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Fed pledges to get tough on Wall Street as adopts Basel rules

The Federal Reserve Building is seen in Washington June 25, 2008. REUTERS/Yuri Gripas
The Federal Reserve Building is seen in Washington June 25, 2008. REUTERS/Yuri Gripas

By Douwe Miedema

WASHINGTON (Reuters) - The U.S. Federal Reserve pledged to draft tough rules for Wall Street while shielding smaller banks from some of the harshest impact of the global Basel III capital rules it adopted on Tuesday.

The central bank voted in favor of the long-awaited U.S. version of the global rules that require banks to use more equity capital to fund their business, to make them more robust after the 2007-09 credit meltdown.

It provided some flexibility to benefit the housing recovery and smaller banks in its final rule, but said it would write four new rules in the coming months to address concerns about the risk the eight largest U.S. banks pose to the financial system.

"The headline here is (that) community banks are getting significant relief," said Allison Breault, an associate at law firm Cleary Gottlieb Steen & Hamilton in Brussels.

"The largest banking organizations are going to be subject to even stricter requirements than they had originally anticipated," she said.

The Basel III accord, named after the Swiss city that is home to its overseer, the Bank for International Settlements, was drawn up to make banks more stable in the wake of the worst financial crisis since the Great Depression.

The pact, which will be phased in starting next year, will force most banks to hold about three times as much top-quality capital as is required under existing rules, to reduce their risk and protect taxpayers from costly bailouts.

Analysts at Barclays said there were no major negative surprises in the rules, and the KBW Bank Index of bank stocks was up 0.6 percent in early afternoon trading in a market that was slightly weaker overall.

Nearly 95 percent of banks with more than $10 billion in total assets were already meeting the Fed's minimum requirement of 7 percent common equity tier 1 capital, with a modest total capital shortfall of $2.5 billion.

LITTLE TO CHEER

The final rule - which numbers 972 pages - drops a provision from the original proposal that would have forced banks to set aside more capital to fund their residential mortgage business.

"The mortgage industry ... fared incredibly well in the final Basel III rulemaking," said Isaac Boltansky, a policy analyst with Compass point Research and Trading, adding it was a "significant win" for the mortgage industry.

Small banks can also opt out of a costly requirement that would have forced them to adjust the value of securities in their trading book on a frequent basis.

But the largest firms did not get any notable carveouts.

"For the biggest banks, there is little to cheer," said Jaret Seiberg, a financial analyst at Guggenheim Partners, a financial services firm.

The Fed said it was drafting four new rules that would go beyond what the Basel accord called for, including a hard cap on how much banks can borrow to fund their business, known as a leverage ratio, and more capital surcharges.

There has been rising concern among U.S. politicians that the Basel pact, which still allows banks to measure risk using their own mathematical models, does not do enough to prevent a repeat from the most recent crisis.

The Fed appears to have taken some of that on board, as Daniel Tarullo, in charge of financial supervision at the Fed, said bank regulators are working on four new rules for the country's biggest banks in the coming months.

Much of the debate has focused on the leverage ratio, which does not take into account banks' risk-weightings and is set at 3 percent in Basel, which many critics of Basel say makes it an unambitious goal. Tarullo agreed.

"The Basel III leverage ratio seems to have been set too low to be an effective counterpart to the combination of risk-weighted capital measures that have been agreed internationally," he said.

SYSTEMICALLY IMPORTANT

U.S. bank regulators are also working on a rule to address risks in short-term wholesale funding, a rule on combined equity and long-term debt, and a capital surcharge for banks that pose a potential threat to the entire system.

These Systemically Important Financial Institutions (SIFI) are: JP Morgan; Citigroup; Bank of America; Wells Fargo; Goldman Sachs; Morgan Stanley; Bank of New York Mellon and State Street.

Two other U.S. bank regulators - the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation - also must approve the Basel rules, which they had proposed together with the Fed.

The OCC's head, Thomas Curry, said in a press release that he intends to sign the rule next week. The FDIC has scheduled a meeting for July 9, and will be the first to put out a proposed rule for a bank leverage ratio.

The FDIC's second-in-command, Tom Hoenig, is an outspoken critic of Basel III, which he says allows lenders to appear well-capitalized when they are not.

He has said the rules are flawed because they give the banks latitude to use complicated measurements of how risky their loans are to determine the capital they must hold.

The Fed's final rule made no major changes to the timeline with which the Basel rules will be introduced compared to the proposed rule, nor to the minimum capital that banks need to hold as a percentage of their total assets.

(Additional reporting by Margaret Chadbourn, Peter Rudegeair and David Henry; editing by Karey Van Hall, Chizu Nomiyama, G Crosse)

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