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U.K. banks are sitting on a $38 billion hole, according to the Bank of England. The regulator announced the shortfall today but did not say which banks were looking thin. The move to shore up reserves is driven by the fear of weakness in the European economy and a need for banks to hit the capital requirements of Basel III. By 2018, banks will need to meet a 7% capital ratio, and recent crackdowns have made that a harder target for banks to hit.

While not every bank is in dire need, the consensus is that both RBS and Lloyds are going to need to go back to the table. HSBC reportedly has one of the largest capital ratios, which was bolstered late last year when the company sold off its Ping An holding. In the middle sits Barclays , which has gone on record to say that it will work through 2013 to improve its capital position.

As the deadline for capital requirements approaches, investors need to watch out for banks that fall short. Raising capital will mean selling off valuable assets, diluting shareholder earnings through new offerings, or cutting back on dividends to retain extra capital.

Loops get closed
Earlier this month, the Basel Committee announced that it was going to treat insured risk differently, making it harder for banks to boost their capital by simply insuring against default. Up to this point, banks had been able to purchase protection for their risky assets, in effect making them less risky. While the premise is sound — and not nearly as close to the rererereinsured mortgage portfolios of 2008 as one might think — banks were abusing the practice. Shocker.

The problem was that banks could buy the insurance, but spread their premiums out over a long timeframe. That meant banks profited immediately on their capital requirements, but didn’t take on the risk of having to pay off the insurance for years. That deferral of risk is one of the things that central banks and regulators have been trying to fight, and Basel decided to crack down on the system.

To this point, banks from Citigroup to Goldman Sachs had been reportedly engaging in the practice to help their balance sheets. While those firms will still be able to insure their risk and add to their capital, they must now recognize the costs associated with that insurance upfront.

Sticky wicket
I know it’s not really like a sticky wicket, but come on. Banks in the U.K. have been fighting to meet these new requirements since their inception. Lloyds is now reported to need about 2.5 billion pounds in order to meet its goal, and the bank has begun selling off some of its holdings to increase its funds. Lloyds came under new public scrutiny this week when the bank confirmed that 25 of its employees had been paid over 1 million pounds in 2012. The drivers of the outcry …read more
Source: FULL ARTICLE at DailyFinance

By John Maxfield, The Motley Fool

Filed under: Investing

This is slightly esoteric, but nevertheless extremely important for bank investors to understand.

At the end of 2010, the Basel Committee on Banking Supervision, an international consortium of banking regulators, finalized an updated set of guidelines for determining how much capital banks should be required to hold relative to the size of their balance sheets.

Prior to the updated regulatory scheme, the largest banks in the United States were obligated to maintain a Tier 1 common capital ratio of 5% (relative to risk-weighted assets) under the Federal Reserve’s Comprehensive Capital Analysis and Review, or “CCAR” — the formal process used by the central bank to ensure that large bank holding companies have adequate capital and capital-management procedures in place.

Under Basel III, this minimum requirement increases dramatically. When fully phased in, Basel III requires bank holding companies to maintain a minimum ratio of Tier 1 common capital to risk-weighted assets of at least 7%, consisting of a minimum ratio of 4.5% plus a 2.5% “capital conservation buffer.” In addition, the Basel Committee has proposed a surcharge for systematically important financial institutions — i.e., too big to fail — of between 1% and 3.5%, depending on the nature of the underlying operation.

Here’s how the latter so-called “SIFI buffer” plays out for the largest U.S. banks:

Bank Holding Company	SIFI Buffer	Tier 1 Capital Requirement
Citigroup	2.5%	9.5%
JPMorgan Chase	2.5%	9.5%
Bank of America	1.5%	8.5%
Bank of New York Mellon	1.5%	8.5%
Goldman Sachs	1.5%	8.5%
Morgan Stanley	1.5%	8.5%
State Street	1%	8%
Wells Fargo	1%	8%

Source: Financial Stability Board’s “Update of group of global systematically important banks.”

As you can see, while global banks like Citigroup and JPMorgan were previously obligated to hold 5% in Tier 1 common capital relative to risk-weighted assets, they must now hold 9.5%, or nearly twice the previous amount. And even primarily domestic operations like B of A and Wells Fargo see their rates ratchet up by 1.5% and 1%, respectively. To make matters worse (at least from a bank’s perspective) the Basel Committee made the risk-weighting of assets a more exclusive process. The net effect is to increase the denominator in the capital equation, which puts downward pressure on the quotient — that is, the ratio itself. Taken together, banks will be much more limited in terms of leverage going forward.

To make this easier to visualize, I created the following chart, which compares how much Tier 1 common capital B of A is obligated to hold under the current rules relative to how much it holds under the Basel III guidelines.

Source: Bank of America’s 2012 10-K, page 73.

Under the current regulatory scheme, known as “Basel I,” the nation’s second largest bank by assets is obligated to hold a minimum of $60 billion …read more
Source: FULL ARTICLE at DailyFinance

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