Strengthening Our Financial System
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Strengthening Our Financial System Presentation Transcript

  • 1. Strengthening Our Financial SystemD E CE MB E R 2 0 1 2
  • 2. IntroductionOur financial system is fundamentally stronger than it was four years ago, when we endured the worstfinancial crisis since the Great Depression. Our banks have added more than $440 billion of fresh capital,putting them on firmer footing to support lending to consumers and businesses. Our financial institutionstoday are also significantly less reliant on short-term financing from private investors, who fled during thecrisis at the first signs of market stress.Even as policymakers took the necessary steps to stabilize our financial system, they also recognized theprecedent those actions might set. So they put in place a series of measures to help eliminate the perceptionthat any institution is too big to fail and avoid a repeat of the Fall of 2008.Regulators face new limitations on emergency authorities employed during the crisis. The Federal Reserve canno longer provide direct support to individual institutions, as it did with AIG. And the Federal DepositInsurance Corporation’s authority to guarantee the financing of bank holding companies was curtailed.Meanwhile, Wall Street Reform gave regulators new legal powers to facilitate the orderly wind down of large,failing financial firms. If the government is forced to step in, equity holders will be wiped out, managementwill be replaced, and the institution will be dismantled. That way, taxpayers will never again have to bear thecost of financial firms’ mistakes.To be sure, our banking system has grown more consolidated in the aftermath of the financial crisis – a trendthat has been taking hold over the last few decades. Yet, compared to its peers, the United States has the leastconcentrated banking system of any major advanced economy – and one of the smallest banking systemsrelative to the size of its economy.Some early evidence also suggests that we are making progress addressing the perception that institutions canstill be “too-big-to-fail” in the post-crisis marketplace. For example, investors are increasingly distinguishingbetween financial institutions, as measured by a wider variance in credit default swap spreads among thelargest banks. Bank borrowing costs have also increased significantly for the largest, most complexinstitutions.We still have more work to do, but all of this is welcome news for those of us who want a safer, fairer andstronger financial system. 1
  • 3. Stronger Balance Sheets A SAFER FINANCIAL SYSTEM U.S. banks have nearly doubled their capital levels since the lows during the financial crisis in order to cushion against unexpected losses, while supporting lending and economic growth. Meanwhile, banks have almost cut in half their dependence on short-term financing, establishing a more stable funding base. Tier 1 Capital Ratios and Short-term Funding for the U.S. Banking IndustryINDEX (2007 Q1 = 100)150 150 U.S. banks have added more than $440 billion 2007 Q1 since the crisis. Tier 1 Common Capital Ratio100 100 Short-term Funding Ratio 50 50 U.S. banks have reduced short-term financing by more than $560 billion since the crisis. 0 0 2001 02 03 04 05 06 07 08 09 10 11 12 Q1 SOURCE: FEDERAL RESERVE (Y-9C, FLOW OF FUNDS), HAVER ANALYTICS, TREASURY/FSOC ANALYSIS. 2
  • 4. Bolstering Bank Capital I A SAFER FINANCIAL SYSTEMTougher new capital standards would require more loss-absorbing capital and, in effect, wouldnearly double the amount of capital all banks are required to hold.TIER 1 CAPITAL, AS A PERCENT OF RISK-WEIGHTED ASSETS TOTAL TIER 1 EQUIVALENT 11% TOTAL TIER 1 2% 8.5% TOTAL TIER 1 1.5% 6%Add’l ADJUSTED FOR Common ~2% MORE STRINGENT EquityTier 1 Common CRITERIA UNDER Equity BASEL III*** 9% Common 7%** Equity ~4%* Pre-2010 Capital Requirements Stronger Capital Requirements Stronger Capital Requirements Under Basel I Under Basel III Using Basel III Risk Weights U.S. regulators have proposed more Basel I required that for banks to be Basel III would require banks to hold stringent risk-weights, which would require “well-capitalized,” they had to set aside more Tier 1 capital overall, and more of banks to hold more capital against their a preponderance of their Tier 1 capital that capital in the form of common assets. Combined with the heightened Basel in the form of common equity, which equity. III standards, banks would, in effect, nearly more effectively absorbs losses. double the amount of capital they hold.* FOR ILLUSTRATIVE PURPOSES. THE 2009 SUPERVISORY CAPITAL ASSESSMENT PROGRAM (SCAP) STRESS TEST REQUIRED COVERED FIRMS TO MEET A QUANTITATIVE 4PERCENT TIER 1 COMMON CAPITAL RATIO. PREVIOUSLY, REGULATIONS REQUIRED THAT FIRMS’ TIER 1 CAPITAL BE PREDOMINANTLY MADE OF COMMON EQUITY, BUT DID NOTSPECIFY REQUIRED LEVELS. ** INCLUDES BOTH A 4.5% MINIMUM AND A 2.5% CAPITAL CONSERVATION BUFFER. *** INCLUDING BOTH CHANGES IN RISK-WEIGHTS ANDINCREASED DEDUCTIONS. THE ADJUSTMENT FOR RISK WEIGHTED ASSETS REFLECTS THE AVERAGE OF DISCLOSED BASEL I AND BASEL III RISK WEIGHTED ASSETS FOR BANKOF AMERICA, WELLS FARGO, CITIGROUP AND JPMORGAN AS OF SEPTEMBER 2012. OTHER BANKS MAY SEE DIFFERENT CHANGES.SOURCE: COMPANY FILINGS AND TREASURY ANALYSIS. 3
  • 5. Bolstering Bank Capital II A SAFERFINANCIAL SYSTEM On top of the more-stringent Basel III 2012 Bank Capital Standards requirements, the largest internationally-active Tier 1 Common Stock, as a Percent of Risk-Weighted Assets banks must hold an additional capital cushion so that they can: Potential common equity 1% o Better withstand financial stress. surcharge on banks that expand o Bear the costs of the risks they create. o Allow smaller banks that pose less risk to Common equity surcharge on 1% - 2.5% compete on a more level playing field. size and complexity Additional capital surcharges discourage banks from becoming big and complex in the first place. o Large banks will face a surcharge of between 1 percent and 2.5 percent based on their size and complexity. Common Common o To curb further growth, large banks could Equity Equity face an additional 1 percent surcharge if 7% 7% they increase in size and complexity. Going forward, banks around the world will also be required to adhere to a new international leverage ratio that: o Sets a floor on the amount of capital a bank must hold against all of its assets, Minimum Requirements Minimum Requirements regardless of their risk. for All Banks for Global Systemically o Brings overseas firms more in line with a Under Basel III Important Banks tougher leverage ratio that has long been applied to U.S. banks. 4
  • 6. Ruling Out Extraordinary Support A SAFER FINANCIAL SYSTEMTo help end the perception of “too-big-to-fail,” new rules have significantly curtailed oreliminated many of the powers used to stabilize the financial system during the crisis… Changes underProgram Description Regulatory Reform Guaranteed more than $3 trillion of money TARP legislation prohibits use of the ESF for market mutual fund shares when faced with the establishment of any future guaranteeMoney Market Fund Guarantee Program a broad-based run; guarantee backed by programs for the United States money market Exchange Stabilization Fund (ESF). mutual fund industry. Dodd-Frank prohibits §13(3) lending to Provided liquidity facilities for both specific insolvent borrowers and requires “broad-Federal Reserve Act §13(3) lending institutions (e.g., AIG, Bear Stearns) and based” program eligibility. A program financing markets (e.g., CPFF, TALF). structured for a single and specific company is prohibited. Open bank assistance and guarantees not Provided open bank assistance, including permitted except for widely-available guarantee the use of federal guarantees on asset poolsFDIC Systemic Risk Determination programs pursuant to “Liquidity Event and bank debt to support term unsecured Determination,” which require joint resolution of financing. approval by Congress.… and many of the key crisis response programs are being wound down.Program Description Expiration Up to $700 billion troubled asset purchaseTroubled Asset Relief Program (TARP) TARP purchase authority terminated in 2010. authority to support financial system. Provided authority to purchase GSE HERA purchase authority terminated at endHousing and Economic Recovery Act (HERA) obligations and securities to support GSEs of 2009. and the housing market. Provided federal guarantees on nearly $350 TLGP guarantees on bank debt will expire atFDIC Bank Debt Guarantee Program (TLGP) billion of bank debt to support term the end of 2012. unsecured financing during the crisis. 5
  • 7. New Tools to Mitigate Financial Threats A SAFERFINANCIAL SYSTEMMeanwhile, Wall Street Reform gave regulators new powers to support financial stability, so thattaxpayers do not bear the burden of the firms’ mistakes. Pre-Crisis Post-Wall Street Reform Banks were required to effectively meet a Tier 1 Today, the largest, most complex banks and designated capital standard of 6% of their risk-weighted nonbanks will be required to hold up to 9.5% of their risk-Capital assets, without a clearly-defined amount of weighted assets in the form of higher-quality Tier 1 common higher-quality common equity. equity.M&A Limits In addition, no financial firm can grow through acquisition in 10% nationwide deposit limit.on Size excess of 10% of all financial firm liabilities. Ability to subject any nonbank financial firm whose failureSupervision of Voluntary SEC program for supervising securities could pose a threat to U.S. financial stability to enhancedNonbanks firms on a consolidated basis. supervision. Lending limits for banks (not including derivative Exposure limits on largest bank holding companies andCounterparty Limits exposures). designated nonbanks across all types of exposures.Securities Activity Volcker Rule prohibits proprietary trading by banks and their Limits only on certain holdings of banks.Limits affiliates. Mandatory central clearing, exchange trading and trade A largely unregulated derivatives market lacked reporting improve transparency and risk management. NewDerivatives transparency and posed significant risk capital and margin requirements makes derivatives trading management challenges for firms and regulators. safer. Firms must submit living wills documenting how they will beResolution wound down without leaving taxpayers on the hook. Limited ability to wind down systemicallyAuthority and Living important financial institutions. Regulators have new authorities to wind down systemically important financial institutions without putting the economyWills or taxpayers at risk. 6
  • 8. CONCENTRATION IN CONTEXT A Consolidating Banking Industry IThe U.S. banking industry has been consolidating at roughly the same pace over the last fewdecades, even after factoring in that several large banks acquired weaker competitors duringthe financial crisis. Total Assets of the Four LargestPERCENT OF U.S. Depository Institutions TRILLIONS OFINDUSTRY ASSETS U.S. DOLLARS45% 41% 7 The financial crisis did not significantly affect the long-term pace of bank consolidation. 6 $5.7T 530% Assets as a 4 21% Share of the Industry (left axis) 315% 12% $1.6T 2 $0.6T 1 Assets in Dollars 2001 2007-09 (right axis) RECESSION RECESSION 0% - 1994 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11SOURCE: SNL FINANCIAL, FEDERAL RESERVE, FDIC, IMF, BANKSCOPE, EUROSTAT, Y-9 BHC. 7
  • 9. CONCENTRATION IN CONTEXT A Consolidating Banking Industry II However, the United States is among the least concentrated banking system of any major economy and among the smallest banking system relative to the size of its economy. Bank Concentration, 2011* 100% Sweden Netherlands Belgium Switzerland SwitzerlandTOP 4 BANKS AS A PERCENT OF TOTAL 80% Italy Canada Germany France BANKING ASSETS 60% U.K. Japan 40% U.S. 20% 0% 0% 100% 200% 300% 400% 500% TOP 4 BANKS AS A PERCENT OF GDP * NOTE: THESE NUMBERS REFLECT LOCAL ACCOUNTING CONVENTIONS (E.G., U.S. GAAP, IFRS) AND THEREFORE MAY NOT BE DIRECTLY COMPARABLE. SOURCE: SNL FINANCIAL, FEDERAL RESERVE, FDIC, IMF, BANKSCOPE, Y-9 BHC. 8
  • 10. CONCENTRATION IN CONTEXT Credit Sources in International ContextThe United States has a diversified financial system that is less dependent on banks as a sourceof credit than in many other countries. Here, markets play a much larger role, which meansbusinesses and families are less reliant on large institutions to provide financing. Where Does Credit Come From in Different Countries? 0% 10% 25% 22% 32% 14% Euro U.S. 6% Zone U.K. 59% 13% 11% 76% 32% Bank Loans The U.K. and the In the U.S., banks Euro Zone are far provide only a more dependent on quarter of the Capital Markets their banks for credit, with the credit. rest coming from Money Market Funds outside the banking system. Corporate BondsSOURCE: TREASURY ANALYSIS AND JPMORGAN. 9
  • 11. MARKET RESPONSE Distinguishing Financial Firms I If investors still perceived large banks as “too-big-to-fail,” we would expect to see persistently low credit spreads with little variation between firms. But in the aftermath of the crisis, investors are increasingly distinguishing between financial institutions, as measured by a wider variance in their credit default swap (CDS) spreads that markets use to assess credit risk. Large U.S. Bank 5-Year CDS Spreads 1100 1000 900 Large bank stress5-YEAR CDS SPREAD (BPS) 500 test results Lehman Bros. bankruptcy Greek, Irish, and 400 Portuguese AVERAGE spreads spike 300 RANGE BETWEEN 200 MIN & MAX 100 0 Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10 Jan 11 Jan 12 PRE-CRISIS POST-CRISIS Before the crisis, there was little differentiation between the After the crisis, there was significant differentiation between CDS spreads of large financial firms and low responsiveness the CDS spreads of large financial firms and higher to external events. responsiveness to external events. NOTE: INCLUDES BANK OF AMERICA, CITIGROUP, GOLDMAN SACHS, JPMORGAN, MORGAN STANLEY, WELLS FARGO. SOURCE: BLOOMBERG. 10
  • 12. MARKET RESPONSE Distinguishing Financial Firms IIIf investors perceived large banks as “too-big-to-fail,” we would expect their borrowing costs tobe low and vary little by the size of the institution or its activities. That was the case before thecrisis. But today, bank borrowing costs have increased significantly for the largest, mostcomplex institutions. Large and Regional U.S. Bank Five-Year Funding Spreads 230 In the wake of the financial crisis, borrowing costs for large banks have risen far more than for smaller, regional banks. 170 2012 AVG 140 140 2012 AVG 110 110 +84 bps 100 +23 bps 85 85 2006 AVG 73 75 75 69 70 61 62 60 63 2006 AVG 55 57 Pre-crisis (June 2006)Bank of Citigroup Goldman JPMorgan Morgan Wells Fargo Fifth Third PNC KeyCorp SunTrustAmerica Sachs Stanley Post-crisis (September 2012) LARGE BANKS REGIONAL BANKSSOURCE: BLOOMBERG AND TREASURY DEPARTMENT ANALYSIS. 11