Wolf’s Finance World

U.S. banking supervisors are using existing authority to raise standards for capital, liquidity and risk management without waiting for the Obama administration and Congress to hammer out a new regulatory structure.

Agencies led by the Federal Reserve and the Office of the Comptroller of the Currency this year are set to propose rule revisions that would increase the amount of capital large banks must set aside against the risk of trading losses, according to government officials. The revisions would follow recommendations of the Basel Committee, the global coordinator for banking regulations based in Switzerland.

U.S. regulators are also proposing stronger guidelines on liquidity risk and this month told banks to improve strategies to guard against the possibility of an abrupt increase in interest rates. The renewed scrutiny comes as firms that received taxpayer support, including Goldman Sachs Group Inc. and JPMorgan Chase & Co., report earnings swelled by gains from securities trading.

“You have got more intensive, more intrusive and more forceful supervision,” said Richard Spillenkothen, a former director of the Fed Board’s Division of Banking Supervision and Regulation and now a Washington-based director at Deloitte & Touche LLP. “Regulators believe going into this crisis in 2007 that capital positions were too low and the liquidity cushions were not sufficiently robust.”

Obama Proposals

President Barack Obama yesterday proposed forbidding banks with insured deposits to engage in proprietary trading solely for their own profit or investing in hedge funds. The proposals, intended to reduce the kinds of risk-taking blamed for the worst financial crisis since the Great Depression, would be part of a broader regulatory overhaul being considered by Congress.

“When banks benefit from the safety net that taxpayers provide, which includes lower cost capital, it is not appropriate for them to turn around and use that cheap money to trade for profit,” Obama said.

Under the revised rule on trading-account capital likely to be imposed by regulators, banks would be obliged to add a so- called stress test to models typically used to calculate a portfolio’s risk. Those tests would require banks to check portfolio moves against more extreme scenarios in financial markets. The revisions would also have stricter capital requirements for some banks’ stock portfolios.

A study published by the Basel Committee in October suggested that large banks would have to boost the capital they set aside for market risk by an average of 224 percent and increase overall capital by 11.5 percent to meet the new standard.

Charges Will Vary

“Capital charges will vary greatly with each bank portfolio,” said Ron Papanek, a strategist at Riskmetrics Group Inc., a firm that sells risk modeling tools to banks and hedge funds. “There are quite a few banks where capital increases will be quite less.”

Joe Mason, a professor of banking at Louisiana State University in Baton Rouge, said that the changes to banks’ value-at-risk models are unlikely to encompass all of the complex securities, such as collateralized debt obligations, that don’t have a long history of prices fast cash advance.

“We have treated this as if it can be dialed into a level of exactitude in a fast-moving world with non-traditional risks,” said Mason.

Fed Chairman Ben S. Bernanke and Sheila Bair, chairman of the Federal Deposit Insurance Corp., are pushing ahead on their own with efforts to strengthen the financial system.

Timely Information

“We are requiring large firms to provide supervisors with more detailed and timely information on risk positions, operating performance, and other key indicators,” Bernanke told the Senate Banking Committee last month.

The Fed in October issued proposed guidance on compensation practices for the bank holding companies it regulates and launched a review of pay policies at more than 20 of the largest banks.

“The Federal Reserve expects all banking organizations to evaluate their incentive compensation arrangements and related risk management, control, and corporate governance processes and immediately address deficiencies,” the Fed said in a notice dated Oct. 27.

Bair said Jan. 12 that the FDIC will seek comment from banks on a proposal that would charge higher fees for deposit insurance for those lenders where compensation structures encourage excessive risk taking.

The scrutiny comes as a recovery from the crisis boosts banks’ profits. The Standard & Poor’s 500 Index, which dropped 1.9 percent yesterday on the Obama proposal, is up 33 percent in the past year.

Crisis Firefighting

Regulators “are moving away from financial-crisis firefighting to thinking about what the architecture of the financial system is going to be,” said Margaret Tahyar, a partner at Davis, Polk & Wardwell, a New York-based law firm.

JPMorgan Chase, the second-largest U.S. bank, said Jan. 15 that profit more than quadrupled on higher investment-banking revenue. Goldman Sachs yesterday reported record earnings of $4.95 billion for the three months ended Dec. 31 compared with a loss of $2.12 billion in the quarter ended in November 2008.

Congress is considering proposals that would reorder authority over the banking system, with draft legislation in the Senate creating a single supervisor and stripping the Fed and other agencies of oversight powers. The overhaul is aimed at avoiding a repeat of the crisis that led to $1.73 trillion in credit losses and writedowns worldwide.

Regulators “were overly generous in 2008 and 2009,” said Eric Hovde, president of Hovde Capital Advisors LLC in Washington, which manages $700 million with a focus on financial stocks. Now, they are likely to get “tougher,” he said.

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