Capital Requirements To Dim Large Bank Dividends, Lead Smaller Banks To Shine?

Federal Reserve

Capital, capital everywhere — but, for big U.S. bank investors, the old Seinfeld punchline: “No dividends for you!”

The famed bank stress tests that have been in place for years and that get attention from Wall Street when it comes time to judge how sound the global financial system may be — or not — are getting a little more, well, stressful. For the bigger banks.

As reported earlier this week, the Federal Reserve is boosting capital requirements for the biggest U.S. banks as part of a new series of rules that take effect in 2018. These banks run the gamut of the biggest names in the business: everyone from Bank of America to Goldman Sachs to Wells Fargo (which has, well, other issues a bit nearer term.)

In remarks made by Fed Governor Daniel Tarullo, the overarching theme is that “financial regulation should be progressively more stringent for firms of greater importance, and thus potential risk, to the financial system.” In a nutshell, this means that these heavy-hitters are going to have to hold more capital on their books going forward, leaving the smaller players — those banks with less than $250 billion in assets on the balance sheet — with relatively less onerous requirements.

What’s the new wrinkle that is coming down the pike? The bigger capital requirements are going to be used in determining if banks, admittedly in rough economic scenarios, would have enough capital to buy back stock or pay dividends, which are both strategies that tend to attract investors.

Also, the Fed would look at activity such as selling off assets in order to maintain solvency (again, in economic rough sledding). What this means is that firms may have to become more conservative in the two aforementioned strategies that lure investors, which may send them toward the smaller players with growth prospects ahead of them.

Indeed, no less a Fed powerhouse than Janet Yellen, who helms the ship, told Congress on Wednesday (Sept. 28) that smaller banks should maybe get a pass on the Volcker Rule that limits compensation but, more importantly, investments, signaling that they might be able to put money to work in portfolios, lending and other activities that, in turn, can be used to reward investors should income accrue.

In banking, subtle shifts in policies that translate into growth — or limit it — can have magnified impact down the line, as, to quote famous bank robber Willie Sutton, investors will “go where the money is.”