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Banks to Face Tougher Regulations

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On Tuesday, the Federal Reserve Board, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC) proposed stricter borrowing rules for most systemically significant U.S. banking organizations. The tougher rules intend to make banks more dependent on equity capital as compared with its reliance on debt and riskier assets.

The regulators are contemplating proactive measures to ensure that the world’s largest banks strengthen their capital and liquidity positions to confront another financial meltdown. Alongside, they are set to carry out on-site assessments of the financial condition of the banks.

A weak capital level is always a threat to the global economy. Needless to say, meeting new rules would act as building blocks for the still shaky global economy, with fewer bank collapses and less involvement of taxpayers’ money for the bailout of troubled financial institutions.

New Rules

The proposed rule directs bank holding companies (BHCs) with more than $700 billion in consolidated total assets or $10 trillion in assets under custody (covered BHCs) to maintain a tier 1 capital leverage ratio of 5%. The new requirement exceeds the minimum leverage ratio of 3% recommended by international banking regulators as part of the Basel III standards. However, failure to achieve the requirement would restrict BHCs for discretionary bonus payments and capital distributions.

Additionally, the proposed rule requires insured depository institutions of covered BHCs to maintain a 6% supplementary leverage ratio to be considered as a "well capitalized" institution for prompt corrective action purposes. The proposed rule is open for public comments over the next 60 days.

The rule, which takes into consideration off-balance sheet items such as derivatives and loan commitments, is expected to be effective in a phased-in-manner as on Jan 1, 2018. This rule will impact 8 most systemically significant U.S. banking organizations, which include Citigroup Inc. (C - Free Report) , JPMorgan Chase & Co. (JPM - Free Report) , Bank of America Corporation (BAC - Free Report) , The Bank of New York Mellon Corporation (BK - Free Report) , The Goldman Sachs Group, Inc. (GS - Free Report) , Morgan Stanley (MS - Free Report) , State Street Corporation (STT - Free Report) and Wells Fargo & Company (WFC - Free Report) .

Moreover, the tougher capital rules, which were approved by the Federal Reserve on Jul 2, 2013, got the consent of FDIC and OCC as well. These rules suggest that U.S. banks would need to set aside more capital as buffer to tide over unexpected losses. Banks will be required to maintain a new minimum common equity tier 1 ratio of 4.5% of risk-weighted assets (RWAs) and a common equity tier 1 capital conservation buffer of 2.5% of RWAs applicable to all supervised financial institutions.

Our Viewpoint

These rules might limit the flexibility of the banks with respect to investments and lending volumes. Moreover, such stringent capital rules may considerably slacken the pace of a worldwide economic recovery in the near term.

Overall, structural changes in the sector will continue to impair business expansion and investor confidence. Several dampening factors -- asset-quality troubles, mortgage liabilities and tighter regulations -- will decide the fate of the U.S. banks in the quarters ahead. However, foraying into the new capital regime will ensure long-term stability and security for the industry.

Though the improving performance by the banks seems already priced in and there remain significant concerns, the sector's performance in the upcoming quarters is not expected to disappoint investors.

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