What is happening?
In January, the Federal Reserve published hundreds of replies to its consultation to hike capital levels for US banks with more than $100bn in assets, aka Basel Endgame.
Judging by the anguished comments, such a hike would be a death knell to the banking industry. Public markets, which power the world’s largest economy, would dry up faster than the Sahara as banks would be forced to run for shade. Lenders warn of having to charge higher rates or even down tools, an “adverse consequence” of beefing up the country’s banking system with more capital buffers.
How bad are we talking? Banks’ Common Equity Tier 1 capital requirements would go up by an aggregate 16 per cent, mostly affecting Wall Street’s biggest banks. JPMorgan’s chief financial officer, Jeremy Barnum, warned in October that the bank would have to set aside an extra $50bn — a 25 per cent increase in capital requirements — to meet the new rules.
Can banks challenge the capital hike?
The US banking industry is famed for its lobbying prowess. But when JPMorgan posts nearly $50bn in record profits for 2023 (off the back of $239bn in revenues) the aforementioned warnings sound more like an echo than an air raid siren. The problem for US banks is that they are doing rather well. In fact, they are doing brilliantly.
Even Wells Fargo, which was slapped with an asset cap in 2018, is still knocking it out of the park. The bank churned out $115bn in revenues last year, a nearly 40 per cent increase from 2022.
Wells Fargo’s own CEO, Charlie Scharf, remarked nonchalantly in December that, despite being confined by a cap for almost six years, it has not been a “material limitation” for the bank.
Risky Finance, a data service that tracks bank regulatory disclosures, has pulled together a five-year snapshot of trading revenues at the largest US banks.
The six top US banks collectively reported trading revenues of $88bn last year. So when Goldman Sachs complains to the Fed that its proposal to calculate capital levels using the “expected shortfall” method over the longstanding “value-at-risk” approach looks and sounds suspiciously like stress testing (which the Fed already subjects them to), it falls on deaf ears.
A back-of-the-envelope calculation suggests that banks can adapt to a higher-capital environment relatively quickly. Risky Finance founder, Nicholas Dunbar, says: “Look at JPMorgan, which currently has $250bn of Common Equity Tier 1 capital. A 20 per cent capital increase would require an additional $50bn. Where would this come from?
“Net income was $50bn in 2023, and JPMorgan pays around $22bn a year to shareholders in dividends and buybacks, so it could be done in a few years (as the Fed suggests in its proposal).”
Can the banks claw it back in extra time?
When I first wrote about Basel Endgame back in August, I gauged the Reg Rage level as Anxiety. Now it’s firmly at Acceptance (albeit masquerading as “Reg Rage”). But are higher bank capital requirements a done deal? It is not over until the fat lady sings, and that could come in the familiar form of Donald Trump.
Should the former US president elbow his way into the White House again, it is only reasonable to assume he will shake things up. The last time Trump was in power, he rolled back key provisions of the landmark post-financial crisis banking package: the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Could we see a repeat of the Trump administration’s 2017 “Cut the Red Tape” regulatory reform initiative? Trump has already expressed his desire to oust incumbent Fed chair Jerome Powell, who is spearheading the regulator’s proposed capital hikes, accusing him of being “political”.
When asked by Fox Business Network if he would offer Powell another four-year term in 2026, he replied: “I wouldn’t do that.”
We do not know who Trump might look to replace Powell with, but the Financial Times reported potential candidates include former investment banker Kevin Warsh and Fed critic Judy Shelton.
Wall Street’s biggest banks are set to comply with Basel Endgame from July 1 2028. But if they keep up the dire warnings, coupled with a Trump victory, they might just score a last-gasp winner and kick Basel Endgame to the curb.
Farah Khalique is the editor of Banking Risk & Regulation, a service from the Financial Times.
