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G-SIB surcharge has banks thinking about systemic risk scores

As regulators elevate the importance of a systemic risk score, banks are increasingly interested in tweaking the formula.

The largest U.S. banks are challenging how the Federal Reserve calculates the scores, which determine capital surcharges for companies classified as global systemically important banks, or G-SIBs. The Fed uses a variety of data points — such as total assets, off-balance sheet exposures and reliance on short-term wholesale funding — to calculate a systemic risk score.

The scores determine banks' G-SIB surcharges, which are tacked on top of various regulatory capital ratios. Higher scores translate to higher capital ratio requirements, which can significantly drag on banks' returns.

In a February 2016 presentation, JPMorgan Chase & Co. detailed how the bank was able to lower its G-SIB surcharge to 3.5% from 4.5% a year earlier. The bank's surcharge has remained at 3.5%, but management is now lobbying for a formula change.

"If we are fundamentally reconsidering the construct of minimum capital levels, then all of the building blocks should be in play, including the G-SIB surcharge, to ensure they all hang together," CFO Marianne Lake said during the bank's first-quarter earnings call.

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Previously, regulators used G-SIB surcharges only for risk-based capital ratios such as common equity Tier 1 ratios. On April 11, the Federal Reserve proposed a rule that would use the G-SIB surcharge to calculate banks' enhanced supplementary leverage ratio, or eSLR. In contrast to risk-based capital ratios, leverage ratios are blunt measures that compare a bank's capital to all of its exposures regardless of risk. Regulators are also considering a stress capital buffer, which would incorporate the G-SIB surcharge in stress testing exercises. JPMorgan is not the only bank concerned about the increased usage of G-SIB surcharges.

"Now you've got that G-SIB buffer, so you're trying to figure out [how it fits] into the stress capital buffer and all that stuff," said Bank of America Corp. CEO Brian Moynihan on a July 16 earnings call. "And I think we need to keep having a dialogue with the industry and with the regulators to keep to getting a middle-of-the-road position here."

The Fed's proposal to revamp the eSLR has attracted comments from several industry leaders, including JPMorgan. In a June 25 comment letter, Lake called on regulators to eliminate the "gold-plating" of the G-SIB surcharge by U.S. regulators. An international group of regulators known as the Basel Committee developed the G-SIB surcharge and systemic risk scores, but the Federal Reserve wrote its own calculation of systemic risk scores that has resulted in higher surcharges.

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Other entities are lobbying the Fed to change its G-SIB calculations, such as the Bank Policy Institute, the new name for a lobbying group combining The Clearing House and the Financial Services Roundtable. Analysts from the industry group have argued that gold-plating puts U.S. banks at a competitive disadvantage relative to their European counterparts. They also point to new regulations passed since the development of the G-SIB surcharge, such as the liquidity coverage ratio, saying that other regulations that reduce systemic risk should translate to a lower G-SIB surcharge.

"A holistic assessment to the capital regime right now — after we went through a 10-year build-out phase — is warranted," said Sean Campbell, an economist with the Financial Services Forum who wrote a piece with researchers from The Clearing House.

The researchers said that because regulations developed after the G-SIB surcharge lower the level of systemic risk, regulators should adjust the surcharge calculation as well. Doing so would slash JPMorgan's G-SIB surcharge from 3.5% to 1.9%. Industry groups also point to statements by the Fed saying it would adjust the surcharge calculation to account for economic growth, something it has not yet done.

"Making sure we're not overcapitalizing the banking system and reducing lending is very important," said Francisco Covas, deputy head of research for The Clearing House. "There is significant literature that [banks are] pulling back on lending to small businesses."

The Federal Reserve seems unconvinced — at least for now. In April, Fed Chairman Jerome Powell said the regulator's G-SIB surcharge did represent a higher standard but suggested he was unconvinced that U.S. banks suffered a competitive disadvantage.

"Our expectations of the largest, most complex, systemically important firms are the highest," Powell said. "And they are going to remain very high. ... As you look around the world, U.S. banks are competing very, very successfully. They're very profitable."

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