HSBC (HBC) CEO MichaelGeoghegan told the Financial Times that he expects international regulators will eventually require banks to have Tier One capital ratios of about 10%.
That’s significantly higher than the 8% target now going the rounds in conversations among regulators and bankers.
If Geoghegan is right, it means banks are going to have to raise a truckload of capital. And of the hardest to raise kind of capital at that.
If you’ve been worried that new rules will require banks to keep more capital in their vaults and that this would reduce their profitability going forward even after the recovery, then this is the stuff of your nightmares.
Raising Tier One Capital isn’t easy. You can’t just go out and borrow the cash you need to get your bank’s capital ratio back into regulators’ good graces. That’s because most kinds of borrowed cash don’t count as Tier One capital. The only things that do count are common stock, disclosed reserves and retained earnings, and non-redeemable non-cumulative preferred stock.
So raising the bar on Tier One capital has a triple effect. It reduces bank leverage. Under a 8% rule, a bank could lend out $92 out of every $100. Under a 10% rule that would drop to $90 out of every $100.
It reduces bank stock dividends. Since retained earnings count as Tier One capital, banks will have an incentive to cut back on how much of their earnings they distribute as dividends.
And finally, it dilutes shareholders. If you owned shares in a bank that needed to issue new stock, your percentaqge ownership of that bank–and of things like its dividend stream–would fall proportionately to the amount of new stock sold to other investors. Let’s say you owned 100 shares of a bank with 1,000 shares outstanding. That means you own 10% of the bank. If the bank has to sell 100 new shares to raise Tier One capital, your 100 shares would represent only 9% of the bank post the share offering.
Banks are already on the lobbying warpath arguing that requiring them to keep higher reserves at a time when the global economy needs them to be doing more lending will jeopardize the recovery. So far that argument hasn’t made much headway among regulators who are almost as interested in restoring their public image as they are with the global economy.
I think the 8% figure will stick. But Geoghegan has raised the possibility that the outcome could be worse than anyone expects. I don’t think 8%, let alone 10%, is priced into bank stocks right now.
Just for the record HSBC is among the best capitalized banks in the world with a Tier One capital ratio of 8.8%. The bank did have to raise $19 billion from shareholders in a rights offering in April to get to that ratio.