U.S. Banks Say Soaring Dollar Puts Them at Disadvantage - WSJ

Feb. 8, 2015 7:37 p.m. ET

WASHINGTON—The strengthening U.S. dollar is rippling through the financial system in unexpected ways, revealing what bankers say is a hidden flaw in a Federal Reserve proposal to increase capital cushions at the nation’s largest banks.

Big U.S. banks say that, under the rule proposed in December, the recent steep rise in the dollar’s value would force some U.S. firms to hold billions of dollars more in capital than foreign competitors, including weaker European banks, because of how the Fed plans to calculate a so-called surcharge levied on the eight most systemically important U.S. banks.

The Fed rule is aimed at forcing big banks to add extra layers of financing to protect against losses. The banks believe it would wind up penalizing U.S. banks if the dollar remains strong against the euro, as many economists expect, because the high exchange rate makes their dollar-denominated assets and operations look larger relative to their European peers.

Officials from banks including Citigroup Inc., Goldman Sachs Group Inc., Bank of America Corp. and Morgan Stanley met privately with Fed officials in January to discuss the threat and other concerns about the rule, according to people who attended. The banks plan to file an official comment letter later this month detailing those concerns and seeking changes to how the proposal calculates the extra capital required.

The currency’s potential impact on big U.S. banks is the latest example of how a strengthening dollar is affecting the U.S. economy. The strong dollar is hitting the profits and sales of a wide swath of corporate America, including firms that expanded overseas aggressively, like consumer-products giant Procter & Gamble Co. and pharmaceuticals company Pfizer Inc., but are now finding that sales abroad are suffering or not keeping up with dollar-based costs. The impact has weighed on U.S. stocks and raised worries about the health of the U.S. economy.

U.S. banks say the currency volatility exposes underlying problems with the Fed’s proposal, which is aimed at forcing banks to shrink by putting a price on bigness but ties their capital requirements in part to forces beyond their control. Banks have already expressed concern that the Fed’s surcharge proposal is tougher than what European regulators are expected to require.

“It was curious that the Fed, in proposing a new surcharge for U.S. banks, that they would choose to in effect double down on an arguably flawed methodology, especially one that would cause a U.S. bank’s surcharge to increase merely because of the dollar strengthening,” said John Gerspach, chief financial officer of Citigroup, on a Jan. 23 conference call with investors. He said the dollar’s rise against the euro likely meant the bank would face a higher surcharge than many expected when the Fed released its proposal.

In a speech on Jan. 30, Fed governor Daniel Tarullo defended the rule, saying it “should provide substantial net economic benefits by reducing the risks of destabilizing failures of very large banking organizations.”

Fed officials have asked banks and others to detail how the rule should be changed during the comment period, which ends Feb. 28. The proposed rule would phase in starting in 2016 and take full effect in 2019.

The surcharge levies an extra capital charge scaled to a firm’s size, complexity, share of the banking market and how heavily it relies on volatile short-term funding, such as overnight loans. Each bank’s score is based on how the firm stacks up against a pool of 74 other global banks in these categories. Banks must meet the requirement by funding themselves with less borrowed money and more common equity, which tends to reduce a firm’s return on equity, an important profitability measure.

The Fed proposal goes beyond an international standard agreed to by global regulators, roughly doubling the surcharge for the big U.S. banks. Banks would fall into capital “buckets” ranging from 1% and 4.5% of risk-weighted assets—though the top of the range could move higher. That comes on top of a base 7% common-equity capital requirement most banks already face.

Steven Chubak, an analyst with Nomura Holdings Inc., said banks like J.P. Morgan Chase & Co., Citigroup and Bank of America Corp. face the biggest impact and might be pushed to hold hundreds of millions of dollars more in capital each because of the currency fluctuations. The greater amounts of capital relative to their earnings would potentially decrease the banks’ value by about 3% each, he said.

“It could result in some unintended consequences,” Mr. Chubak said. “Twelve months ago, I don’t think anybody anticipated this particular issue arising.”

Big bank financial chiefs raised concerns about the rule during a Jan. 7 meeting with Mr. Tarullo and two Fed staffers, according to people familiar with the gathering and a disclosure on the Fed’s website, posted after inquiries from The Wall Street Journal. Mr. Tarullo meets with the bankers two or three times a year to discuss a variety of issues, these people said, and at this meeting the bankers aired their concerns.

Mr. Tarullo excused himself from that part of the discussion “because the discussion was turning to a pending rule making,” a Fed spokesman said. But the Fed staffers who heard the complaints suggested that the banks include the concerns in an official comment letter, which will be public, people involved in the session said.

At the meeting were Citigroup’s Mr. Gerspach as well as Goldman Sachs’s Harvey Schwartz, Morgan Stanley’s Ruth Porat, Bank of America’s Bruce Thompson and State Street Corp.’s Michael Bell. All are CFOs at their firms. Representatives for the banks either declined to comment or didn’t respond to requests for comment.

As they analyzed the details of the Fed proposal, bankers realized the unexpected role of currency rates. The Fed rule relies on financial data compiled by the Basel Committee that is expressed in euros, which enables regulators to compare U.S. banks with their foreign competitors using just one currency. Under the Fed rule, the data are converted to dollars using a spot exchange rate provided by Basel.

The problem is that the dollar’s rise made the asset bases and operations of the U.S. banks look larger relative to their European and Asian peers.

“I think we’d probably all sit around the table and say, ‘It seems like a slightly strange outcome that financial institutions in the slower growth part of the world would end up with lower capital and those in the faster growing part of the world would end up with more capital,’” Mr. Schwartz of Goldman Sachs said during a Jan. 29 investor call.

“I think there’s probably a lot of ways this issue could be thoughtfully addressed,” Mr. Schwartz said of the currency problem.

Write to Victoria McGrane at victoria.mcgrane@wsj.com, James Sterngold at james.sterngold@wsj.com and Ryan Tracy at ryan.tracy@wsj.com

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