The phrase “too big to fail” was originally coined during the mid-1980s but it gained popularity during the 2007 financial meltdown. The phrase ascertains the some institutions/corporations are so large and interconnected that it would be disastrous for the economy if they were to go bankrupt.
In another such attempt, Republican Senator David Vitter and Brown are proposing a draft which will require large banks to hold as much as 15% capital. This is even higher than the 10% minimum capital requirement under Basel III regulations. The proposed bill differentiates between the relative size of banks, which is why banks between $500 billion and $50 billion in assets will be required to have 8% capital relative to their assets. Further, the draft bill aims to take away a government policy subsidy in order to provide a level playing field.
If the bill is approved, it will have a negative impact on the lending abilities of at least the six largest banks, including JPMorgan Chase & Co. (NYSE:JPM), Citigroup Inc (NYSE:C), Goldman Sachs Group, Inc. (NYSE:GS) and Morgan Stanley (NYSE:MS).
JPMorgan Chase & Co. (NYSE:JPM)
JPMorgan Chase & Co. (NYSE:JPM) reported an over 15% earnings beat for the first quarter of the current year. The results were positively impacted by better expense management and growth in the bank’s mortgage banking. Besides, the bank increased its capital base, as measured by its Basel III Tier 1 common ratio.
JPMorgan Chase & Co. (NYSE:JPM) saved $248 million in expense during the first quarter as its quarter’s expenses came in at $6.8 billion. While Wells Fargo & Co (NYSE:WFC), the largest home lender reported a slowdown in its mortgage banking unit, JPMorgan reported 37% increase in its mortgage originations during the first quarter of the current year. Besides, the bank was able to increase its Basel III Tier 1 common capital ratio by 20 bps to 8.9%. This is still significantly below the new proposed 15% capital requirements.
While JPMorgan Chase & Co. (NYSE:JPM) will face difficulties increasing its capital base, smaller regional players including PNC Financial Services (NYSE:PNC) and Regions Financial Corporation (NYSE:RF) would be the biggest losers. The new rules will put a cap on growth of these regional banks.
PNC Financial Services (NYSE:PNC)
At the end of the first quarter of the current year, PNC Financial Services (NYSE:PNC) had $301 billion worth of assets under its management. This is below the $500 billion threshold. Therefore, according to the new regulations, PNC Financial Services (NYSE:PNC) would be required to hold 8% of capital relative to its assets. However, if the assets swell above $500, the bank would be required to hold at least 15% as capital. This is a significant jump, which would hinder growth at PNC Financial Services (NYSE:PNC). The bank currently estimates its Basel III Tier 1 common ratio at 7.9%, just marginally below the new proposed regulation’s minimum requirement.
Regions Financial Corporation (NYSE:RF)
The case is similar for Regions Financial Corporation (NYSE:RF), as it holds $121 billion worth of assets at the end of the first quarter. Regions reported a 15% earnings beat when it reported its first quarter results. The latest results were positively impacted by a 4 bps hike in the net interest margin and an 8% decline in the operating expenses, partially offset by 4% decline in the fee based income.
Conclusion
While there is consensus that banks need to be made more stable to survive another crisis on their own, I believe the new stringent regulations will hinder growth in the US banking sector. While the large banks may only experience a slowdown in lending, their smaller counterparts will end up as the biggest losers.
The article Stringent Capital Requirements for Too Big to Fail originally appeared on Fool.com and is written by Adnan Khan.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
