On Tuesday, U.S. regulators, in addition to adopting risk-weighted capital standards derived by the Basel Committee, approved a near doubling of leverage-ratio minimums for the eight largest U.S. banks: JPMorgan (JPM), Citigroup (C), Bank of America (BAC), Wells Fargo (WFC), Morgan Stanley (MS), Goldman Sachs (GS), Bank of New York (BK) and State Street (STT).
The resulting supplemental leverage ratio (SLR) would require the eight systemically important financial institutions (SIFIs) to raise as much as $63 billion to $89 billion in Tier 1 common equity by 2019, at the holding company and insured-depository levels.
So why is the result arguably a positive for financial stocks and for the U.S. markets?
The regulators' moves may serve as a kind of inoculation against uncertainty: The positive long-term prospects signaled by these events should be reassuring as shareholders prepare to endure a dose of mixed news in the context of second-quarter earnings reports. This Friday, July 12, JPMorgan will lead the industry into an expectedly sloppy quarter of earnings reports, reflecting the weak economy.
The first reason to be upbeat, amid seemingly gloomy news on the regulatory front, is that in trying to figure out what would be included in the denominator for the leverage-cap calculations, many top bank analysts had modeled far worse. Morgan Stanley, for instance, had cautiously anticipated as much as a 170% gross-up to GAAP assets, instead of the 43% increase apparently adopted by the Federal Deposit Insurance Company and Office of the Comptroller of the Currency.
As my colleague Joe Engelhard notes, securities lending, securities borrowing, reverse repos, derivatives and unconditionally cancellable commitments will be excluded, at least for now. And a smaller denominator will spell more manageable multi-year capital raises.
Second, coming a day after the committee had released a press release and discussion paper questioning the efficacy and complexity of its own Basel III risk-based capital ratios, the event further reinforced that the U.S. might be winning a global buy-in regarding the need for a stronger leverage ratio. A few European bank regulators had fought against the inclusion of the supplemental leverage ratio during Basel III negotiations, insisting upon a quantitative impact study, a period of observation and an opportunity to recalibrate in 2017. But we now see a chance for eventual international agreement on a non-risk-weighted leverage ratio above the 3% level heretofore approved.
For U.S. banks, this would significantly reduce the risk of regulatory arbitrage (and capital inadequacy) as well as feared lack of comparability with foreign banks -- a potentially big win, given perceptions that U.S. regulators were intent on increasing the SLR unilaterally.
Third, just moving beyond the uncertainty relating to the issue may go a long way toward removing a policy-related overhang that has bedeviled holders of bank stocks for months, as remaining Dodd-Frank mandates make their way to implementation and in the aftermath of Washington's reaction to JPMorgan's "London whale" trading losses. The latter prompted, among other things, introduction of Brown-Vitter TBTF legislation on Capitol Hill and hawkish saber-rattling from Fed Governor Dan Tarullo, FDIC board member Thomas Hoenig and others.
To be sure, stakeholders will still have to endure anxieties over additional senior BHC debt requirements that are likely to emerge in the context of Orderly Liquidation Authority rules this fall and potential frictions against market-making and underwriting potentially accompanying a final Volcker rule. But with only a couple of other exceptions (resolution on final SIFI buffers and measures to reduce reliance on wholesale funding), Washington's "Great Recession" re-regulation cycle is nearing the point of being fully vented.
Perhaps in anticipation -- skating to where the puck is going to be -- investors have endured the noise of the first half of 2013 while treating the Big Eight (with the exception of Bank of New York) to market-beating 20%-33% gains since January.
The fun part of the story is that although investors, since May, have begun to grapple with their feelings about rising interest rates, amid market reaction to notional Fed tapering after Labor Day, it's worth remembering that a steepening yield curve could only be good for the banks. Along with final clarity on the regulatory front, this may be why many have viewed the financials as positive cyclical plays at this stage.
And of course, in the longer run, the health of the U.S. economy will be only as strong as its banking system: A let-up in adverse credit conditions will allow continued improvement in the housing sector, as the U.S. economy at large also enjoys relief from the throes of deleveraging.