BNY Mellon and State Street are at risk of failing to comply with the Basel III supplementary leverage ratio (SLR) requirements, and should retain higher levels of capital in order to ensure compliance, according to a report by Moody’s.
Of the eight systematically important US banks, BNY Mellon and State Street were identified as having low ratios, based on their balance sheets for the first half of this year.
BNY Mellon’s holding company ratio was estimated at 4.6 percent, and State Street’s was estimated at 5.1 percent. From 2018, the minimum ratio will be 6 percent.
According to the report, although State Street’s SLR surpassed the 5 percent mark, that of its lead bank was estimated at 4.9 percent. BNY Mellon declined to release its bank-level SLR, however the report suggested that its advanced and standardised tier one ratios are already meeting requirements.
Allen Tischler, senior vice president at Moody’s, said: "In large part, this compliance challenge for BNY Mellon and State Street is due primarily to elevated deposit levels because of low interest rates and to the high levels of liquidity deployed by central banks worldwide."
He added: "When rates rise, both banks expect significant deposit runoff, which will shrink their balance sheets and help them comply with the SLR."
The report suggested that if global interest rates do not rise over the next 12 to 18 months, these banks will have to start retaining significantly more capital in order to meet the requirements.
It said that BNY Mellon and State Street have thus far failed to take “aggressive action” towards meeting the requirements because there is an expectation of deposit outflow in a higher-rate environment.
Tischler said: "This stance may have been reasonable at the beginning of 2015, when the market expected the Federal Reserve to raise interest rates by mid-year, but no longer: Rates have yet to rise, and market forecasts for a rate hike continue to move farther into the future."
If rates do not rise, the banks will have to be more aggressive in managing their balance sheets, and could resort to issuing non-cumulative preferred stock or cutting back commitments on trading books.
The drop in return on capital could lead to more risk-taking in order to generate income and could, ultimately, have long-term negative effects.
However, a source close to State Street pointed out that the bank’s tier one equity capital ratio is, in fact, above the threshold anticipated under the new regulation.
The source also said: “No one actually knows yet what the common equity tier one requirement will be, because that won’t be set until the end of this year. The globally systemically important banks surcharge will be refreshed next year, and it won't be fully effective until 2019.”
A spokesperson for State Street said: “We’ve been having constructive conversations with clients on the challenges the industry is facing with excess deposits. Our clients face the challenge of selecting viable alternatives in the face of the same environmental factors that are causing excess deposits.”
“Depending on the client and their view of their liquidity needs and investment mandates, we have discussed the use of different outlets including sweeping deposits and using market repo facilities. We have also introduced a sophisticated tool that allows asset managers to stress test their liquidity, which can help them evaluate and potentially reduce their liquidity needs.”
BNY Mellon declined to comment.
