19 Major Banks Face Tougher Capital Rule

By Binyamin Appelbaum
Washington Post Staff Writer
Friday, April 24, 2009

Federal banking regulators plan to announce a new, tougher standard for the capital reserves held by 19 large banks that could force some of those firms to sell ownership stakes to the federal government, according to people familiar with the matter.

Regulators have used the new standard in testing whether those banks -- almost all of which got government rescue money -- have enough capital to survive elevated losses. The Federal Reserve plans today to share the results of those "stress tests" with bank executives at meetings around the country.

Companies that fall short -- even those with enough capital under the traditional regulatory standard -- will be required to meet the new standard, said the sources, who spoke on condition of anonymity because the plan has not yet been announced. For banks that have trouble raising additional capital from private investors, the only available option could be a sale of common shares to the federal government. In some cases, the government would swap its preferred shares for common shares. Other companies might get additional federal money.

The standard for now applies solely to the 19 banks. In adopting it alongside the existing rule, regulators are bowing to criticism from investors that the government's standard has overstated the ability of companies to absorb losses. The new, narrower standard resembles a measure already used by those investors, known as tangible common equity, or TCE, which counts as capital only money raised from basic sources such as quarterly profits and the sale of common stock.

Investor skepticism has bedeviled the Treasury Department's efforts to infuse banks with new capital, because those investments qualified as capital only under the government's definition. Regulators have watched as investors fled banks such as Citigroup, which held plenty of regulatory capital but not enough TCE, pushing those banks to the brink of collapse and rendering obsolete the regulatory judgment that the banks were healthy.

Comptroller of the Currency John C. Dugan, who regulates national banks, said officials had accepted the need to address investor concerns.

"I don't think there's any doubt that there's a consensus that the quality of capital needs to be improved in terms of having more common tangible capital in institutions of all kinds," Dugan said. "Part of the reason measures didn't have the impact is because of this perception that it's not the same and it doesn't count as much."

Dugan declined to comment on what that new standard should be. Regulators measure the adequacy of bank reserves in several ways, but the most prominent measure, Tier 1 capital, requires banks to hold $6 in capital for every $100 in loans and other commitments. The money is intended to serve as a buffer against losses.

Regulators have long emphasized a preference for capital raised from the most basic sources, but they have never before articulated a specific standard. Most financial analysts regard $3 in tangible common equity for every $100 in assets as the minimum acceptable ratio.

The difference between the two standards has broadened over time as regulators have allowed banks to count the proceeds from the sale of various other financial instruments, and even the fruits of various bookkeeping techniques. Most recently, federal regulators agreed in the fall to broaden the definition to include the money that banks got from Treasury.

Many financial analysts instruct clients to ignore regulatory capital and focus instead on TCE. They consider this money a more stable and reliable reserve than capital from other sources, such as from the sale of preferred shares, which a bank might desire to repay, thereby depleting its capital.

Jim Leach, a former congressman from Iowa who chaired the House Financial Services Committee and now teaches at Princeton University, said that regulators erred in broadening the capital definition, and that a return to the narrower standard was overdue.

"The fact that we even have anything other than TCE is a reflection on judgment, which was deeply lacking," Leach said.

A minority of investors and analysts have sided with the government, arguing that the broader definition is more accurate.

But in recent months, the market has appeared to decide the issue. The final blow may have come last month, when Citigroup persuaded the government to convert its investment to common shares that would qualify the money as tangible common equity.

"The market really cares about TCE and it doesn't care about Tier 1," the government standard, said Robert P. Kelly, chief executive of the Bank of New York Mellon. He expressed support for an increased regulatory focus on the standard sought by investors.

Staff writers David Cho and Neil Irwin contributed to this report.

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