Q1 2014 Banking Review: Basel III Common Equity Tier 1 Capital Ratio

U.S. banking giants formally started reporting their capital condition in terms of the Basel III capital requirements in the first quarter of this year, marking the first step towards a fully phased-in disclosure under the new rules by 2019. ^[1] These changes make it difficult to compare the banks’ statutory capital ratios for Q1 2014 with the reported figures in previous quarters; fortunately, the country’s largest banks have been reporting their pro forma fully-phased in Basel III capital ratios since late 2012, allowing us to understand the quarter-on-quarter capital ratio changes for these banks over the period fairly well.

These banks have prioritized Basel III compliance over recent years – something that they could achieve in tandem with their profitability goals, which required them to make sweeping changes to their business model. This would explain why many global banking giants have already met their Tier I common capital requirements, although full compliance is only expected by the end of 2019. In this article, we highlight the degree to which the largest U.S. banks – JPMorgan (NYSE:JPM), Bank of America (NYSE:BAC), Citigroup (NYSE:C), Wells Fargo (NYSE:WFC), Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS) – have improved their Tier I common capital ratios over the last six quarters. While some of them have surpassed requirements comfortably, some have barely made the mark and are expected to continue to shore up their capital over the next few quarters.

See our full analysis for Bank of America | Citigroup | JPMorgan | Wells Fargo | Goldman Sachs | Morgan Stanley

In the wake of the global economic downturn of 2008, financial regulators around the world have been working on tighter rules to ensure the sustainability of global banks in the event that such circumstances repeat in the future. The need for the banks to shore up their capital structure has figured at the top of their list of to-dos. The Basel III norms formulated by the Basel Committee on Banking Supervision (BCBS) form the crux of the proposed financial sector reforms, with banking industry regulators for each country implementing additional controls beyond those laid out under these standards. As a consequence, banks around the globe have diligently worked to meet the stringent guidelines, even though the standards themselves have not yet been finalized.

While increasing the common equity and Tier I capital requirements laid out in Basel II, the Basel III norms also tighten the banks’ capital structures by proposing additional capital buffers, a minimum leverage ratio and adding mandatory requirement ratios – the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR). But of all these regulatory capital ratios, the common equity Tier I (CET1) capital ratios are most often used as a quick reference to gauge a bank’s capital strength and also to compare them side-by-side. This is the figure we tabulate below to allow for the comparison of the country’s biggest banks.

The figures below have been taken from the quarterly filings for each of the banks since Q3 2012 (the period for which data is available for all the banks) and refer to the pro-forma fully phased in CET1 ratio figure they report. It should be noted that some of the banks revise the Tier I common capital ratios from time to time retrospectively, to account for ongoing modifications in the Basel III standards. The table also includes the CET1 ratio target regulators have set for each of these banks. These are different for each of the banks based on their complexity, global footprint as well as interdependence (see The Basel III Challenge For Banks: Why Extra Capital Requirements?). Finally, the buffer mentioned here is the difference between the target and the bank’s CET1 ratio at the end of Q1 2014.

Citigroup leads the U.S. banking giants with a core Tier I capital ratio figure of just under 10.5% at the end of Q1 2014 – a considerable effort, considering that the diversified banking group has improved the figure by almost two percentage points within six quarters. The bank’s decision to shift non-performing and non-core assets into the umbrella Citi Holdings division in 2009 and to subsequently divest them has paid off quite well. This has helped the bank systematically reduce the size of its risk-weighed asset (RWA) base, which forms the denominator in the calculation of the core Tier I capital ratio. It must be noted that the 13 basis point (0.13%) decline in the Q1 2014 figures was from a change in the manner the size of risk-weighed assets (RWA) was calculated. Bank of America’s steeper 40 basis point (0.4%) decline also stems from the same reason.

While Citigroup ranks highest among these banks in terms of absolute Tier I capital ratio figures, Wells Fargo does the best in terms of achieving its target ratio. With a CET1 ratio of slightly above 10%, the predominantly U.S.-focused bank faces a lower capital requirement target than its other peers on the list, whereas Citigroup has the highest target figure along with JPMorgan. Morgan Stanley comes in second in terms of actual CET1 ratio as well as buffer, as the investment bank’s decision to scale back its capital-intensive FICC business and complete the acquisition of the remaining stake in Smith Barney from Citigroup over the last few years gave it a comfortable margin.

JPMorgan stands out as the only bank which has barely achieved its capital requirement target, with all the others shoring up capital enough over the last couple of years to beat Basel III requirements by at least 90 basis points (0.9%). As the bank is not expected to make any major changes to the business model, it clearly intends to build its tier 1 capital gradually over the coming quarters by relying on its strong earnings figures.

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1. Basel III phase-in arrangements, BIS Website [↩]