Earlier this week, the regulators published the new Basel III rules for the U.S. banks. While some standards were left unchanged, others were changed to better suit the relatively smaller banks. However, Bloomberg reports that the regulators are now gearing up to introduce much more stringent rules for the large cap banks. Particularly, JPMorgan Chase & Co. (NYSE:JPM), Wells Fargo & Co (NYSE:WFC), and Goldman Sachs Group Inc (NYSE:GS) are poised to face rules that are even more stringent than the newly published Basel III regulations.
The discrimination
It seems that the regulators are willing to give some leverage to the relatively smaller banks as I noted the relaxations given to the non-advanced banks when the new Basel III rules were published. In contrast, the regulators are in no mood to spare the large cap banks. I believe this discrimination is important in setting new capital regulations because there is a considerable difference in the sizes of the largest six banks compared to smaller banks.
More stringent rules than Basel III
The regulators are consulting to set a minimum ratio of capital to assets that exceed the 3% floor set under the final Basel III regulations. Expectations are that this ratio may be doubled in order to make the large banks safer. Another measure might force the large cap banks to hold a minimum amount of equity and long-term debt to help the authorities dismantle defaulting lenders. Further, banks that rely on short-term (wholesale funding) might be required to hold additional capital.
Risk weighted vs capital regardless of risk
After the financial crisis, the regulators became doubtful about the complex formulas behind those risk weights. The 2008 crisis also gave rise to a debate whether the risk weightings should be continued to be used as a risk control measure. The regulators are increasingly demanding a minimum capital against assets, regardless of the assets’ perceived risk. It is believed that the risk weightings can easily be manipulated.
Eroding profits
An obvious consequence of the stringent capital requirements on the large banks will be a hindrance in their lending abilities. Since the large banks will be required to hold more capital, less capital would be available for lending purposes. When the banks’ lending abilities are hurt, you should expect profit erosion and even shareholder distribution suspensions.
The Fed closely monitors shareholder distributions including share buybacks and dividends for the U.S. banks. JPMorgan Chase & Co. (NYSE:JPM) currently offers a quarterly dividend rate of $0.38 per share and yields 2.90%. Further, the bank has been authorized to buyback $15 billion worth of its own common shares. So, the combined shareholder distributions form a significant part of the total returns.
Wells Fargo & Co (NYSE:WFC) yields 2.90% on its quarterly dividend of $0.30 per common share. Both its quarterly dividend rate and the shareholder buybacks increased recently. In comparison, Goldman Sachs Group Inc (NYSE:GS) offers a dividend yield of 1.30% on its quarterly dividend rate of $0.50 per common share. Further, Goldman Sachs Group Inc (NYSE:GS) decided to reward shareholders by buying 75 million of its common shares.
So, these shareholder distributions form an integral part of the total return these banks provide their investors, and a suspension of these distributions would mean lesser returns for investors.
