Global Sifi buffers is both the likely new name of FT Alphaville’s pub trivia team and a hotly followed piece of financial regulation.
The Financial Stability Board is not due to formally announce its capital recommendations until November, but we already have a good idea what to expect. (The Federal Reserve is also still to announce its proposals.) The very biggest banks are expected to be subject to a 250bps tier one capital surcharge, with the threat of an extra 50bps charge left over to disincentivise supersizing.
Ahead of financials’ second quarter earnings, which kick off with JPMorgan Chase on Thursday, Nomura’s Glenn Schorr has quantified and examined the potential impact of the G-Sifi buffer on JPM and Bank of America.
To calculate the additional cost of the buffer, Schorr compares the incremental Basel III tier one capital cost for the two big banks relative to the cumulative capital cost if they were split into smaller entities (thereby avoiding the G-Sifi charge). Excerpt from the note below, followed by tables showing the capital costs for JPM and Bank of America (click to expand).
Based on our analysis, we estimate that the incremental Basel III Tier 1 common capital required for JPM and BAC would be ~$24bn on a combined basis versus that of an equivalent non-G-SIFI designated company. We think as we enter into 2Q earnings, investors will be keenly focused on the ability of universal banks to adapt and retain solid levels of profitability in the face of the sizable headwinds imposed by the long list of regulatory burdens.
For good measure, Schorr also did a back of the cigarette pack analysis of the G-Sifi buffer’s GDP effect. We’re not sure it addresses the other side of the ledger — gains from a more stable financial system — but here’s the estimate nonetheless:
Given a 250bps G-SIFI buffer, the total impact to global GDP could reach $140bn, as each 100bps increase in the Basel III capital ratio knocks about $56bn off global GDP. Finally, as U.S. G-SIFI intuitions appear to face a more restrictive regulatory environment (no Volcker rule, less restrictive derivatives reform, and no Collins amendment facing non-U.S. players), we wonder if the additional G-SIFI buffer has gone too far.
(That estimate is based on assumptions made by BIS in this working paper on Basel III’s long-run economic impact.)
Nomura also briefly discusses its take on the qualitative impact of the G-Sifi buffer. In short, unsurprisingly, banks will (continue to) reallocate capital and play around with everyone’s favourite topic, risk-weighted asset (RWA) mitigation:
Firms Will Adapt to the New Reality: The game has changed, but so will the players. Higher capital requirements and RWA inflation will cause some disruption, but the firms won’t just sit there like punching bags, as they are not static entities and will adapt via repricing (we are already seeing this in consumer banking) or shrinking/reallocating capital (such as in private equity investments and subprime holdings) to cover their cost of capital (we calculate that a 15% reduction in estimated RWAs could effectively more than halve the ROTCE impact of a 250bps SIFI buffer). We think the dynamic changes that took place in the early 2000s in FX and equities are instructive examples of successful adaptation.
We think there will be room for meaningful RWA mitigation (both active and passive) and optimization (just look at European peers). As the banks have their risk models approved by the Federal Reserve over time, the U.S. banks’ RWAs/total assets ratios are likely to move closer in line with European banks over time. RWA mitigation and optimization efforts can have a meaningful impact on Tier 1 common ratios, given the outsized RWA inflation of certain asset classes under Basel III.
Speaking of RWAs, FT Alphaville popped along on Wednesday morning to Sifma’s conference on the impact of the Dodd-Frank Act. We’ll try and jot down some further observations a bit later, but in the first panel on macroprudential regulation, the issue of US-Europe RWA differences came up quite a bit. We found a couple of points made by panel participants especially interesting.
First, Steven Strongin, Global Head of Invesment Research at Goldman Sachs, suggested the danger of banks being given too much discretion over what can be determined RWAs. In a nutshell, this would benefit poorly run banks at the detriment of well run (properly capitalised) banks.
Second, Wilson Ervin, Senior Adviser to the CEO of Credit Suisse, described the US-Europe arguments over RWAs as “a phony war”. He cited Morgan Stanley and Citigroup analysis claiming that two-thirds of the difference was due to different accounting systems (which is kind of the problem, but whatever) and different collateral requirements.
All the more reason, then, for some RWA international peer review, at the very least.
We’ve plonked the Nomura note in the usual place.
Around the world in 25 megabanks – FT Alphaville
Regulatory Reform Summit 2011 – Sifma
BASEL III: Long-term impact on economic performance and fluctuations – BIS (pdf)
Repairing risk-weightings … with ratings – FT Alphaville