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Portfolio > Alternative Investments > Hedge Funds

Biggest banks to face tougher debt limits to end too-big-to fail

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Global regulators are considering how to raise capital requirements for the world’s biggest banks as they implement tougher debt-financing limits designed to rein in too-big-to fail lenders.

The Basel Committee on Banking Supervision already imposes higher capital ratios on the 30 largest global banks, led by JPMorgan Chase & Co. and HSBC Holdings Plc, based on the riskiness of their businesses. The committee is now seeking feedback on a surcharge to the so-called leverage ratio, which is based on the size of balance sheets, without consideration of risk. The charge could be made a hard minimum requirement that mustn’t be broken, or designed as a buffer, which can be temporarily breached in times of crisis.

“One way to maintain the relative roles of the risk-based ratio and the leverage ratio in the regulatory capital framework would be to introduce a higher” leverage ratio for global systemically important banks, it said in proposals published on Wednesday.

The 2008 financial crisis demonstrated that some financial institutions were so big and tightly linked to every aspect of the global economy that they could not be allowed to fail, eliminating their incentives for controlling risks. Since then, regulators have sought to impose external controls on their risk-taking.

The Financial Stability Board, chaired by Bank of England Governor Mark Carney, created five categories of banks, with requirements that they hold extra capital ranging from 1 percentage point to 3 percentage points of risk-weighted assets.

The Basel committee, which brings together regulators from around the world, asked whether an additional leverage ratio requirement should be fixed and applied equally to all 30 banks on the list. An alternative would be to vary the requirement depending on the category the lender is assigned to under the risk-based framework, it said.

Basel is also considering whether there should be a limit set on how much additional Tier 1 capital can be used to satisfy any new requirement, it said. While additional Tier 1 securities vary by jurisdiction, they are typically cheaper for banks to issue than common equity. Under the risk-based framework, banks can count AT1 securities equivalent to 1.5 percent of risk-weighted assets toward minimum capital requirements.

The committee is considering whether to make a higher leverage ratio part of a tougher minimum requirement, or if it should require banks to hold a pool of capital as a buffer against risks linked to their size. If that solution is chosen, then the question is whether optional payouts such as dividends, staff bonuses and additional Tier 1 interest, should be restricted automatically if losses eat into the buffer, or if the regulator should step in and demand a capital plan.

The committee also proposed a new method for banks to assess their exposure to derivatives, which may reduce the amount of capital lenders need to meet restrictions on leverage. The committee, which includes the Federal Reserve and European Central Bank, also took steps toward alleviating banks’ concerns that they’re taking a capital hit on the billions of dollars in collateral they receive from customers for handling derivatives.

Responses are due by July 6.

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