U.S. Banks Rank High In Systemic Importance: OFR

A comparison of several of the largest U.S. banks with other global systemically important banks around the world reveals that the U.S. banks rank high on measures of systemic importance, notes OFR.

Office of Financial Research in its August 4, 2015 report titled: “A Comparison of U.S. and International Global Systemically Important Banks” highlights a potential weakness in the Basel Committee’s scoring methodology.

Basel’s systemic importance indicators and scores

According to the OFR report, the Basel Committee on Banking Supervision’s scoring methodology is intended to measure the threat to global financial stability that a G-SIB would pose if it were to fail. The report notes once adopted in a national jurisdiction, the result is a capital add-on intended to reflect these global threats.

The OFR report further highlights that the Federal Reserve Board recently adopted this methodology to determine which U.S. banks are G-SIBs. The report notes the final U.S. rule uses both the Basel Committee methodology (referred to as Method 1) and an alternative formula (referred to as Method 2), then uses the higher of the two surcharges as the add-on requirement. However, the report points out that Method 2 replaces some indicators with new metrics that are not yet publicly reported by banks.

The Basel Committee methodology for G-SIB designation uses 12 indicators of systemic importance, grouped into 5 major categories viz.: size, interconntectedness, substitutability, complexity and cross-jurisdictional activity.

The following table captures the systemic importance scores for the 30 G-SIBs which have been computed by applying the Basel Committee methodology to indicator values publicly disclosed by the banks on their websites:

The following graphs elucidate the overall scores can be grouped by region with cutoffs for the “bucket” to which each bank would be assigned under the methodology, based on the bank’s overall score.

Large U.S. banks rank high across multiple measures

According to the OFR report, of the G-SIBs with the top 10 scores, half are U.S. insti­tutions, including the highest-scoring bank. The report highlights that JPMorgan Chase & Co. (NYSE:JPM) tops the list of the 10 largest G-SIBs as measured by total expo­sures, which also includes Citigroup Inc. (NYSE:C) and Bank of America. However, when bank size is measured by reported total assets, JPMorgan Chase ranks sixth and no other U.S. bank makes the top 10:

As can be deduced from the above graph, the 10 G-SIBs that score highest on interconnectedness reflect the weighted sum of the banks’ scores for intra-fi­nancial system assets, intra-financial system liabilities and securities outstanding.

As set forth in the following graphs, the substitutability category is also largely dominated by U.S. banks, and American banks rank relatively high on complexity scores:

The OFR report highlights that the G-SIBs in the highest systemic importance bucket using 2013 data have lower Tier 1 risk-based capital ratios as of end-2014 than other G-SIBs:

Of note, the current Basel Committee methodology uses end-of-year exchange rates in the calculation of G-SIB scores, thereby creating a potential incentive for a bank to alter its activities near the end of the year in response to exchange rate movements to avoid moving up a bucket. The report suggests a simple alternative method that reduces this incentive by using the average exchange rate over the year or during the fourth quarter.

Although the final U.S. rule may mitigate the effects of exchange-rate fluctuations, the OFR report notes the fixed methodology under Method 2 will require periodic review to determine that the resulting scores and surcharges continue to appropriately address banks’ systemic importance.

See full study below.