debt scenario successfully. As per the reports, Morgan Stanley and Goldman Sachs are performing on a better level as the reliance is mostly on holding company debt. However, the bank regulators aren’t too keen to take into account the separate business mix and funding profiles of all the banks. The proposed business mix is an important fact that is directly related to the debt requirement.

Why is the regulatory limit essential for banks?

This is an important question that needs to be answered. The probable debt rules have been decided mainly because the government bailouts interrupt the market process that imposes limits. For instance you can take the deposit insurance backed by FDIC. The availability of this special deposit insurance assures that the depositors don’t have to worry about the leverage. The bank runs are not expected at all, so depositors are made immune to severe losses. As a consequence, the chances increase for banks to suffer due to the leverage.

Erroneous evaluation of the bank risk may encourage financial loss and in such a circumstance, debt problems may arise. It’s better to control the situation from beforehand rather than struggling to  eliminate financial obligations later. So, it’s essential to evaluate the bank risk properly.

Is there any chance for the situation to change in future?

At the initial level, the new leverage ratio was supposed to be advantageous. However, now the situation is changing. Thomas Hoenig, one of the chief defenders of the stricter leverage guidelines, is now planning to soften up the regulations for U.S. banks. Hoenig is the vice chairman of the Federal Deposit Insurance Corp. In a recent interview, he said that he is planning to consider allowing banks to omit cash from the total amount of assets while calculating the equity. On 25th November, Hoenig said in an interview “It deserves discussion, but I don’t think it deserves immediate exemption without some careful thought”. However, he strongly opposes the exclusion of U.S. Treasury securities from the asset count as the securities are expected to lose the value after rise in interest rate.

Why is the change needed?

Laurence D. Fink, the Chief Executive Officer of BlackRock Inc, said in an interview last week, “I am alarmed right now it may have unintended consequences.” He also stated, “There’s a possibility we’re going to be going too far with leverage ratios.” Fink fears that the restrictions implemented by the bank regulators may reduce the liquidity in the market in future. This will only affect the interest rates on Treasuries and mortgages. Mortgage rates may also rise significantly due to this; there is a chance for average rates to increase from 4.5% to 5.25%. Not only this but the limited leverage will also affect bank lending. As a consequence, the overall economy may suffer in near future. So, Fink believes that before the regulations take a toll on the overall economy, there must be some modifications.

 

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