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Big Banks Need More Capital Buffer

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The Financial Stability Board (FSB) has specified four banks as extremely vital in the entire banking system. Also, FSB expects these banks to hold additional capital that would act as a buffer for absorbing any potential losses in adverse scenarios. These banks have been chosen on the basis of the 2011 data, related to their size, interrelations as well based on a host of other conditions.

These four banks include Citigroup Inc. (C - Free Report) , Deutsche Bank AG (DB - Free Report) , HSBC Holdings Plc. and JPMorgan Chase & Co. (JPM - Free Report) . With the big banks being armed with adequate capital, any threat to the financial system at times of potential crisis can be avoided while the need for any government bailouts can be done away with.

According to the FSB, these four banks need to bear a capital surcharge of 2.5% over the statutory requirements specified in the Basel III accords. The other 24 banks included in the list of systemically important financial institutions should bear lesser surcharges ranging between 1% and 2%. Notably, in an effort to function smoothly, according to the Basel III accord, banks are required to retain capital corresponding to no less than 7% of the risk-weighted assets.  

However, the allocations are provisional and the final list will be chalked out in 2014, while the additional capital requirements for the global systemically important financial institutions will be phased in with the onset of 2016 and are scheduled to be completely met by 2019.

The list was drawn up as the FSB organized progress reports for a G-20 finance ministers meeting as well as the Central Bank governors in Mexico this weekend. Some of the reputed banks have been criticized for not taking adequate initiatives towards improving their risk profile.

These banks need to be administered carefully and supervisors need to adopt proactive measures. Alongside, the banks are required to systematically draw up a succession plan and an efficient assessment of the overall risk profile of the institutions should be conducted.

We believe such measures would serve as building blocks for efficient financial system overtime. Though in the short term, the strict capital norms may curb banks’ lending powers and they many need to overhaul their business, these steps are aimed at improving the bank’s overall health, reduce risk and less involvement of taxpayers money in rescuing them.

Currently, JPMorgan retains a Zacks #2 Rank, which translates into a short-term Buy rating while Citigroup, Deutsche Bank and HSBC maintain a Zacks #3 Rank, implying a short-term Hold recommendation.

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