Authored by
Steen Jakobsen via his TradingFloor.com
blog,
This week's biggest news
is not the Nonfarm Payrolls, or the European Central Bank or even Portugal's
government falling. No - this
week's big deal is the openness with which the Federal Reserve is preparing a
major margin call on the too-big-to-fail banks in the US.
This has been a long
time coming since the introduction of the Dodd-Frank law back in 2010 but it is
a game changer. Remember all
macro paradigm shifts come from policy impulses, often mistakes.
Fed approves step one in
a three step plan
Under the final rule,
minimum requirements will increase for both the quantity and quality of capital
held by banking organisations. Consistent with the international Basel
framework, the rule includes a new
minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.5
percent and a common equity tier 1 capital conservation buffer of 2.5 percent
of risk-weighted assets that will apply to all supervised
financial institutions. The rule also raises the minimum ratio of tier 1
capital to risk-weighted assets from four percent to six percent and includes a
minimum leverage ratio of four percent for all banking organisations. In
addition, for the largest, most internationally-active banking organisations,
the final rule includes a new minimum supplementary leverage ratio that takes
into account off-balance sheet exposures. (See the press release here)
I know you are thinking:
Wow, this is the most
interesting thing I have seen in years :-) but alas it is - because it is in
fact a major margin call on the US holding banks.
Note how this adoption
is only the first set of a series of new rules. Let me introduce you to: Daniel Tarullo, The Federal Reserve Governor in charge of
regulation after the implementation of the Dodd-Frank law in 2010. (As a
consequence of Dodd-Frank, the Fed got a permanent regulatory governor.)
I had nothing else to do
so I read his latest speeches which are surprisingly clear (considering that
he's a policy guy).
Governor Daniel K.
Tarullo At the Peterson Institute for International Economics, Washington, D.C.
The speech considers the
"additional charges" which are coming and today's Basel III was only
item number one:
First, the basic
prudential framework for banking organisations is being considerably
strengthened, both internationally and domestically. Central to this effort are
the Basel III changes to capital standards, which create a new requirement for
a minimum common equity capital ratio. This new standard requires substantial
increases in both the quality and quantity of the loss-absorbing capital that
allows a firm to remain a viable financial intermediary. Basel III also
established for the first time an international minimum leverage ratio which,
unlike the traditional US leverage requirement, takes account of
off-balance-sheet items.
Second, a series of
reforms have been targeted at the larger financial firms that are more likely
to be of systemic importance. When fully implemented, these measures will have
formed a distinct regulatory and supervisory structure on top of generally
applicable prudential regulations and supervisory requirements. The governing
principle for this new set of rules is that larger institutions should be
subject to more exacting regulatory and supervisory requirements, which should
become progressively stricter as the systemic importance of a firm increases.
This principle has been
codified in Section 165 of the Dodd-Frank Act, which requires special
regulations applicable with increasing stringency to large banking
organizations. Under this authority, the
Federal Reserve will impose capital surcharges on the eight large US banking
organizations identified in the Basel Committee agreement for additional
capital requirements on banking organisations of global systemic importance.
The size of surcharge will vary depending on the relative systemic importance
of the bank. Other rules to be applied under Section 165—including counterparty
credit risk limits, stress testing, and the quantitative short-term liquidity
requirements included in the internationally-negotiated Liquidity Coverage
Ratio (LCR)—will apply only to large institutions, in some cases with stricter
standards for firms of greatest systemic importance.
An important, related
reform in Dodd-Frank was the creation of orderly liquidation authority, under
which the Federal Deposit Insurance Corporation can impose losses on a failed
systemic institution's shareholders and creditors and replace its management,
while avoiding runs and preserving the operations of the sound, functioning
parts of the firm. This authority gives the government a real alternative to
the Hobson's choice of bailout or disorderly bankruptcy that authorities faced
in 2008. Similar resolution mechanisms are under development in other
countries, and international consultations are underway to plan for cooperative
efforts to resolve multinational financial firms.
A third set of reforms
has been aimed at strengthening financial markets generally, without regard to
the status of relevant market actors as regulated or systemically important.
The greatest focus, as mandated under Titles VII and VIII of Dodd-Frank, has
been on making derivatives markets safer through requiring central clearing for
derivatives that can be standardised and creating margin requirements for
derivatives that continue to be written and traded outside of central clearing
facilities. The relevant US agencies are working with their international counterparts
to produce an international arrangement that will harmonise these requirements
so as to promote both global financial stability and competitive parity. In
addition, eight financial market utilities engaged in important payment,
clearing, and settlement activities have been designated by the Financial
Stability Oversight Council as systemically important and, thus, will now be
subject to enhanced supervision.
A margin call is
coming...
To illustrate the case,
here's several quotes and links from today's media:
Crenews.com: Federal regulators on Tuesday are
scheduled to unveil and vote on the final provisions they have set for the US's
implementation of international banking standards that could result in banks
pulling back on their commercial real estate activities, including lending,
mortgage servicing and CMBS investments. Industry groups are lobbying to lessen
the potential impact of the rules.
See also USA Today: Most banks are already in compliance with
the rule, according to the Fed, though it estimates about 100 banks will need
to raise roughly USD 4.5 billion in capital by 2019.The new rules simplify the
risk calculations for mortgages, a process that community lenders had argued
was too complex and would limit their ability to provide home loans. Community
and regional banks comprise more than 90% percent of US lenders, according to
the Federal Deposit Insurance Corp (FDIC). The Fed unanimously approved the
792-page set of standards, which were mandated by the 2010 financial overhaul
law. The FDIC and the Office of the Comptroller of the Currency are also
expected to approve the new standards
Reuters: However, the Fed warned it was drafting four more
rules that would go beyond what the Basel accord called for,
including one on leverage and another on a capital surcharge. (See full version
of this story here.)
Conclusion
Why is this important?
Because part of the Fed's
new remit since Dodd-Frank makes it responsible for bubbles in banking — it is
even more interesting because clearly, to me at least, this is a major part of
why Bernanke and Dudley at the FOMC are willing to ignore the lower inflation.
This low inflation has both monetarist and Keynesians up in arms, and as it is
often the case, the REAL reason for major macro paradigm shifts comes from
policy mistakes in this case pro-cyclical regulation.
Prepare yourself and
please do read the above.
If not we are doomed to focus on QE-petering while Fed gives the whole banking
industry a major margin call.
The
Bottom Line (as Jakobsen comments) is that banks run on "leveraged" /
borrowed money - Now the Fed is going to reduce their ability to use leverage
which technically equates to a margin call - put more money up or reduce
position.
1 comment:
The banks that try to fight Basel are the ones that don't have gold. The banks that have gold will try to use Basel to their advantage.
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