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What new bank rules mean for you

By Claes Bell, CFA · Bankrate.com
Thursday, July 11, 2013
Posted: 6 pm ET

Hear that groaning sound? It's your bank figuring out how much new capital it has to raise under new rules approved this week by the Federal Reserve, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency.

Those rules, part of a broader international effort known as Basel III, will require banks to increase the amount of equity capital they have on their balance sheet relative to the amount of debt they have.

As with any company, lowering the amount of debt a bank is carrying ultimately lowers its chance of bankruptcy because smaller debt payments are easier for a bank to cover in times of trouble. Also, if a bank does go bankrupt, there will be more of an equity cushion to bear the brunt and make sure debt holders are made whole.

"This framework requires banking organizations to hold more and higher quality capital, which acts as a financial cushion to absorb losses, while reducing the incentive for firms to take excessive risks," Fed Chairman Ben Bernanke said in a statement. "With these revisions to our capital rules, banking organizations will be better able to withstand periods of financial stress, thus contributing to the overall health of the U.S. economy."

Considering that the financial crisis blasted a $19.2 trillion hole in Americans' household wealth, according to the Treasury, trying to prevent another one is a pretty big deal.

But that additional security comes at a substantial cost to banks and their shareholders. The higher capital requirements will reduce banks' ability to increase their earnings through leverage, a mainstay of the banking business, says Don Hutson, the national industry partner overseeing financial services for BKD, a national business accounting and advisory firm.

"They will not be able to leverage their balance sheet up as high," Hutson says. "Even if you earn the same amount of money, your return on investment is lower because you've got more at risk, and you've got more invested there."

Requiring banks to hold less debt relative to equity also will increase their tax burden because interest paid to debt holders is tax deductible, and that will be a big drag on the mostly larger banks that Basel III rules apply to, says Bert Ely, a banking consultant based in Alexandria, Va.

"The hidden, or not-so-hidden, agenda is to look upon capital as a tax, which it is because it's more costly due to corporate federal income tax, and basically use higher capital standards as a way to force the big guys to downsize by incenting them to drop those lines of business that cease to generate an adequate return on equity," Ely says.

While it's unlikely any bank customers will shed a tear for banks' diminished ability to earn profits, the new rules will likely make banks even more single-minded in their push to boost profits.

For customers of large banks, that's likely to show up in higher rates for consumer loans, higher fees and more aggressive cost-cutting through branch closures and staff cutbacks, Ely says.

"To the extent that banks are going to carry a higher capital level, they're going to have to generate the profits to earn a market rate of return on that equity in some fashion," Ely says.

Hudson says that if you bank at a community bank, you may be safe. Community banks got off a little easier than the bigs.

"The regulators came out early on and indicated that it was going to apply not only to the largest banks, which was the original attention of Basel III, it was also going to apply to all the other banks," Hutson says. "Some of those things that were creating such problems with the community banks are to be taken out, so the community banks ultimately got some relief with the final rules."

Hutson still expects the rules to affect community banks but to a lesser degree than with large banks.

"Ultimately, it will come down to how the regulators apply it to community banks, but I think everybody believes that it will ultimately require banks to retain more capital than they currently have," Hutson says.

Follow me on Twitter: @ClaesBell.

Senior banking reporter Claes Bell is a co-author of "Future Millionaires' Guidebook," an e-book written by Bankrate editors and reporters. It's available at all the major e-book retailers.

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