By Ryan Tracy, Victoria McGrane and Justin Baer
WASHINGTON--The Federal Reserve sent a message to the largest
U.S. financial firms: Staying big is going to cost you.
The Fed's warning, articulated in a pair of rules it finalized
Monday, is among the central bank's starkest postcrisis regulatory
moves pressing Wall Street banks to consider their size and
appetite for risk.
The Fed completed one rule stating that the eight largest banks
in the country should maintain an additional layer of capital to
protect against losses, its plainest effort yet to encourage them
to shrink. At the same time, it offered a reprieve to General
Electric Co.'s finance unit from more-intensive regulation, after
the company promised to cut its assets by more than half.
The moves reinforce the central mandate of the Dodd-Frank
financial overhaul law signed by President Barack Obama five years
ago.
Regulators have pushed big banks to expand their capital buffers
to better absorb losses, reduce their reliance on volatile forms of
funding, improve their risk management and cut back on risky
assets. Annual "stress tests" measure banks' resilience and can
restrict shareholder payouts at firms that don't pass.
For Wall Street banks and their investors, the emerging regime
presents a series of choices: specifically whether to pay the cost
of new regulation, which will fall to the bottom line, or change
their business models by shedding businesses or withdrawing from
certain markets, such as owning commodities.
The Fed "clearly intends the very largest U.S. banks to buckle
under this new capital regime, restructuring quickly and
dramatically," said Karen Petrou, a managing partner at Federal
Financial Analytics, a policy-analysis firm.
J.P. Morgan Chase & Co., the largest U.S. bank with assets
worth $2.449 trillion, will have to maintain more capital than any
of its peers, with an additional 4.5% of assets levied as a result
of Monday's rule. J.P. Morgan has resisted calls from lawmakers and
others to break up their operations, and instead have jettisoned or
adjusted certain businesses to comply with the new mandates.
"Everything's doable--it just costs money," said Glenn Schorr, a
banking-industry analyst with Evercore ISI, the research arm of
investment bank Evercore Group LLC. Mr. Schorr said banks could
hold less capital, but would have to cut parts of their business as
a result.
Fed Chairwoman Janet Yellen, before voting to approve the new
measure, said financial firms must "bear the costs that their
failure would impose on others." She offered banks the choice of
maintaining more capital to reduce the chance they would fail, or
get smaller and reduce the harm their failure would have on the
financial system.
These kinds of restrictions on banks have prompted worries about
unintended consequences, such as volatility in financial markets
that some ascribe to banks being less willing to take on risk.
The Financial Services Roundtable, a trade group representing
big banks, said the new capital rule adopted Monday will push banks
to curtail lending. "Regulators should reasonably address risk, but
this rule will keep billions of dollars out of the economy," said
Tim Pawlenty, the group's president.
Unclear is how far regulators intend to push the biggest banks.
Ms. Yellen and other officials left open the possibility that the
capital rule finished Monday would be incorporated into the central
bank's annual stress tests, a significant move that would make it
harder to meet the test's targets without banks making further
changes to their balance sheets.
Both Goldman Sachs and Morgan Stanley have shed nearly
one-quarter of their assets since 2007, cutting capital-intensive
trading activities that no longer produce the profits that justify
their costs. In Goldman's case, the firm has also sold ancillary
businesses that don't fit into its long-term plans, such as
insurance.
J.P. Morgan Chief Executive James Dimon has defended the bank's
scale, citing its good returns and high customer satisfaction. "We
still want that pre-eminent position, and we're not going to give
that up for anyone," he said at J.P. Morgan's investor day in
February. A J.P. Morgan spokesman on Monday said the bank is
analyzing the rule.
Still, in 2014 the bank stopped operating about a dozen
businesses, including physical commodities and student-lending
origination. The Wall Street Journal reported in February that J.P.
Morgan would begin charging large institutional customers fees for
certain deposits, citing rules that make holding money for some
clients too costly. Retail deposits weren't impacted.
The other seven large banks covered by the new rule, including
Citigroup Inc. and Bank of New York Mellon Corp., must maintain
additional capital buffers of between 1% and 3.5%, the Fed
said.
Already, Wall Street firms have taken steps ahead of the Fed's
move, issuing billions of dollars in preferred shares and long-term
debt, beefing up capital by retaining earnings and bolstering
profits from businesses considered safer, such as wealth- and
asset-management.
"We're not capital short," James Gorman, Morgan Stanley's chief
executive, said during a conference call on Monday before the Fed's
final rule was released. "If anything, we're capital heavy."
Out of the eight big banks, only J.P. Morgan doesn't have enough
capital to meet the rule, which comes into full effect in 2019. The
bank has a $12.5 billion shortfall, according to Fed officials.
J.P. Morgan executives have said they believe they can cut
businesses and take other actions to meet the deadline.
The size of each bank's additional capital requirement is
tailored to the firm's relative riskiness, as measured by the Fed's
formula, which considers factors such as size, entanglements with
other firms and internal complexity. As those factors shrink or
grow, so will a bank's surcharge.
In a sign of the central bank's preferences, on Monday it
delayed until 2018 tough rules that would have fallen on GE Capital
in 2017, giving the GE unit time to carry out its wind-down plan.
GE Capital was under scrutiny because U.S. regulators in 2013
judged its failure could hurt the broader U.S. economy and
designated it "systemically important," a label created under the
Dodd-Frank that brings stricter oversight to such firms from the
Fed.
GE since said it planned to shed the very qualities--and
assets--that made the finance unit subject to oversight in the
first place. No company has been able to lose the label of
"systemically important" and the Fed didn't promise GE would be
able to, either. GE said Monday it was "grateful" for the Fed's
action.
Emily Glazer and Ted Mann contributed to this article.
Write to Victoria McGrane at victoria.mcgrane@wsj.com
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