GS Goldman Sachs Group Inc

By Ryan Tracy 

This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (May 8, 2018).

WASHINGTON -- The largest big-bank rule changes proposed since President Donald Trump took office would refashion one of the core responses to the 2008 financial crisis, generating an unusual level of opposition for the consensus-driven world of bank regulation.

Trump-appointed officials are retooling the leverage ratio, a capital rule adopted to curb excessive borrowing. The changes portend more freedom for gigantic lenders such as Bank of America Corp. and Goldman Sachs Group Inc. to expand activities they have cut back in recent years. Officials say other restrictions will still prevent the banks from taking outsize risk.

Capital rules seek to prevent too much risk-taking by forcing bankers to fund loans and investments with a minimum amount of investors' equity, as opposed to less-secure borrowed money.

Big bank critics across the political spectrum support the leverage ratio as a relatively simple curb. Bankers say the current version is so strict and simplistic, it discourages them from low-risk activities.

Regulators are siding with the industry and recently proposed two major changes that would diminish its significance.

"That's going to allow us to have more flexibility," Bank of America Chief Financial Officer Paul Donofrio said on an April 16 call with Wall Street analysts.

He was referring to a joint proposal by the Federal Reserve and the Office of the Comptroller of the Currency to lower the leverage ratio for the largest U.S. banks. With the changes, the bank could expand some business lines or potentially return more profits to shareholders, he said. The Fed has separately proposed cutting back the leverage ratio's role in its annual "stress tests" of big banks.

The proposals are among the first in a series of expected changes to the postcrisis regulatory regime erected by the Obama administration. Trump-appointed regulators also are rewriting the Volcker rule trading ban and revisiting bank liquidity rules with the aim of lowering regulatory burden.

Opposition, particularly to the joint Fed-OCC proposal, is coming from both conservatives and liberals.

"We haven't had a recession since 2008, so from one point of view, our 'too big to fail' banks have never really been tested," Sen. John Kennedy (R., La.) told Fed Vice Chairman for Supervision Randal Quarles at April 19 Senate Banking Committee hearing. Echoing Democrats on the panel, Mr. Kennedy cautioned against "fooling with the leverage ratio until we see how our banks do in a real, full-blown recession."

Fed governor Lael Brainard's April vote against the Fed-OCC leverage ratio proposal is the only dissent among 315 Fed board votes on record since 2012.The Obama appointee said in a recent speech that banks are profitable and her colleagues should be worried about loosening capital rules.

"A booming economy can lead to a relaxation in lending standards and an attendant increase in risky debt levels," she said.

Mr. Quarles, a Trump appointee who backed the proposals, on Friday said "these new rules will maintain the resiliency of the financial system and make our regulation simpler and more risk sensitive." The agencies are taking public comments on the proposals and could finalize them later this year.

Regulators measure banks' capital in two primary ways. "Risk-weighted" rules assign each asset a different value, so a bank bound by them would need to fund mortgages with more equity than a Treasury bond, for instance. Leverage ratios are simpler calculations comparing equity to total assets.

After the 2008 bailouts, regulators decided their risk-weighted capital rules had failed. They responded by writing new risk-weighted capital rules and, as a backstop, tightening leverage ratio requirements.

The new system has made banks safer by building up their loss-absorbing capital. Fed officials also say it is having unintended consequences.

For the biggest U.S. banks, leverage ratios are often stricter than risk-weighted capital rules. The Fed says this gives bankers the wrong incentive: The leverage ratio treats relatively safe, low-margin activities the same as riskier and more profitable ones, so why not take more risk?

"Removing that perverse incentive was something that was important to do quickly," Mr. Quarles told the Senate panel.

Regulators in the Obama administration also wanted to recalibrate the leverage ratio, but the proposals under Mr. Quarles' watch go beyond what his predecessors telegraphed.

To pass annual "stress tests," the largest banks currently must score well on two leverage ratios. The Fed is proposing to remove one. The Fed-OCC proposal also reverses a policy that required huge bank holding companies to maintain a tighter leverage ratio at taxpayer-insured bank subsidiaries.

Leverage ratios have been a factor in banks' business decisions. Some shrunk inventory of corporate and Treasury bonds -- holdings that counted against their leverage ratios. Goldman finances fewer short-term loans known as repurchase agreements or "repos." JPMorgan started charging for certain types of deposits.

A larger question is whether the proposals will allow these companies to grow their overall size, or to draw down capital and send it to shareholders. If that occurred, banks would have less equity to absorb losses in a downturn.

The Fed says that won't happen because risk-weighted capital rules will remain strict. It points to an analysis of how the new rules would have affected banks in recent years.

JPMorgan says its overall capital requirements "would likely be higher" under the proposals.

Analysts at Goldman did a forward-looking analysis and reached a different conclusion: If future Fed's stress tests yield results similar to the 2017 exam, big banks besides Goldman would be able to maintain about $5.4 billion less capital on average.

--Telis Demos contributed to this article.

Write to Ryan Tracy at ryan.tracy@wsj.com

(END) Dow Jones Newswires

May 08, 2018 02:47 ET (06:47 GMT)

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