At US G-Sibs, capital buffers have thinned since 2016

The amount of capital that large US banks hold as a cushion in excess of minimum requirements has declined by almost half since 2016.

The median US global systemically important bank (G-Sib) had a minimum Common Equity Tier 1 (CET1) capital requirement of 9.5% of risk-weighted assets as of the second quarter of this year, and a buffer above this minimum of 3.1%.

In Q1 2016, this minimum was 5.9% and the buffer amount 6%. Over the last three years, therefore, the ratio of the buffer amount to minimum requirement has fallen to 35.5% from 102.1%.

The median total CET1 capital ratio – the sum of the amount held to cover the minimum requirement and the buffer – was 12.6% for Q2, up from 11.8% in Q1 2016. But this is down from a peak of 12.8% for Q3 2017.

Of the eight US G-Sibs, Citi and Bank of America Merrill Lynch (BAML) reported the two lowest capital buffers for Q2, of 2.45% and 2.49%, down from 8% and 4.4%, respectively, in Q1 2016.

On the flipside, State Street and Goldman Sachs had the highest buffers, at 4.26% and 4%, respectively, down from 6.8% and 6.3% three years ago.

What is it?

Each bank subject to US advanced approach regulatory capital rules must maintain an institution-specific CET1 capital ratio, made up of a 4.5% minimum requirement and the sum of their respective capital conservation, countercyclical and G-Sib amounts.  

Why it matters

Banks maintained large capital buffers in anticipation of their regulatory minimums rising to their fully-loaded amounts, which were only reached at the start of this year. Now that the steady-state minimums are in force, banks may argue they don’t need their buffers to be as big as they used to, as their mandatory requirements are not expected to increase steadily over time as in previous years. This frees them to reduce their buffers, and release capital to shareholders in the form of dividends and buybacks.

However, the thinner a bank’s buffer, the more susceptible it is to be wiped out in a market crisis. This would cause a world of pain, for if a firm dipped beneath its institution-specific CET1 ratio, it would be forced to curb capital releases, accept regulatory sanctions and become the target of negative news headlines. 

Even though the US minimum requirements are supposedly fixed, the Federal Reserve has the discretion to set a countercyclical capital buffer (CCyB). This tool exists to allow regulators to increase minimum capital requirements during growth periods and wind them down again when the economy sours. Activation of the CCyB would thin G-Sib buffers even more.

In addition, the largest US banks may find they have to reconsider their capital planning in advance of the Fed’s planned stress capital buffer. This would replace the capital conservation portion of the institution-specific minimum ratio with a requirement based on each bank’s worst-case losses in its most recent Comprehensive Capital Analysis and Review stress tests, plus four-quarters of planned common stock dividends. As the SCB would fluctuate in size over time, in line with each firm’s stress-test performance, buffer amounts above this minimum may have to increase in size to absorb the volatility. 

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