Aftermath of Financial Crisis for the Big-6 U.S. Banks: Basel III Proposals on Credit Derivatives, Effects and Reactions

Abstract

In the wake of the 2008 financial crisis, bank regulators are paying more attention to derivatives. In a move that can be seen as a step away from fair-value accounting, bank regulators (Basel III) have proposed to calculate bank leverage ratios using notional values, rather than fair values, of written credit derivatives. In addition to changing the calculation of regulatory ratios, the proposed changes will also improve bank disclosure of exposure to credit derivatives. This study investigates the effect of the proposed changes on the leverage ratios of the six largest U.S. banks, five of which currently disclose information to calculate the proposed leverage ratios. Wells Fargo and JPMorgan are least affected by the proposed changes. Goldman Sachs and Bank of America suffer a 1 to 1.4 percentage point decline in leverage ratio, while Morgan Stanley suffers a 2.4 percentage-point decline to below the critical 5% threshold. Citigroup does not currently provide the necessary disclosures. We also examine the reaction of the six banks, in the form of comment letters, to the proposed changes. While the letters were apparently coordinated, the Wells Fargo and JP Morgan letters carry the most positive (or least negative) tone, consistent with our expectations.