Christine Cumming Visiting S cholar, Rutgers University June 17, - - PowerPoint PPT Presentation

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

For discussion purposes. Comment s welcome.

1

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.

For discussion purposes. Comment s welcome.

2

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.

For discussion purposes. Comment s welcome.

3

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.

For discussion purposes. Comment s welcome.

4

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.

For discussion purposes. Comment s welcome.

5

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

For discussion purposes. Comment s welcome.

7

S

• 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

• n 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” .

For discussion purposes. Comment s welcome.

8

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

0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 1 2 3 4 5 6 7 8 9

Key Balance S heet Elements/ Total Assets

GS Wells

Dep Lns Trad S ecur LTD CET1 HQLA

Goldman S achs and Wells Fargo span the set of commercial/ investment banking models.

The Business Model Matters

For discussion purposes. Comment s welcome.

10

For discussion purposes. Comment s welcome.

11

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

All 8 banks (the top ten excluding BNY/Mellon and State Street) Trading Banks: JPMC, Bank of America, Citigroup, Goldman Sachs and Morgan Stanley Commercial Banks: Wells Fargo, US Bancorp, and PNC 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 HQLA 3.39 2.53 7.52

For discussion purposes. Comment s welcome. 12

• 10
• 5

5 10 15 20 25 1 2 3 4 5 6 7 8

All 8 Banks 5 Trading 3 Commercial

Legend: 2-Deposits 3-Loans 4-Trading Assets 5-S ecurities 6-Long-Term Debt 7-CET1 8-HQLA

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

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.

For discussion purposes. Comment s welcome.

13

For discussion purposes. Comment s welcome. 14

• 10
• 5

5 10 15 20 25 30 35 40 1 2 3 4 5 6 7 8

Change in Total Assets 2011-2015

Key: 1-JPMC 2-Bank of America 3-Citibank 4-Goldman 5-Morgan S tanley 6-Wells Fargo 7-US Bancorp 8-PNC Financial

For discussion purposes. Comment s welcome. 15

• 100

100 200 300 400 500 1 2 3 4 5 6 7 8

Deposits Loans

Key: 1-JPMC 2-Bank of America 3-Citibank 4-Goldman 5-Morgan S tanley 6-Wells Fargo 7-US Bancorp 8-PNC Financial

Changes in Deposits and Loans Relative to Total Assets: Percentage Change 2011-2015

For discussion purposes. Comment s welcome. 16

• 20

20 40 60 80 100 120 140 160 1 2 3 4 5 6 7 8

Chart Title

Deposits Loans

Key: 1-JPMC 2-Bank of America 3-Citibank 4-Goldman 5-Morgan S tanley 6-Wells Fargo 7-US Bancorp 8-PNC Financial

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)

For discussion purposes. Comment s welcome. 17

Percentage changes in the S hare of Trading Assets and S ecurities in Total Assets 2011-2015

Key: 1-JPMC 2-Bank of America 3-Citibank 4-Goldman 5-Morgan S tanley 6-Wells Fargo 7-US Bancorp 8-PNC Financial

• 80
• 60
• 40
• 20

20 40 60 80 1 2 3 4 5 6 7 8

Trading S ecurities

For discussion purposes. Comment s welcome. 18

Key: 1-JPMC 2-Bank of America 3-Citibank 4-Goldman 5-Morgan S tanley 6-Wells Fargo 7-US Bancorp 8-PNC Financial

• 100
• 50

50 100 150 200 250 300 1 2 3 4 5 6 7 8

L/ T Debt CET1 HQLA

Percentage Changes in Key Liquidity and Capital Measures Compared to Total Assets 2011-2015

Notes on S

• me 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

0.05 0.1 0.15 0.2 0.25 0.3 0.35 0.4 0.45 0.5 0.02 0.04 0.06 0.08 0.1 0.12 0.14

LTD+HQLA/ Total Assets Common Equity/ Total Assets

Relationship between common liquidity and common equity relative to total assets

Capital Requirements

Liquidity Require- ments

But here, too, what we

• bserve may well reflect

the ultimate Basel III and TLAC requirements push- ing firms into a zone.

We might also expect a steep tradeoff between capital and liquidity (although the relationship is no doubt complex).

For discussion purposes. Comment s welcome.

20