The Federal Reserve’s banking stress tests suggest that the US banking regulator is taking an increasingly conservative stance on capital planning. Although the Basle Committee has given local regulators until 2019 for full implementation of the new capital, leverage and liquidity regime, the Fed’s supervisory initiative tests might lead to the de facto adoption of Basle III in the US as early as next year, analysts say.
"There is a belief in Europe that the US will seek to avoid implementing Basle III for political reasons. However, the opposite is more likely to be true," says David Barrosse, managing director at Capstone DC, a Washington DC-based financial advisory firm specializing in policy analysis and regulatory due-diligence services for institutional investors. "The Fed’s rule-making process around the Comprehensive Capital Analysis and Review (CCAR) is forcing US banks that want to make dividend payments to investors to move to fully phased-in capital requirements faster than the Basle Committee’s own timeline."
At issue is apparent regulatory sleight of hand by the Fed, which last June proposed that its minimum tier 1 common capital ratio of 5% under Basle I definitions would remain the regulatory limit until 2016 for the purpose of the CCAR. However, the text of the final rules governing the CCAR process published in December appeared to change this timeline, noting instead that the "The Board will work with the other federal banking agencies to implement Basle III and to propose a Basle III tier 1 common capital ratio as a new minimum regulatory capital ratio."
Banks and investors must now wait to see whether they will be required to maintain a capital ratio based on final Basle III definitions during the 2013 stress test. "There is a [significant] chance that the Basle III capital definitions will be brought forward, and the phase-in period will be ignored for the purpose of capital planning," says Barrosse.
With final details on Basle III tier 1 capital definitions expected this year, US banks might face the prospect of stress tests based on the 7% minimum tier 1 common capital ratio. Although much lower than the 19% minimum mooted by Swiss regulators at the beginning of the consultation, any increase in capital requirements will complicate banks’ capital-raising and distribution plans. Indeed, four of the 19 banks subject to the latest test failed to receive regulatory approval for capital distributions at the 5% hurdle, with Citi notably missing out by 10 basis points and several others only just making the cut.
Although the 15 banks that got approval can now return capital to investors and resume share buybacks, the prospect of a 7% minimum in 2013 could mean that the number of those that do not get approval will rise next year. For example, less than half of the test group passed CCAR 2102 with a tier 1 common capital ratio higher than 7%, assuming no capital actions after Q1 2012, with the large money-centre banks conspicuous in their absence from the list.
Investors say that the Fed’s apparent willingness to impose de facto rule changes amid an otherwise public consultation process adds unwelcome uncertainty at a time when the global regulatory playing field is already confused. "Banks need clear guidelines so they can allocate capital," says Audrey Meyer Lampert, managing director and global banking analyst at Babson Capital Management in Hartford, Connecticut. "It’s extremely unhelpful when regulators appear to change their mind in the middle of the rule-making process, and uncertainty around the timing and content of regulation is contributing to volatility in financial markets."