The Federal Reserve Board has adopted a final rule that establishes risk-based capital surcharges for the largest, most interconnected US-based bank holding companies pursuant to section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. A bank holding company whose measure of systemic importance exceeds a defined threshold would be identified as a global systemically important bank holding company (GSIB) and would be subject to a risk-based capital surcharge, thereby increasing the capital conservation buffer that such a bank must maintain. As stated by the Chair of the Federal Reserve Board, Janet L. Yellen, “A key purpose of the capital surcharge is to require the firms themselves to bear the costs that their failure would impose on others. In practice, this final rule will confront these firms with a choice: they must either hold substantially more capital, reducing the likelihood that they will fail, or else they must shrink their systemic footprint, reducing the harm that their failure would do to our financial system. Either outcome would enhance financial stability.”1

The surcharge uses one of two methods of calculation, including an alternate method of calculation than the regulatory framework agreed to under the Basel Committee on Banking Supervision (BCBS).2 The result is, in some cases, nearly twice as large a buffer (roughly 1.0 – 4.5% of the bank’s total risk-weighted assets) on account of a firm’s reliance on short-term wholesale funding.3  Additionally, the new method of calculation is less reliant on factors variable to the relative size of other banks, which depends on an annual Aggregate Global Indicator amount.  4

Quick Summary of GSIB Surcharge Rules5

  1. Banks identified as GSIBs would be required to maintain an additional capital buffer of roughly 1.0 – 4.5% of the bank’s total risk-weighted assets, dependent on a number of factors.
  2. The capital buffer would be phased in over three years, beginning on January 1, 2016 and becoming fully effective on January 1, 2019.
  3. The Fed has identified eight (8) US banks that would initially be subject to the enhanced surcharges.
  4. The Federal Reserve Board has identified two methods that each bank should use in determining the additional surcharge, the higher calculation of which is to be applied:
    1. Method 1 follows the BCBS guidance in basing its calculation on a bank’s size, interconnectedness, substitutability, complexity, and cross jurisdictional activity;
    2. Method 2 replaces the substitutability metric with one based on a bank’s reliance on short-term wholesale funding, most likely resulting in the higher of the two calculations.
  5. The purpose of the new rule would be to force the largest banks to internalize the threat of harm to US financial stability and to reduce the impact of their failure to near the impact of the failure of a large bank holding company that is not a GSIB.

For more information, read the complete Federal Reserve document: Regulatory Capital Rules: Implementation of Risk-based Capital Surcharges for Global Systemically Important Bank Holding Companies

Determination of GSIBs

Table 1 – Systemic Indicators6
Category Systemic Indicator Indicator Weight
Size Total exposures 20%
Interconnectedness Intra-financial system assets 6.67%
Intra-financial system liabilities 6.67%
Securities outstanding 6.67%
Substitutability Payments activity 6.67%
Assets under custody 6.67%
Underwritten transactions in debt and equity markets 6.67%
Complexity Notional amount of over-the-counter derivatives 6.67%
Trading and available-for-sale securities 6.67%
Level 3 assets 6.67%
Cross-jurisdictional activity Cross-jurisdictional claims 10%
Cross-jurisdictional liabilities 10%
Total for 12 indicators across 5 categories 100%

Methods of Calculating the GSIB Surcharge7

The first method for calculating the GSIB surcharge uses the formula above for determining whether or not the entity is in fact a GSIB. Any entity that scores 130 or higher (currently only the eight largest US banks), will be forced to comply with the initial 1.0% GSIB surcharge, with additional surcharges added as the indicator score increases.8 Note that this method is a relative approach, as it measures a BHC’s systemic indicator score in proportion to the corresponding aggregate global indicator amount rather than against a fixed amount, thus providing a floor surcharge for GSIBs.

The second method of calculation is similar to the first, but with two key differences. Unlike the first method, it replaces the substitutability factor with a quantitative measure of the GSIB’s use of short-term wholesale funding, as the Federal Reserve Board deemed such funding to pose the greatest vulnerabilities to US financial stability. Also in contrast, the second method uses a fixed approach by assigning a constant to each of the factors it uses rather than comparing it to the global aggregate indicators. Because the method 2 surcharge is likely to be the applicable surcharge, it better enables a firm to manage its risk profile.

Impact on Financial Planning9

BHCs should consider the impact of the additional GSIB surcharge in conjunction with the other capital and liquidity buffers that are already in place, such as the common equity tier 1 capital minimums. The surcharge will be phased in at 25%, 50%, 75% and 100% annually, beginning on January 1, 2016 and coming into full effect on January 1, 2019. Since the GSIB surcharge can change from year to year per the results of the FR Y-15 report, we feel that BHCs should be ready to increase this buffer even further on an annual basis, if needed. Method 1, which compares BHCs relative to each other, results in a floor surcharge that cannot easily be adjusted, aside from reducing the overall size of the portfolio. However, under the Method 2 calculation, we believe that institutions could choose to manage their risk profiles more actively by adjusting their reliance on certain fixed variables. BHCs that rely heavily on short-term wholesale funding may consider scaling back on such sources of revenue in order to reduce their applicable GSIB surcharge. However, Method 2 is still heavily dependent on factors such as the broader economy, which can cause artificial spikes. The Board has promised to review these external factors and adjust annually. Overall, we see these structural changes significantly impacting BHCs’ ability to conduct their business both in method and in quantity.

Possible Consequences of Failing to Adhere to the GSIB Surcharge:

  1. Capital Harm: Failure to maintain the capital surcharge would subject the GSIB to restrictions on capital distributions and discretionary bonus payments.10
  2. Reputational Risk: We believe that BHCs that are unable to perform adequate capital buffers are likely to see loss of reputation among investors.
  3. Regulatory Scrutiny: In our view regulators are likely to take a closer eye to those BHCs failing to meet minimum capital conservation buffers as these institutions should pose the greatest threats to the financial stability of the US.

Key Considerations for Clients

  • The calculation of the GSIB surcharge is on top of capital conservation requirements already in place, further increasing the amount of capital BHCs must hold onto.11
  • BHCs should begin planning immediately to hold onto additional capital as the first phase-in will come into effect on January 1, 2016.12
  • We feel that BHCs should have contingency plans in the event that additional buffers are needed due to an annual increase in the GSIB surcharge calculation.
  • Depending on the structure of the business, we think BHCs may be able to reduce their surcharge by minimizing short-term wholesale funding.

While initially only the eight largest US banks are expected to be subject to the GSIB surcharge, smaller banks should monitor their annual FR Y-15 reports to help avoid these possible surcharges.13

References

  1. Board of Governors of the Federal Reserve System, press release, “Federal Reserve Board approves final rule requiring the largest, most systemically important U.S. bank holding companies to further strengthen their capital positions,” July 20th, 2015. Available at: http://www.federalreserve.gov/newsevents/press/bcreg/20150720a.htm
  2. “Regulatory Capital Rules: Implementation of Risk-based Capital Surcharges for Global Systemically Important Bank Holding Companies,” Federal Reserve System, 12 CFR Part 217, RIN 7100 AE-XX. Available at: http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20150720a1.pdf
  3. Board of Governors of the Federal Reserve System, press release, “Federal Reserve Board approves final rule requiring the largest, most systemically important U.S. bank holding companies to further strengthen their capital positions,” July 20th, 2015. Available at: http://www.federalreserve.gov/newsevents/press/bcreg/20150720a.htm
  4. Ibid
  5. Ibid
  6. Ibid
  7. Ibid
  8. “Regulatory Capital Rules: Implementation of Risk-based Capital Surcharges for Global Systemically Important Bank Holding Companies,” Federal Reserve System, 12 CFR Part 217, RIN 7100 AE-XX. Available at: http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20150720a1.pdf
  9. Board of Governors of the Federal Reserve System, press release, “Federal Reserve Board approves final rule requiring the largest, most systemically important U.S. bank holding companies to further strengthen their capital positions,” July 20th, 2015. Available at: http://www.federalreserve.gov/newsevents/press/bcreg/20150720a.htm
  10. Ibid
  11. Ibid
  12. Ibid
  13. Ibid

Newsletter Author: Jason Gould

Newsletter Contact Person: Craig Unterseher

Disclaimer: This blog is intended for general informational purposes only, does not take into account the reader’s specific circumstances, may not reflect the most current developments, and is not intended to provide advice on specific circumstances. Accenture disclaims, to the fullest extent permitted by applicable law, all liability for the accuracy and completeness of the information in this blog and for any acts or omissions made based on such information. Accenture does not provide legal, regulatory, audit or tax advice. Readers are responsible for obtaining such advice from their own legal counsel or other licensed professional.

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