How Do The Largest U.S. Banks Fare In Terms Of Basel III Compliance?

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Investors in the largest U.S. banks were not thrilled with news that the Federal Reserve is working on capital requirements that are stricter than the requirements laid out under Basel III norms, as evidenced by the KBW Bank Index sliding 1% on Tuesday, September 9. Morgan Stanley’s (NYSE:MS) shares fell the most (2.7%), owing to reports that banks with a larger dependence on short term funding are likely to attract a higher capital surcharge. Investment banks Goldman Sachs (NYSE:GS) and Morgan Stanley rely heavily on overnight loans for their day-to-day operations, with such loans accounting for almost 40% of their total funding sources. [1] Higher common equity tier 1 (CET1) ratio requirements will force the banks affected to take a harder look at their business models to find ways to shrink their balance sheets. The banks will also have to cut down on their capital return plans, and may even have to issue more shares to make up for any capital shortfall.

While the proposed increase in capital requirements is definitely not good news for the banks, how well do these banks fare in terms of existing Basel III requirements? In this article, we highlight the degree to which the six largest U.S. banks have improved their Tier I common capital ratios over the last seven 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 AmericaCitigroupJPMorganWells FargoGoldman SachsMorgan Stanley

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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 Basel III standards 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. Notably, 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. Also, the CET1 figure for some of the banks fell by as much as 40 basis points (0.4%) between Q4 2013 and Q1 2014 due to a change in the way the size of risk-weighed assets (RWA) was calculated for these banks, as they adopted the new valuation guidelines proposed under Basel III. 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 Q2 2014.

Q3 2012 Q4 2012 Q1 2013 Q2 2013 Q3 2013 Q4 2013 Q1 2014 Q2 2014 TARGET BUFFER
Morgan Stanley 9.00% 9.50% 9.70% 9.90% 10.80% 10.50% 10.20% 10.70% 8.50% 2.20%
Citigroup 8.64% 8.74% 9.34% 10.03% 10.50% 10.59% 10.46% 10.58% 9.00% 1.58%
Wells Fargo 8.01% 8.18% 8.39% 8.55% 9.54% 9.78% 10.04% 10.09% 8.00% 2.09%
Bank of America 8.97% 9.25% 9.52% 9.60% 9.94% 9.96% 9.56% 9.89% 8.50% 1.39%
Goldman Sachs 8.50% 8.80% 9.00% 9.30% 9.80% 9.79% 9.72% 9.84% 8.50% 1.34%
JPMorgan 8.38% 8.74% 8.86% 9.33% 9.33% 9.50% 9.58% 9.79% 9.50% 0.29%

Morgan Stanley leads the U.S. banking giants with a CET1 figure of 10.7% at the end of Q2 2014 – a considerable effort, considering that the banking group has improved the figure by almost two percentage points within seven quarters. The ratio has benefited from the investment bank’s decision to remain stingy with returning cash to shareholders – instead focusing on acquiring 100% of Smith Barney from Citigroup over the last two years. Morgan Stanley’s long term strategy of cutting down on the capital-intensive fixed-income trading business has also helped reduce the size of its risk-weighed assets (RWA), which in turn has given the CET1 figure a boost. The bank also ranks at the top in terms of achieving the highest capital buffer over and above the mandatory target set for it by regulators. Morgan Stanley’s CET1 figure at the end of Q2 2014 is a good 220 basis points (2.2% points) higher than its target of 8.5% that needs to be achieved by 2019. Notably, this means that the investment bank will not have to worry too much about working on its capital ratios even if the Fed decides to impose an additional 2% capital surcharge on the bank for reasons detailed above. [1]

Citigroup comes in at a close second with a CET1 figure of just under 10.6%. 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.

JPMorgan stands out as the only bank that 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 130 basis points (1.3%). As the bank is not expected to make any major changes to its 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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Notes:
  1. Fed to Hit Biggest U.S. Banks With Tougher Capital Surcharge, The Wall Street Journal, Sept 8 2014 [] []