New FSB List Increases Capital Target For Citigroup, BofA; Requirements Reduced For HSBC, Barclays and Morgan Stanley

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The Financial Stability Board (FSB) recently released its annual list of 30 global systemically important banks (G-SIBs), and a total of seven banks are now in a different risk category compared to last year. [1] While the FSB now classifies Citigroup (NYSE:C), Bank of America (NYSE:BAC), ICBC and Wells Fargo (NYSE:WFC) under a risk category one notch higher than the level last year, HSBC (NYSE:HSBC), Barclays (NYSE:BCS) and Morgan Stanley (NYSE:MS) have moved down one level in the classification. As the mandated minimum capital ratio that a global banking giant needs to maintain is determined by the risk category – or more formally the “additional loss absorbency-level bucket” – the FSB places that bank in, this would mean an increase or decrease in capital requirement levels for these seven banks.

In this article, we will detail the impact of the new categorization on these banks. We will also elaborate on the rationale behind the FSB’s capital requirement guidelines and allocation of individual banks into these buckets while highlighting the major changes in the FSB’s list since 2011 – when the regulator first published its list of G-SIBs.

Understanding The Role Of The FSB And Its Categorization Of G-SIBs

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Following the global economic recession, the biggest concern among financial regulators was to ensure that the biggest and most important banks do not buckle under economic pressure the way they did in 2008 when governments were forced to step in and pump in billions of taxpayer dollars to bail-out them out. The concept of a bank acting as the economic backbone of a region or a nation led to the larger idea of banks which are systemically important on the global scale – the G-SIBs.

The FSB, backed by the G20 nations, is charged with overseeing the financial condition of the world’s largest bank – with specific focus on identifying G-SIBs and coming up with ways to making them more robust. As the biggest global banks are extremely diversified in their operations, and as splitting their traditional lending business from the more volatile investment banking operations comes with a long list of issues, the most acceptable solution for the regulators and the banks was to increase the amount of capital they hold. As a “one-size-fits-all” approach couldn’t be used for all these banks, their capital requirements were staggered by categorizing them on the basis of their business models, geographical diversification, quality of asset base, and a plethora of such factors. The final capital requirement for a particular bank was to be determined as the sum of the minimum level of capital requirement of 7% and an applicable surcharge which was one of 5 values: 1%, 1.5%, 2%, 2.5% and 3.5%.

The highest surcharge of 3.5% was proposed as a deterrent to an extremely large-sized bank from growing any further, and no bank has been categorized in this bucket since the inception of this methodology. As for the other proposed buckets, the FSB rated the G-SIBs based on their inter-connectedness, size, complexity, global reach, and even the ability of other firms to take over their functions in the event of their failure. So, if a bank falls in Bucket 4 – like Citigroup (NYSE:C) or JPMorgan Chase (NYSE:JPM) – then it is mandatory for it to hold an additional 2.5% in capital over and above the 7% base minimum, or a total of 9.5%.

The table below summarizes the changes in the FSB’s list of G-SIBs from 2011, and highlights banks that saw a change in their category in 2016 (red: 1 notch higher, green: 1 notch lower).

GSIB_2016Update

Note: Commerzbank, Dexia and Lloyds were dropped from the list in 2012, Standard Chartered was added in 2012, ICBC in 2013, Agricultural Bank of China (ABC) in 2014 and China Construction Bank (CCB) in 2015. Also, BBVA was added to the list in 2012, but dropped in 2015.

What A Category Change Means For The Banks Affected

The direct impact of the FSB’s new list on Citigroup, Bank of America, ICBC and Wells Fargo is to raise their mandatory minimum capital ratio requirements by 50 basis points (0.5% point). So Citigroup’s minimum capital ratio increases from 9% to 9.5% and so on. It must be remembered here, though, that the capital requirments as set by the FSB are generally used as the base minimum figure by country-specific financial regulators. For most U.S. banks, the Federal Reserve prescribes capital surcharges that are already greater than what the FSB’s most recent list recommends.

This is true for Citigroup, Bank of America as well as Wells Fargo, who currently need to maintain a minimum capital ratio figure (on a fully phased-in basis) of 10%, 10% and 9% respectively under Fed rules (see How Do The Largest U.S. Banks Stack Up In Terms Of Their Core Capital Ratio?). The FSB’s new suggested threshold level for them is 9.5%, 9% and 8% respectively. As all these banks already comply with the stricter capital requirement figure, the FSB’s change does not affect them unless the Fed decides to bump their minimum figure up by another 50 basis points. Notably, the current target capital level for JPMorgan is 10.5%, so it is very possible for the Fed to impose the same criteria for Citigroup in the near future.

As for HSBC, Barclays and Morgan Stanley, the reduced capital ratio is a result of their focus on divestments in the recent past – something that has lowered their importance globally. While HSBC has slashed its global footprint considerably over recent years, Barclays has pulled out of Africa and parts of Europe. Given Barclays continuing struggle to increase its capital position, the reduced requirement come as a respite to the British banking giant (see How Do Major European Banks Fare In Terms Of Meeting Core Capital Ratio Targets?). In case of Morgan Stanley, the lower capital requirments are a result of the bank’s efforts to shrink its debt trading business. It must be remembered here that Morgan Stanley is already the best capitalized bank among all the G-SIBs, so the reduced capital target should pave the way for the bank to return more cash to investors through dividends and share repurchases in the near future.

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Notes:
  1. FSB publishes 2016 G-SIB list, FSB Press Releases, Nov 21 2016 []