Over two years, top US banks’ capital fell 5%

Stress capital buffer could reduce CET1 a further $40 billion

Aggregate Common Equity Tier 1 (CET1) capital held by the eight systemic US banks dropped $42.6 billion (-5%) between Q3 2017 and end-2019. It could fall a further $40 billion (-5%) on implementation of the new stress capital buffer (SCB), says Federal Reserve governor, Lael Brainard.

CET1 increased 9% between Q2 2014 and Q3 2017, and has been on an uneven downward trend since. Higher payouts to shareholders, through dividends and stock buybacks, are one reason the banks’ capital piles have diminished. Payouts have exceeded earnings in two of the last three years on average, and the ratio of payouts to net income hit 117% in 2019. Wells Fargo had the highest payout ratio of the eight: 163%.

Brainard says the Fed’s new SCB could erode current required CET1 across all banks by $60 billion (-5%) and actual CET1 capital by $120 billion (-10%).

 

But Fed governor and vice-chairman for supervision, Randal Quarles, said that “through the cycle” the systemic banks’ CET1 requirement would increase $46 billion.

Quarles’ assessment is based on the average change in required CET1 capital that would have occurred had the SCB been effective from 2013–19.

 

Who said what

“Banks worked hard to build their capital buffers following the crisis. It is imprudent to reduce the loss-absorbing capital at the core of the system at this point in the cycle, when large banks are internationally competitive, and payouts have been exceeding earnings” – US Federal Reserve governor, Lael Brainard.

What is it?

The stress capital buffer alters the US bank solvency framework by integrating stress-test results into firms’ risk-based capital requirements.

The SCB amount for each bank will be set equal to its peak-to-trough CET1 capital ratio decline projected under the annual Comprehensive Capital Analysis and Review’s severely adverse scenario, plus four quarters of planned common stock dividends as a percentage of risk-weighted assets (RWAs). The SCB will be floored at 2.5% of RWAs.

Why it matters

The SCB injects volatility into banks’ risk-based capital requirements, as these will now fluctuate in line with their stress-test performances as well as the size of their planned dividends. 

This may, in part, explain the different impact analyses offered by Quarles and Brainard. The former based his on what the likely capital effects over the past seven years would be and the latter solely on the effects in the here and now. 

Systemic banks have got better at estimating their stress-test results in recent years, which may have given them the confidence to lower CET1 amounts by increasing payouts. This trend may continue if banks sense they can gauge their SCB amounts accurately going forward, and have sufficient capital headroom. 

Citi, for example, believes it will be able to reduce its CET1 ratio to standardised RWAs to 11.5% from 11.7%, even under the SCB.

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