Wall Street

Fed's hard line on funding to bring more pain to Wall Street

The U.S. Federal Reserve's drive to wean Wall Street off risky funding sources is expected to bring more financial pain to the biggest U.S. banks in the coming months, analysts warned on Wednesday.

They said bank regulators' release this week of tough new limits on debt funding is just a preview of other rules that may have even more bite.

The eight largest U.S. banks must boost their capital levels by an estimated total of $68 billion to meet new limits on debt that regulators approved on Tuesday, a move designed to reduce banks' reliance on the type of risky financing that fueled the 2007-2009 financial crisis.

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Goldman Sachs and Morgan Stanley could be most affected since regulators proposed a framework that is tougher on businesses like the selling of credit derivatives to protect against corporate defaults, according to Steven Chubak, a banking analyst at Nomura Securities.

Traders on the floor of the New York Stock Exchange.
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Executives at some of the biggest Wall Street banks said in interviews that they began planning for the rules when they were proposed last year, and they expect to be in full compliance before the regulations take effect in 2018.

But analysts paid special attention to comments from Federal Reserve Governor Daniel Tarullo, who said on Tuesday the tough rules should spur regulators to set more funding limits.

Those proposed reforms include a surcharge for the biggest global banks and possibly additional capital rules for banks that rely on risky, short-term funding.

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Fed officials also want banks to hold much more long-term debt to make it easier for regulators to unwind failing banks in a crisis.

"I call them the four horsemen of the apocalypse," said Greg Lyons, who leads the financial institutions group at the law firm Debevoise & Plimpton, in reference to the leverage rules and the three other pending requirements.

Without insight into how tough these other rules will be, experts said it's hard to put a number on how much more capital banks will have to raise, or how banks may restructure their businesses to soften the blow.

"We've got all of these pieces but ... it's not clear we know where we're going overall, or what the world looks like when we get there," said Oliver Ireland, a partner with Morrison & Foerster in Washington.

Uncertain future

The Fed and two other bank regulators on Tuesday set leverage requirements for the biggest bank holding companies to maintain top-tier capital, such as shareholder equity, equal to 5 percent of total assets. Insured subsidiaries must meet a 6 percent ratio.

The rules, part of a global agreement to require more capital after the 2007-2009 financial crisis, would apply to JPMorgan Chase, Citigroup, Bank of America, Wells Fargo, Goldman Sachs, Morgan Stanley, Bank of New York Mellon and State Street.

But the three other rules often mentioned alongside the leverage ratio are outstanding, and less is known about how they will turn out.

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The long-term debt requirement, which would convert to equity in a crisis and serve as a capital buffer for a failed bank, and the surcharge for global banks are both priorities for international regulators as well as the Fed.

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Tarullo has made cracking down on short-term funding a pet project, mentioning it frequently.

On Tuesday, he said the finished leverage requirement "provides a little bit of reinforcement to ... the possibility of an additional capital charge addressed to the vulnerability of firms to runnable, wholesale, short-term funding."

Extra pressure from lawmakers and outside groups continues to encourage regulators to end the perception that the U.S. government would bail out the biggest banks if they were to fail. That gives regulators added incentive to clamp down further on funding.

The International Monetary Fund recently published a study that found that assumption lets the biggest U.S. banks borrow more cheaply than smaller banks, with the savings on funding costs ranging from about $20 billion to $70 billion.

Ireland said funding rules for banks probably will only get tougher in this environment.

"I think you have to look at this on the background of 'too big to fail,'" Ireland said. "And there's still a lot of talk in Congress about higher capital levels for too-big-to-fail (banks)."

By Reuters