Having cut risk, Wells Fargo may win a lower G-Sib surcharge

Wells Fargo continued to reduce its systemic footprint in the third quarter, and may be in line for a smaller too-big-to-fail capital surcharge in 2022 as a result.

The San Francisco-based bank had a systemic risk score, as calculated using the Federal Reserve’s methodology, of 323 basis points as of end-September, down from 335bp in Q2. This is below the 330bp threshold at which its current 2% systemic risk capital add-on applies. If Wells Fargo makes it to year-end with its score below 330bp, it will qualify for a lower 1.5% charge.

On the flip side, custody bank State Street saw its score rise 7bp to 235bp over the quarter. This tips it into the 1.5% surcharge bucket, and the bank will have to lower its score below 230bp by end-December to avoid a 50bp increase to its systemic risk requirement. The score increase was largely driven by an increased reliance on short-term wholesale funding (STWF).

 

The average systemic risk score across the eight global systemically important banks (G-Sib) for Q3 2020 was 499bp, barely changed from Q2 or Q1, but still elevated compared to the 484bp recorded a year ago.

BNY Mellon saw its score rise the most over the third quarter, by 9bp to 315bp, within the 1.5% surcharge bucket. JP Morgan and Bank of America also saw their scores increase, by 3bp to 797bp, and 5bp to 552bp. The former is in line for a 4% surcharge at year-end if its score remains above 730bp.

 

What is it? 

US G-Sibs are designated using the Basel Committee’s assessment methodology to gauge systemic risk. The total score is found by averaging the scores of five systemic indicator categories: size; interconnectedness; complexity; cross-jurisdictional activity and substitutability.  

The Federal Reserve uses its own measure, known as Method 2, which uses a different calculation formula, deriving a G-Sib score from the sum of the first four indicator categories above plus a short-term wholesale funding factor. Individual indicator values are multiplied by fixed coefficients to produce a final G-Sib score. These Method 2 scores are calculated quarterly, but only the year-end score is used to set each bank’s capital surcharge for the following year but one.   

The G-Sib surcharge applied to designated firms is the higher of that determined by the Basel Committee’s methodology and by the Fed. Under both methods, the higher the score, the higher the G-Sib surcharge, which currently ranges from 1% to 3.5% under Method 1, and from 1% to 4% under Method 2.

Why it matters

Wells Fargo has slashed its systemic risk score quarter after quarter in 2020, at a time when most of its peers have seen theirs spiral in the course of the coronavirus crisis.

One contributing factor is that the bank has been barred from growing its balance sheet since February 2018, following a cease-and-desist order imposed by the Fed as punishment for a series of consumer abuses and risk management failings. This has prevented its size indicator score from increasing over this period.

But this year the bank has hacked away at the kinds of assets and contracts that contribute to its interconnectedness and complexity scores, too. Intra-financial system assets fell 23% over the nine months to end-September, and trading assets 21%. The firm has also snipped its overseas exposures. Cross-jurisdictional liabilities have dropped 27%, and assets 6% year-to-date.

Wells Fargo already has a low stress capital buffer assigned it by the Fed. With a smaller G-Sib surcharge, the bank would have an all-in Common Equity Tier 1 (CET1) capital requirement of 8.5%, compared with 9.5% for Bank of America and a whopping 11.3% for JP Morgan. The lower capital burden may allow it to compete more effectively with its rivals in the future.

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