Fed’s Rosengren: Banks With Broker-Dealer Units Need More Capital

Money News, April 17, 2013. All Rights Reserved.

Boston Federal Reserve President Eric Rosengren said banks should hold more capital if they own a broker-dealer unit because such businesses pose greater risks during periods of financial stress.

“Bank holding companies with large broker-dealer affiliates should hold more capital to reflect the reduced stability of their liabilities during times of stress,” Rosengren said in prepared remarks for a speech in New York.

Rosengren made his call as members of Congress and regulators try to reduce the risk that a large bank failure might result in a taxpayer-funded bailout. Senate Republicans and Democrats are discussing legislation that would boost capital standards. Fed officials are considering ways to curb balance-sheet expansion at the largest banks and toughen capital requirements for the largest firms.

“Despite the central role that broker-dealers played in exacerbating the crisis, too little has changed to avoid a repeat of the problem,” Rosengren said at the 22nd Annual Hyman P. Minsky Conference in New York. “I firmly believe that a reexamination of the solvency risks of large broker-dealers is warranted.”

The Fed-assisted emergency sale of Bear Stearns Cos. to JPMorgan Chase & Co. in March 2008 was the first time since the Great Depression that the U.S. central bank had come to the assistance of a securities firm, as opposed to a bank.

Lehman Bankruptcy
Six months later, the bankruptcy of Bear Stearns’s larger rival, Lehman Brothers Holdings Inc., shocked financial markets and led the three biggest U.S. securities firms — Merrill Lynch & Co., Goldman Sachs Group Inc. and Morgan Stanley — to be acquired by or convert to banks in an effort to get the backing of the Fed.

To help keep the firms afloat during the financial crisis in 2008, the Fed launched the Primary Dealer Credit Facility, which at its peak lent out $156 billion. A second facility, the Term Securities Lending Facility, lent an additional $246 billion at its peak.

“Given that recent history, the assumption that collateralized lenders like broker-dealers are not susceptible to runs has been proven wrong,” Rosengren said at the conference, hosted by the Levy Economics Institute of Bard College and the Ford Foundation.

SEC Regulation
“Broker-dealer capital regulation by the SEC remains largely unchanged, despite the lessons of the financial crisis,” he said. “Consequently, broker-dealers remain vulnerable to losing the confidence of funders and counterparties should the world economy again experience a significant financial crisis.”

The Boston Fed chief, formerly his bank’s head of supervision, has previously taken the lead in calling for additional regulations on the money-market fund industry that were subsequently endorsed by all 12 Fed presidents.

The 2011 bankruptcy of MF Global Holdings Ltd. once again called into question the ability of independent securities firms to survive on funding provided by the capital markets. Jefferies Group Inc., which staved off a run on its own funding in the wake of MF Global’s collapse, agreed in November to combine with its largest shareholder to shore itself up against future market turmoil.

“The status quo represents an ongoing and significant financial-stability risk,” Rosengren said.

Basel Standards
U.S. and international regulators have an analytical approach that requires more capital for risks embedded in large bank holding companies. The Basel Committee on Banking Supervision has decided that systemically important global banks should bear a charge of 1 percent to 2.5 percent more capital to total assets weighted for risk based on their size, complexity and interconnectedness.

The Financial Stability Board in November listed 28 banks that should be subject to the requirement for additional capital. The list is updated annually and a phase-in period begins in 2016.

Global trading banks such as Citigroup Inc., JPMorgan Chase, HSBC Holdings Plc, and Deutsche Bank AG occupy the top tier in the group, bearing a charge of 2.5 percent. Barclays and BNP Paribas are in the second tier, with a charge of 2 percent; Goldman Sachs, Morgan Stanley, Bank of America Corp., Credit Suisse Group AG and four other banking groups are in the third tier, at 1.5 percent.

Stress Tests
In addition, the Fed determines capital adequacy through its stress tests which include a separate diagnostic for firms with large-scale trading operations.

The Fed tested the 19 largest banks this year against three different scenarios with 26 variables including exchange rates, incomes and interest rates. In addition, six bank holding companies with “significant trading activity” — Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley and Wells Fargo & Co. — had their portfolios stressed under conditions of a global market shock.

Rosengren said that securities-trading units should face higher capital requirements whether they are in a bank-holding company or not.

“Given the very different risks of runs posed by broker-dealers and their less stable liability structure, an argument can be made for higher capital requirements for broker-dealers as well as organizations, such as bank holding companies, with significant broker-dealer operations,” he said.

Rosengren, 55, became president of the Boston Fed in July 2007, and previously served in the economic and supervision departments of the bank.