A Heuristic View of Evolving Capital and Liquidity Standards Christine Cumming Visiting S cholar, Rutgers University June 17, 2016 at Meetings of the International Atlantic Economic Society Washington, DC October 15, 2016 1 For discussion purposes. Comment s welcome.
A Heuristic View: What’s Really Changed in Capital Requirements? Thesis: The greatest challenge in framing capital and liquidity requirements is in the capital markets business. Basel III liquidity standards deserve more intention. Thesis: Traditional commercial banking at large institutions face less constraint from Basel III capital standards when compared to capital markets activities. Thesis: S ize, interconnectedness and systemic importance j ustify some increase in capital and liquidity requirements as asset size and other systemic indicators increase. 2 For discussion purposes. Comment s welcome.
The Difference Between Bank and S ecurities Firm (Broker-Dealer) Capital Requirements Haberman (1987) offers a nice exposition of the historical differences between bank and broker/ dealer capital requirements. Two principal difference: assumed managerial time horizon and liquidation as the resolution method . Broker/ dealer capital requirements emphasize the combination of credit quality and liquidity of assets. Broker/ dealer requirements did not contemplate the “ fire sale” problem around very large broker/ dealers. 3 For discussion purposes. Comment s welcome.
Both Capital for Credit Losses and S ufficient Liquidity Matter for Capital Markets Businesses Capital markets today involve both substantial credit risk and liquidity risk. The need for time, capital and liquidity to unwind positions has been “ rediscovered” many times in the aftermath of crises. Basel III incorporates a higher “ through the cycle” standard on counterparty credit risk exposure. 4 For discussion purposes. Comment s welcome.
Do Basel III capital and liquidity requirements work well for capital markets? Basel III gives us separate requirements for capital and liquidity. Liquidity is challenging for capital markets activities. S ection 23A Absence of stable funding sources Limited opportunities for stable revenues S tress testing to capture the dynamics of the capital markets business through the still developing CLAR process. 5 For discussion purposes. Comment s welcome.
How the new Basel III likely constrain the capital markets business The likely binding requirements in general are: CET1/ R WA CET1/ Leverage Exposure Measure Level 1 assets/ net cash outflows portion of the LCR The definit ion of Level 1 asset s is very narrow and limit s t he amount of ot her liquid asset s t hat count t oward HQLA For trading banks, the latter two requirements are especially challenging. For discussion purposes. Comment s welcome. 6
In Contrast, The Impact on Traditional Commercial Banking Appears to be Less Minimum capital requirements have not changed greatly for commercial banking activities. New emphasis on CET1 (common equit y) Improved qualit y of capit al The capital conservation buffer and the G-S IB surcharge Banks largely funded by deposits and with a small nonbank component 7 For discussion purposes. Comment s welcome.
S o what do we see from Bank Annual Reports? Notes on the Following Charts I would call t his look at t he dat a as t he first , “ observat ion st age” of t he scient ific process— not hypot hesis t est ing! To span business models, dat a from t he 2015 and 2011 annual report s for eight of 10 largest BHCs in 2015. The t wo not included are BNY/ Mellon and S t at e S t reet , bot h largely focused on cust ody, t ransact ion processing and payment s and set t lement businesses. The focus is on convent ional balance sheet element s rat her t han on regulat ory rat ios. Because of t he small number of really large inst it ut ions, t he analysis risks being more of a “ st ory” . 8 For discussion purposes. Comment s welcome.
Data Definitions Assets— Total Assets Deposits— Total Deposits, noninterest and ineliterest-bearing Loans— Loans net of loan loss reserves. Trading assets— fair value of securities inventory plus the asset-side value of derivatives (current value owed) S ecurities— the investment account, securities held to maturity and, in some cases, available for sale. Long=term debt— largely senior and unsecured debt. CET1— common equity Tier 1 as defined by Basel III: common equity, paid-in capital, and retained earnings. Disclosed in 2015 reports; estimated from 2011 reports where the closest equivalent is tangible common equity (used in the S CAP and disclosed by many banks that year). High quality liquid assets: only a few banks disclose this at year-end 2015; 2016 is the first year the LCR requirement is in effect. When not disclosed, constructed by taking eligible balance sheet items and applying the prescribed haircuts to eligible Level 2 assets. 2011 data estimated in the same manner. S hould be viewed as an approximation. For discussion purposes. Comment s welcome. 9
The Business Model Matters Key Balance S heet Elements/ Total Assets 0.8 Dep Lns Trad S ecur LTD CET1 HQLA 0.7 0.6 Goldman S achs and Wells Fargo span the set of 0.5 commercial/ investment banking models. 0.4 0.3 0.2 0.1 0 1 2 3 4 5 6 7 8 9 GS Wells 10 For discussion purposes. Comment s welcome.
Change in the Composition of Assets/ Liabilit ies: Percentage Change in the Proportion Relative to Total Assets from 2011 to 2015 for Certain Key Balance S heet Items, weighted by asset size for each group of banks Trading Banks: All 8 banks (the top JPMC, Bank of Commercial Banks: ten excluding America, Citigroup, Wells Fargo, US BNY/Mellon and Goldman Sachs and Bancorp, and PNC State Street) Morgan Stanley Financial Deposits 6.49 6.68 -0.21 Loans 2.54 2.80 -4.2 Trading -3.45 -3.32 -0.48 Securities 1.25 0.67 2.01 L/T Debt -2.84 -3.59 1.01 CET1 1.97 2.33 0.52 11 For discussion purposes. Comment s welcome. HQLA 3.39 2.53 7.52
Growth in Key Balance S heet Quantities 2011 to 2015 as a Proportion of Total 2011 Assets for All 8 Banks and the Five Trading Banks and 3 Commercial Banks Legend: 25 20 2-Deposits 3-Loans 15 4-Trading 10 Assets 5 5-S ecurities 6-Long-Term 0 1 2 3 4 5 6 7 8 Debt -5 7-CET1 8-HQLA -10 All 8 Banks 5 Trading 3 Commercial For discussion purposes. Comment s welcome. 12
We are seeing the impact of capital and liquidity requirements in the evolution of business models Consider changes between 2011 and 2015. We use simple percentage changes over the four years (not CAGR). Plenty of caveats are in order for the comparability of data across the years. 13 For discussion purposes. Comment s welcome.
Change in Total Assets 2011-2015 Key: 1-JPMC 40 2-Bank of 35 America 30 3-Citibank 4-Goldman 25 5-Morgan 20 S tanley 15 6-Wells Fargo 10 7-US Bancorp 8-PNC Financial 5 0 1 2 3 4 5 6 7 8 -5 -10 For discussion purposes. Comment s welcome. 14
Changes in Deposits and Loans Relative to Total Assets: Percentage Change 2011-2015 Key: 500 1-JPMC 400 2-Bank of America 3-Citibank 300 4-Goldman 5-Morgan 200 S tanley 6-Wells Fargo 100 7-US Bancorp 8-PNC Financial 0 1 2 3 4 5 6 7 8 -100 Deposits Loans For discussion purposes. Comment s welcome. 15
Percentage Changes in Deposits and Loans Relative to Total Assets: 2011-2015 (Excluding Goldman and Morgan S tanley Loans in order to see other institutions) Key: 1-JPMC Chart Title 2-Bank of 160 America 140 3-Citibank 120 4-Goldman 100 5-Morgan 80 S tanley 6-Wells Fargo 60 7-US Bancorp 40 8-PNC Financial 20 0 1 2 3 4 5 6 7 8 -20 Deposits Loans For discussion purposes. Comment s welcome. 16
Percentage changes in the S hare of Trading Assets and S ecurities in Total Assets 2011-2015 Key: 80 1-JPMC 60 2-Bank of America 40 3-Citibank 20 4-Goldman 5-Morgan 0 1 2 3 4 5 6 7 8 S tanley 6-Wells Fargo -20 7-US Bancorp -40 8-PNC Financial -60 -80 Trading S ecurities For discussion purposes. Comment s welcome. 17
Percentage Changes in Key Liquidity and Capital Measures Compared to Total Assets 2011-2015 Key: 300 1-JPMC 250 2-Bank of America 200 3-Citibank 4-Goldman 150 5-Morgan 100 S tanley 6-Wells Fargo 50 7-US Bancorp 8-PNC Financial 0 1 2 3 4 5 6 7 8 -50 -100 L/ T Debt CET1 HQLA For discussion purposes. Comment s welcome. 18
Notes on S ome Circumstances Affecting Values Changes in loans and deposits are large because the base is low. Trading assets at US Bancorp and PNC Financial are small; the changes therefore look large. The sharp increase in S ecurities and HQLA for Wells Fargo reflect a strategic decision to greatly increase the securities account. Long-term Debt declined for Bank of America and Citigroup between 2011 and 2015; this may reflect the end of the FDIC’s Temporary Liquidity Guarantee Program for medium-term debt. For discussion purposes. Comment s welcome. 19
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