US banks forced to hold billions more in extra capital

The Federal Reserve has announced new capital ratios for US banks dictating that banks have to lift their level of equity to total assets to five per cent. Of course, the main reason is risk management, creating a financial buffer for losses that were seen during the financial crisis. Cold comfort perhaps for the eight main US banks affected by this capital ratio hike, which include Bank of NY Mellon, Goldman Sachs and JP Morgan.

Janet Yellen the head of the Fed has voiced strong support for the new regime, saying that in the financial meltdown that banks had grown so large and so overleveraged, they posed a threat to overall economic stability. This is the US government’s attempt to avert another crisis and try and maintain a stable financial environment.  But the main issue for US banks is that they will be worried about their global competitive position and how they will perform internationally.

The European Central Bank (ECB) announced last autumn that capital ratios could be set at as much as eight per cent, despite Basel III earmarking a possible three per cent capital ratio limit.  Since then, the Basel Committee’s oversight body, the Group of Governors and Heads of Supervision have watered down these rules and sources indicated that big global banks’ average ratio could be raised from 3.8 per cent to four per cent. With the Fed pushing for a higher minimum, this could put US banks on a global back foot.

The technology issues

The cost of complying to capital ratio requirements – whether at US or EU levels - will be a steep one. On one hand they have the rationalisation plans they have to activate, stripping overheads and offloading risky assets. On the other hand they have to invest huge amounts into the audit and compliance systems that will enable them to prove their mettle to regulators.

One of the main issues for banks is that compliance is a cost centre rather than a profit centre. The technology and the teams of analysts, consultants and compliance officers needed to ensure the audit trail is bullet proof don’t come cheap.

But compliance is now an unmoveable part of the landscape – perhaps the next challenge is to look at compliance differently. How can banks use it to their advantage in infrastructure terms? How can they use it to implement best practice across the organisation? It is right to say they don’t have a choice – non-compliance means heavy fines and being in the regulatory black books. But whether it’s capital ratio legislation or other regulation, banks need to start viewing compliance adherence in a more positive, business transformative way.