US regulators are contemplating tighter capital requirements for the big banks, which could force them to withhold dividend payments.
Several news sources recently reported the Federal Reserve and the FDIC are weighing tough capital requirements for the nation’s money center banks. The new standards may even force the banks to withhold dividend payments for as long as five years. And this is something else for investors in financials to seriously consider.
A Brief Primer on Proposed Capital Requirements
The new standard would increase the amount of required capital to 6% of combined assets – regardless of the risk. According to Bloomberg News this is twice the level established by the Basel III Accord which was set at 3%, a leverage ratio US lawmakers have been pressuring regulators to beyond.
While tighter leverage ratios are a necessary safety measure to prevent bank failures, one has to wonder whether the new proposed standard could hand cuff the banks from raising capital by selling shares. If the report is accurate about how banks would be forced to halt dividend payments for five years, then an onerous 6% standard could have unintended consequences.
How Will Proposed Standards Affect the Banks?
Some observers argue such a tight threshold means the banks will need to retain more of their earnings. So withholding dividend payments will allow banks to build capital. Without getting lost in the weeds of counting assets and calculating simple leverage, it seems investors will be forced to put their money elsewhere.
Moreover, the banks will also be forced to rein in lending in order to comply with the proposed standard. And the liquidity needed in the consumer finance and housing markets will be harder to find. Ultimately the long overdue housing recovery and a return to economic growth and job creation may be hampered – a lingering problem since the financial tsunami of 2008.
Which US Banks Are at Risk?
Some of the nation’s big banks like Bank of America Corp (NYSE:BAC), Citigroup Inc (NYSE:C), and JPMorgan Chase & Co. (NYSE:JPM) would be caught up in the 6% dragnet, according to estimates by one investment bank cited in the Bloomberg story.
Tighter capital requirements obviously will ensure better stability for the financial system. At the same time, some analysts argue tightening the threshold in “volatile” markets could drain the system of much needed capital from investors. And this only adds to the legal and regulatory challenges these and other large lenders are facing.